PENSIONS, TIMES ARE CHANGING

Landscape

The changes to pension regulations which allow those who are not in a defined benefit (DB) schemes to withdraw as much as they like from their pension pot, as opposed to purchasing an annuity, has received extensive coverage.

A less well-publicised change in the pension landscape is the revised methodology for calculating the Pension Protection Fund  Levy (PPF Levy ) for companies that have introduced asset back funding partnerships (ABFP) as a means to reduced deficits in their defined benefit schemes.

Asset Backed Funding Partnerships

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ABFP’s involve the securitisation of an asset, to create a regular income stream over a specified period of time. The trustees invest in the ABFP which becomes a pension scheme asset. Subject to certain exceptions, not more than 5% of the current market value of scheme assets may be invested in Employer Related Investments (ERI) at any time. To get round the ERI constraints the assets are held within a Scottish Limited Partnership (SLP) which is a separate legal entity from its partners and therefore does not constitute self-investment.

The business assets which have been used in ABFP’s include property, inventories, and receivables and intangible assets, such as brands. Intangible assets are often not on the company’s balance sheet, as they have been organically created by the company over many years. The employer contributes the asset to the SLP, which then “rents” it back to the employer for ongoing use within its business for a fee. These fees provide a profit stream to the SLP from which a profit distribution is paid to the pension scheme.In the event of default the Trustees will exercise “step in” rights which enable them to realise the asset.

The investment in the SLP is normally valued within the pension scheme accounts as the discounted value of the future cash flows to be received from the SLP.The value of the investment in the SLP reduces the pension scheme deficit and effectively enables the employer to make payments to reduce the schemes deficit over a longer time frame than would otherwise be required by the Pensions Regulator, thereby releasing funds to be used within the business.

ABFP’s have provided a valuable tool for companies facing growing pension deficits which have resulted from the increase in pension liabilities on the back of low interest rates and bond yields, and increased life expectancy. An additional benefit of ABFP’s is that that they reduce the annual Pension Protection Fund (PPF) Levy.

The PPF

The Pensions Regulator has accepted ABFP’s as long as they are valued robustly following specific rules that meet the guidance criteria. However, the PPF has changed the rules under which employers can claim a reduction for investments in ABFP’s for the calculation of the PPF levy with effect from March 31st 2015. The new rules are more onerous for scheme trustees and will in most cases result in an increase in the PPF levy, which is paid by the employer.

The PPF levy comprises two components – the scheme based levy (SBL) which is paid by all DB schemes based on their total pension liabilities and – the risk based levy (RBL) which is paid by DB schemes which have a deficit. The RBL is based on the net pension liabilities which would be assumed by the PPF in the event that the employer becomes insolvent. The RBL also takes into account the specific risk of the employer becoming insolvent based on a scoring system developed by Experian.

The Pensions Regulator has categorised ABFP’s as Asset Backed Contribution (ABC) arrangements.The PPF have advised that since the assets used in ABC arrangements are typically used in an employer’s business it is inappropriate to consider the “going concern” value of the ABC arrangement, when the employer has itself suffered an insolvency event.  The PPF consider that the investment is in an ABC arrangement is inherently more risky than other plan assets in an insolvency context. Consequently, the PPF have advised that the value of the investment in the SLP in the schemes accounts must initially be deducted from plan assets for the purpose of calculating the RBL.

To get credit for the ABC arrangement, the Trust must certify its value under the assumption that the employer has suffered an insolvency event. The Trustees must obtain an annual valuation from a qualified valuer to determine the likely value that would be realised by the Trustees when the secured asset is sold subsequent to the employer becoming insolvent.

Valuers must assess not only insolvency scenarios such as administration or receivership where the assets are kept in good condition and the business may be sold as a going concern, but also scenarios such as liquidation where a fundamental business breakdown means that assets are realised at greatly reduced prices, particularly intangible assets such as brands.

Stuart Whitwell
Stuart Whitwell

Valuers must consider whether the secured asset can be realistically separated from the rest of the company’s assets and still realise significant value, as well as consider the practical issues for the Trustee to  realise the secured asset, whilst a receiver, administrator or liquidator is disposing of the remaining business assets.  This may be a significant issue when the secured assets are brands or specialised real estate. Where the secured assets are assumed to be inseparable and therefore sold with the remaining business assets to a single purchaser, the valuer must consider how the realisable value would be allocated.

The PPF expect the valuer to consider the likely dividend payable to unsecured creditors on insolvency, which means that the valuer must assess the realisable value of the remaining business assets and the amount of secured and unsecured creditors.

The PPF also require the valuer to probability weigh the type of insolvency event the company is likely to enter, given the nature of the business, the assets and liabilities of the company at the time of the valuation and the charges secured against the company’s assets as well as the impact of being part of a wider group if this is the case.

The valuer also has a strong duty of care to the PPF and they have to acknowledge that the PPF will be relying upon their valuation to reduce the company’s annual levy to the fund.

Does this make sense?

In our opinion, yes.  The purpose of the RBL is reflect the risk of a DB scheme entering the PPF in the event that that an employer has become insolvent. The scale of the net liabilities that would become the responsibility of the PPF must be determined.  It is both fair and reasonable that the value attributed to an ABC arrangement for the purposes of calculating the RBL can be realised in practice.

This is especially true when we are considering an insolvency event where administrators and liquidators will be in charge of the company’s assets with an obligation to realise the best value outcome for secured and unsecured creditors, but the trustees have the right to step in and sell the secured assets from under the insolvency practitioner’s nose.  Can they work together; is it in both parties’ best interests to do so and why?And if not, what would be the consequences?

It is in the interests of the tax payer that these schemes and arrangements are real and genuine and truly reduce risk.

Stuart Whitwell is Joint Managing Director at Intangible Business

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