Considering employer covenant

Simon Kew looks at TPR’s guidance on employer covenant.

10 November 2015

It is approaching ten years since The Pensions Regulator (TPR) introduced the notion of ‘employer covenant' to the pensions industry, via their first Code of Practice 03 - Funding Defined Benefits. Just over a year ago, the Code was revised, entrenching covenant even further in the scheme funding process. Most recently, in August of this year, TPR issued guidance on ‘assessing and monitoring the employer covenant' to lift the lid on its views for assessing and monitoring covenant.

In short, the guidance reinforces the principle that assessing covenant, including an appreciation of wider market dynamics, is not a ‘one-off' process. Monitoring should be in force, along with appropriate triggers, to ensure that trustees can react nimbly and appropriately to changes in covenant. This monitoring should run alongside planning for potential outcomes in investment or funding assumptions, through 'stress-testing'.

Most obviously, changes to the group or board structure could affect covenant – particularly current as we are already starting to see an upturn in mergers and acquisitions (M&A). Corporate activity provides challenges for the trustees of a scheme, particularly as the information they receive is usually after the transaction has taken place. Impartial analysis of the position before and after the deal is, therefore, imperative. Calls for employers to proactively share details of proposed activities are well-intentioned, although some remain sceptical as to how effective they will be.

In addition to M&A, significant variations in forecast affordability, requests for extended recovery plans, large dividend payments or proposals to refinance may all require further investigation by trustees. This is something employers should be aware of as they may wish to undertake their own impact assessments.

Further afield, major industry moves such as the merger of two industry competitors, regulatory changes, technological innovations or structural decline may adversely influence a scheme's sponsor. These are not areas where trustees can bring about much influence, if any, although an understanding of their likelihood and potential effects is essential.


Given all of the above, we must remember that monitoring should be proportionate to the size and complexity of the scheme and the sponsor(s) meaning that, in the majority of cases, it is unlikely to be time-consuming or expensive. Complex modelling can be interesting, but, ultimately whether a sponsor can fund the scheme from cashflow now and in the future is the key. Ascertaining that can be tricky, particularly moving into the mid to long term. But, it is fundamental to assessing employer covenant, which is why monitoring and adjusting to changes is vitally important.

The guidance also puts objectivity centre stage by very clearly flagging that, where the trustees don't currently employ a covenant adviser, the regulator would expect them to bring in external advice where there is a ‘failure to agree' with an employer and/or a conflict of interest on the trustee board. We know that employer nominated trustees can bring valuable experience and insight to a trustee board, although they may be conflicted when funding matters are being decided. They can, of course, work closely with an external covenant adviser to provide relevant information and data to expedite the process, helping to reduce overall costs.

Finally, I couldn't consider TPR's latest guidance without referring to the integrated approach to scheme funding. It is expected that the regulator is due to issue some guidance before the end of the year on this very subject. I don't expect it to stray too far from recent messages, namely expecting external funding advisers (covenant, actuarial and investment) to work together to provide the trustees with joined-up advice – something they should be doing with, or without, TPR's encouragement!

At a glance

  • It is around ten years since TPR introduced the notion of employer covenant 
  • Assessing employer covenant should not be a one-off process.
  • Monitoring should be proportionate to the size and complexity of the scheme and sponsor

This article first appeared in Professional Pensions

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