Since Tata Steel put its UK business up for sale in April, the saga has been a sorry one for those whose jobs are at risk – but the latest twist is welcome.
This article originally appeared in Financial News on 6th June 2016.
On April 26 the Government announced a consultation on a series of “exceptional” measures they are considering for the pension scheme attached to Tata – the British Steel Pension Fund.
Interestingly, two of the options proposed break a previous taboo - the consultation openly discusses how the trustees might be able to cut accrued pension rights without members’ consent. True, the Government is at pains to point out that any legislative change would single British Steel out due to its “unique circumstances” and be subject to a raft of limits on how far the trustees can go with their cuts.
It is fairly obvious, though, that the British Steel Pension Fund is not unique. At worst another 1,000 pension funds could be forced to seek the help of the Pension Protection Fund, according to a recent report by the Pensions Institute and Cass Business School.
Even more interesting is the tacit acknowledgement that UK law does not necessarily provide the best outcomes for members of pension funds associated with companies in danger of insolvency.
The consultation on Tata should be the start of a process that could change UK pension law to allow much greater flexibility in situations where the sponsor cannot afford to stand behind its pension promises.
Struggling businesses cannot simply offload their pension liabilities – that’s fair enough. However, the law only provides one option to a business that cannot afford its pension promises – go bankrupt and pass the pension fund to the PPF. As the government consultation acknowledges, this is a “lose-lose” situation as the members take a heavy haircut to their pensions and shareholders suffer a complete loss of equity.
It is not legally possible for trustees to renegotiate the pension contract before a bankruptcy in an effort to salvage value on behalf of their members. However, a restructuring could provide members with a better pension outcome than the PPF allows and allow the company additional breathing space to find a solution that might save thousands of jobs.
For an underfunded scheme with a weak sponsor, it’s a question of when, rather than if, a haircut will be applied. The members should not have to wait and watch the pension fund enter the PPF – resulting in reduced benefits and having their pension assets parked in a conservative portfolio. As in almost every other aspect of commercial life, the trustees should have the power to negotiate with the sponsor and consider other options.
These should include cutting guaranteed benefits, thereby alleviating the financial burden the sponsor cannot afford, and introducing risk sharing through, for example, a defined contribution top-up. This would allow the members to continue to save for their future. Instead of locking into the reduced benefits the PPF offers, it would be possible to provide members with a higher pension by taking controlled investment risks.
What if the trustees of the British Steel Pension Fund could restructure their scheme and offer their members this type of hybrid solution? The advantage with a hybrid approach is that the members still have a minimum retirement income, albeit at a lower level. At the same time, this solution gives members some exposure to financial markets which, over time, should help provide a better pension.
Exactly what such a hybrid solution could look like depends on the situation of the individual scheme and what type of restructuring deal the trustees can reach with the sponsor.
The British Steel consultation does not go quite this far. It does not allow cuts to existing pensions, only curbs on how fast they can increase in future, but the proposed solutions will still be reasonably onerous to any sponsoring company. But it seems the Government is thinking seriously how to release Tata Steel from its pensions obligations.
Will this be enough to save this company? Perhaps not, but more flexibility in the law would be very helpful in providing more options for other corporates in similar circumstances. With the right regulatory oversight, pension restructuring could be a win-win for both the company and pension fund members.