PPF: Assessment of Guarantor Strength & the Impact of Insolvency

Introduction

In December 2012, the PPF revised its contingent assets guidance (the “Guidance”) for the levy year 2013/14, with the aim of giving schemes “a better steer” on what to consider when planning to use guarantees as contingent assets. It has now published a summary of its observations on the assessment of guarantor strength and revised its FAQs on the subject.

In this Alert:

• Key points
• Background
• Assessing guarantor strength: the impact of insolvency
• Which potential insolvency scenarios should be taken into account?
• Effect on contingent assets

Key points

• When assessing guarantor strength, trustees must consider the “reasonably foreseeable” impact of an insolvency of the scheme employer(s).
• To make this assessment, trustees are likely to need input from a covenant assessor.

Background

Since the levy year 2012/13, trustees of schemes with Type A contingent assets must certify that they “have no reason to believe that each certified guarantor, as at the date of the certificate, could not meet its full commitment under the contingent asset as certified” (the “Certification”). This aims to ensure that the reduction in risk provided by the contingent asset justifies the corresponding reduction in the PPF levy.

Assessing guarantor strength: the impact of insolvency

For the levy year 2013/14, when considering the strength of a guarantor, trustees must recognise that the guarantee would only be likely to be called upon in the event of an insolvency of the pension scheme’s sponsoring employer. This aims to prevent the certification of assets where the failure of the scheme’s employer would render the guarantor unable to meet its commitment.

Therefore, as part of their assessment of the guarantor’s position, the PPF considers it appropriate for trustees to take account of the reasonably foreseeable impact of the insolvency of the employer(s) whose liabilities are being guaranteed, assuming that were to occur in the near future.

The latest publication from the PPF is intended to assist trustees in determining this impact. It gives several examples of when a guarantor would and would not be likely to be able to meet its commitment on an insolvency of the scheme employer(s) and includes some basic case studies to highlight weaker and stronger examples of guarantor companies.

In broad terms, the PPF indicates that the more intertwined the assets, liabilities and operations of the scheme employer(s) and the guarantor (whether directly or indirectly), the more unlikely it is that, on an employer insolvency, the guarantor would be able to meet its commitment under the guarantee. It is clear that, in the PPF’s opinion, for the trustees to be confident of the guarantor’s strength, the guarantor should largely be financially independent of the scheme employer(s).

Which potential insolvency scenarios should be taken into account?

The PPF states that “trustees should consider all the scenarios in which an employer could fail. If the insolvency of a third party company is a possible ‘trigger’, but is unlikely, then it is reasonable to exclude it from the assessment”.

This seems to require trustees to consider all the ways in which a scheme employer may become insolvent, as well as the likelihood of each event occurring. Although this is not a PPF requirement, most trustees are unlikely to be able to reach a conclusion on this without the input of covenant assessors.

Effect on contingent assets

The insolvency assessment will make it more difficult for many trustees to give the Certification. As the beneficiaries of a levy reduction, the onus will be on employers to provide their scheme’s trustees with enough information to satisfy them of the guarantor’s ability to meet its obligations under the guarantee, notwithstanding an insolvency of those employer(s).

With the deadline now less than a month away (5pm on Thursday 28 March 2013), trustees and employers wishing to certify / re-certify a PPF guarantee should tackle this issue as soon as possible