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Covenant reporting, monitoring and advice

What exactly is a covenant?

Employer covenant is the strength of the business supporting a pension fund. It is defined by the Pensions Regulator as ‘the extent of the employer’s legal obligation and financial ability to support the scheme now and in the future’. It is the ultimate support for the funding and investment risks faced by a pension scheme. Understanding the quality of this support and the risks associated with it is fundamental to fully integrated risk management. It’s at the heart of what we do.

Understanding the strength of the covenant

The covenant is, firstly, the ability of the business to support the pension scheme over time and, secondly, its ability to pay cash into the scheme where there’s a shortfall. The Pensions Regulator’s guidance on integrated risk management clearly positions the employer covenant as one of the three fundamental risks to which a pension scheme is exposed. Indeed, the two other risks, i.e. funding and investment, cannot be adequately managed unless the trustees have first assessed the strength of the employer covenant and understood its capacity to underwrite them.

Why monitor employer covenant?

Employer covenant risk is not static: companies and markets continually evolve. It is therefore critical that you actively monitor your scheme’s covenant. While the Pensions Regulator suggests monitoring the employer covenant position at least annually, many trustees assess the employer covenant more frequently, particularly where the perceived risk associated with the employer covenant is higher.

 

You need to understand and critically evaluate the employer’s capacity to make deficit repair contributions as part of its recovery plan. The assessment of affordability can be complex and there is no ‘one size fits all’ approach to assessing the level of contributions that an employer should be making to its scheme. The answer to the question of ‘what is appropriate?’ may depend on a number of factors including the funding position and risk volatility of the scheme, the competing cash-flow demands of the employer, and the treatment of other stakeholders.

Affordability is a complex challenge

With pension deficits remaining at historically high levels, and many sponsors suffering from the impacts of Brexit and COVID-19, the affordability of contributions is often a complex challenge that requires a careful balancing of competing demands on cash flows.

What can we do for you as a trustee?

  • We can help you to build robust and balanced viewpoints on the appropriate level of contributions, taking account of the specific circumstances of both the pension scheme and the employer, and ensuring that the pension scheme is treated equitably.
  • We focus on the key issues of the investment and funding risks to the scheme over the long term and the likelihood of the employer covenant supporting those risks, if it was ever asked to do so.
  • We track changes in the strength of the employer covenant over time and identify the precise impact of particular transactions and events affecting the employer’s organisation as the scheme’s sponsor.
  • We can provide you with tailored insight as to how the covenant interacts with a pension scheme’s journey plan over time.
  • We can give you a long-term view, plus practical recommendations for the next steps, options for improving the covenant, and considerations for planning the scheme’s journey towards its long-term target.
  • We can help you to prepare monitoring frameworks based on the main risks facing your schemes and integrated with your investment monitoring, and to develop actionable contingency plans to respond to negative events as and when they arise.
  • We offer a series of flexible, scheme-specific training modules that can be combined and tailored as necessary to give you what you need for your particular scenario.

A unique approach to covenant assessment

  • As one of the largest covenant assessment teams in the market, we can tailor our teams to your specific circumstances and sector.
  • Our independent status means that we are not conflicted
  • Thanks to our background in corporate finance, our multi-disciplinary team focuses on the key issues for trustees.
  • Our wider team can provide specialist support if your needs evolve beyond covenant assessment e.g. distress, end-game planning, ESG reporting.