The PSI score dropped by 11% in March 2020 to a low point of 81, wiping out half of the growth made since the 2007/8 financial crisis. The sharp drop in the PSI score reflects the shock to the global economy. The market volatility earlier this year had a significant impact on companies’ and their pension schemes’ ability to support their employees’ and members’ retirement benefits. This was driven by pension liabilities soaring, as a function of the falling gilts yields, and substantial falls to the value of pension scheme assets due to adverse market movements. As the lockdown eased and consumer confidence picked up, the PSI score bounced back in June 2020, albeit not to pre-COVID-19 levels. Given the ongoing disruption, the recently announced (at time of publication) second lockdown and the US election outcome, it remains uncertain how the PSI will move over the rest of the year.
During the first lockdown, although most industries have suffered greatly as consumers are less mobile and have less disposable income, some industries have stayed relatively stable or even improved their scores during the crisis. This could potentially be replicated to an extent over the coming months given the second lockdown announced on Sunday 1 November.
Unsurprisingly, the PSI score for the consumer discretionary sector (which includes, travel and leisure, retail) has declined materially in March 2020. The retail sector in particular has faced many challenges in recent years. As a result we have seen an increasing number of cases where Company Voluntary Arrangements (CVAs) are being used as a tool to restructure the liabilities of troubled businesses.
Although pension schemes are often not the target when liabilities are compromised as part of CVAs, schemes are nonetheless impacted because they often have a large share of the vote in CVAs. This means that pension schemes can often be one of the key decision makers as to whether the CVA progresses or not.
It is worth considering the impact that these restructuring options may have on schemes. Companies subject to CVAs are quite often in a distressed state and so may have limited or reduced ability to support their pensions schemes. In addition, pension schemes may also have direct or indirect holdings in retail/travel and leisure businesses as part of their asset mix, thus making them susceptible to fluctuations in the value of these businesses. This may result in an increased and potentially more volatile deficit.
Meanwhile, technology and telecommunications companies have demonstrated resilience in their PSI scores during the pandemic. This is likely to be supported by a greater proportion of people working from home and therefore having a greater dependence on companies operating in the technology and telecoms sector.
TPR has made it increasingly clear in recent years that it expects pension trustees to act more like lenders. It expects pension trustees to gain a seat at the negotiating table (particularly in situations involving a transaction or a restructuring of the employer) with other stakeholders in order to ensure that members’ benefits are properly protected.
However, this is not always straightforward in practice, particularly during a global health crisis where the viability of many businesses is at risk, and where trustees often have to consider the trade-off between ensuring support for the scheme whilst maintaining covenant strength over the medium to longer term.
While trustees often have powers (for example, to call early valuations or maybe even to amend contribution rates) they will need to tread carefully in ensuring that the business remains viable, particularly at a time where other stakeholders, such as lenders, may have significant power.
One of the challenges faced by trustees during the early stages of this pandemic was the lack of forward-looking financial information from sponsors. This was because at that time there was so much uncertainty that many management teams did not feel comfortable sharing forecasts which were susceptible to significant changes at short notice.
However, now that it has been over six months since the start of the first lockdown, and despite the continued uncertainty, management teams are becoming increasingly comfortable sharing their best view of how their company is expected to perform over the short to medium term. In particular, in many cases companies have performed better when measured against forecasts compiled in April and May of this year. This has provided additional confidence in the achievability of forecasts that are being shared with trustees now.
The key question now will be whether this improved confidence continues throughout further lockdowns? We note that in many cases companies have already built in the impact of a potential second lockdown into their forecasts and therefore there may not be significant changes in forecast performance as a result of the new restrictions.
What we have found effective in a number of cases is to work with the information available and to consider a number of scenarios, rather than waiting to see which scenario would play out. This way, trustees can be part of the discussions with other key stakeholders whilst they are taking place, rather than being notified of what has happened later down the line, when all meaningful decisions have already been made.
Another key learning from this crisis is the importance of good contingency planning and the decisive execution of it. Even if your scheme and employer operates in an industry that appears to be free from any distress now, ensuring a good contingency plan that is backed by a sound IRM approach is becoming more important, if not essential.
This is consistent with TPR guidance on IRM plans which has been in circulation since 2014. The impact that Covid has had on both corporates and schemes means that we are seeing more trustee focus on IRM now than at any time in the last six years. In fact, we have observed in a number of cases that trustees have sought to implement or enhance their existing IRM framework in the wake of the first lockdown. These newly devised IRM frameworks could be put to test during the second lockdown. As part of this trustees are often also revisiting their schemes’ investment strategies, and assessing if the funding methodology (including the expectations for investment outperformance) is consistent with the investment strategy.
The Pensions Support Index tracks the relationship between the financial strength of the FTSE 350 companies and their defined benefit pension obligations, indicating the overall level of employer support offered to these pension schemes. Rather than just looking at the absolute size of the obligations, we compare the deficit number to the cash generation, profitability and assets of companies supporting their schemes.
Where appropriate, calculations have been restated for updated actuarial assumptions.
To reflect the impact of COVID-19, we have used the companies’ latest market capitalisation and updated actuarial assumptions as proxies to produce estimated scores as of Q1 and Q2 2020. Therefore, these scores may be different from the PSI 2021 scores for the same quarters when we update the model with actual company financial data next year.
The PSI should not be viewed as a replacement for an employer covenant review or other professional advice.