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Employer Covenant: Final Guidance
The Pensions Regulator (TPR) has published guidance on “Monitoring employer support: Covenant, contingent assets and other security” (the Guidance).
What is the employer covenant?
For the first time TPR has expressly defined "employer covenant". TPR says it is:
“the employer’s legal obligation and its ability to fund the scheme now and in the future. The strength of it depends upon the robustness of the legal agreements in place and the likelihood that the employer can meet them. As scheme sponsor the employer underwrites the risks to which the scheme is exposed, including underfunding, longevity, investment and inflation.”
Earlier TPR guidance included the concept of willingness as a crucial element of covenant along with ability to pay. Willingness has now been dropped from the definition, with TPR recognising that ”recent experience has shown that willingness can evaporate just when it is needed most”.
But that does not mean that trustees can ignore willingness altogether. A failure to demonstrate willingness to fund the scheme “should alert trustees to the inappropriateness of taking an optimistic view of employer covenant”.
Can trustees monitor covenant themselves?
TPR has aimed to strike a proper balance between specifying a process for monitoring employer covenant and not imposing unnecessary costs on trustees and employers.
The guidance requires trustees to take a proportionate approach to covenant assessment, by using the resources already available to them. For example, the guidance notes that a “positive working relationship” between the employer and trustees is important. But to promote openness, the trustees should be prepared to commit to confidentiality in respect of price sensitive information.
Appointing external covenant assessors
The guidance also makes it clear that trustees may only require external support for those items for which they do not have the required skills on the trustee board. TPR emphasises that it does not require standardised reports “that do not add value”, and so trustees may only need to request input on certain issues.
If advice is sought from a professional covenant assessor, TPR indicates that the appointment should be subject to a “robust selection process” bearing in mind the trustees’ budget.