January 15
Carillion collapse causes covenant catastrophe

This morning’s news of Carillion’s liquidation adds yet more high profile names to the list of pension schemes which have been unable to meet their objective of providing full benefits to their members. Carillion’s 13 UK DB pension schemes will now enter assessment for entry to the Pension Protection Fund (the ‘PPF’), the lifeboat fund offering compensation to members of DB schemes whose employers have suffered insolvency.

More than 1,000 DB schemes have now entered the PPF since it was established in 2005. However, the PPF’s latest annual accounts suggest that it is currently in a strong financial position, with assets of £29bn and a surplus of £5bn. Even if Carillion’s schemes enter the PPF with a collective deficit of close to £1bn, there should not be any material risk of this sinking the lifeboat fund.

The Carillion announcement also reminds trustees of other DB schemes that employer covenant is the biggest risk to which the members of their pension scheme are exposed; it is only in the scenario of employer failure that members do not receive their full benefits. The Pensions Regulator has recently been emphasising the importance of trustees understanding their employer covenant, and ensuring that schemes have robust integrated risk management frameworks in place.

The Pensions Regulator expects that as well as monitoring covenant, funding and investment risks, integrated risk management plans should prescribe steps which will be taken if there is a deterioration in covenant. This could include strengthening the assumptions used to calculate the funding liabilities or reducing risk in the investment strategy. However, in the case of Carillion’s schemes it is difficult to conclude that either of these steps would have ultimately been beneficial for the pension schemes.

If we (somewhat simplistically) assume that the trustees of the Carillion schemes were broadly comfortable with the strength of their employer covenant until the first profit warning was announced in July 2017, this would not have given them much time to respond to the apparent weakening of their position. Making the funding assumptions more prudent would have been very unlikely to have led to any more cash coming into the schemes in the short term, as Carillion’s biggest pension schemes already had a recovery plan extending out to 2029, suggesting that the trustees would not have been able to persuade Carillion to increase their annual contributions. Instead, increasing the deficit would probably have led to a longer recovery plan.

Similarly, reducing the risk in the investment strategy would have been unlikely to be beneficial. Its latest statutory accounts show that in aggregate Carillion’s DB schemes held 49% of their assets in equities and property, with the rest in bonds, cash and cash equivalents. If some of these assets had been moved out of equities and into bonds, this would probably have led to lower investment returns. Between 10 July 2017 and 12 January 2018 the FTSE All-Share achieved a total return of 8%, compared to a total return of 2% for fixed interest long term gilts.

In our experience a more valuable boost for DB schemes can often be to obtain a robust contingent asset. This should provide a valuable asset to the scheme at the time when they need it most, i.e. on the failure of their employer. Indeed, in our Risk of Ruin research analysis which we published last year (www.riskofruin.co.uk), we concluded that providing a robust contingent asset to a DB scheme can often be more valuable than additional cash contributions, in terms of improving the chances of being able to pay full benefits to all members. Perhaps in light of these conclusions, this is also a solution which the Pensions Regulator usually favours.


  • Failure of the Trustee!
    The simple truth that I am beginning to see in all of this is that the Trustee, for whatever reason, did not insist on Carillion paying more contributions into the Schemes in prior years! The papers I have seen from the Trustee Covenant Advisers clearly show the Trustee was advised to seek greater contributions. Why did the Trustee not follow this up?!
    Created by: Quintas Petreas
    Created: 08 February 2018
  • Mr
    Surely the provision of a contingent assets is even more unlikely than increased cash payments, as Carillion was heavily indebted and all potential assets used as security for this lending?
    Created by: Craig Holson
    Created: 19 January 2018
  • Its all about cash to the Scheme
    If the Company had been serious about protecing member benefits it would have agreed way higher deficit recovery contributions. Forget all about what else you say about covenant stength and investment returns! The problem (in simplistic terms) has been that not enough was paid into the Scheme to reduce the deficit and ultimately the reliance in Carillion for covenant support. Make no mistake - this situation firmly rests with the Company, its amangement and the Board of Trustees. Mr Frank Field MP should have a "field" day with this one ... and if he does not, then we the taxpayers would like to know why!!
    Created by: Anthony Light
    Created: 19 January 2018

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