FDs who take a proactive approach can limit calls from their trustees for additional or accelerated contributions and take steps to control future volatility.

Finance directors are likely to be in for difficult conversations with the trustees of their defined benefit pension schemes during 2009, even if the Company showed a surplus in its 2008 accounts. 

This is because funding for company accounting purposes discounts pensions liabilities by reference to AA corporate bond yields, which were unusually high at the end of 2008, whereas, for scheme funding purposes, pensions liabilities are measured by reference to the assumed rate of return for scheme assets, which conversely may be low.

During 2008, the aggregate deficit for pension schemes of FTSE100 companies reportedly doubled to £130bn. 

At the same time, in many cases the economic downturn has had an adverse impact on the strength of the employer covenant (which for this purpose is the ability and willingness of the employer to fund the scheme).  As a consequence, many trustees will be reviewing their funding and investment arrangements. 

If trustees adopt more conservative scheme funding assumptions this will increase the value of the pension liabilities.  Adopting a more conservative investment strategy may lead to greater stability.  However, this is expensive to implement at a time when scheme assets have fallen dramatically and the scheme is already significantly under funded. 

Finance directors will inevitably be concerned about the impact that increased contribution requirements may have on their business. 

Employers will often not be able to afford increased contributions and, in some cases, may not be able to continue to meet existing contribution obligations.

The Pensions Regulator recognises this and has recently issued a statement reassuring companies that the scheme funding regime is flexible enough to cope with the economic downturn and there may be scope to renegotiate deficit payments provided that dividends are not being paid.

Finance directors who take a proactive approach may be able to limit calls from their scheme trustees for additional or accelerated contributions and take steps to control future volatility.

Some finance directors are reaping the benefits of early action, for example where their scheme transferred assets from equities to bonds before the second half of 2008 (often encouraged by the employer's wish to reduce volatility), or where liabilities were removed by effecting a buy-out with an insurance company when prices were competitive and scheme funding was relatively good.

Finance directors may well think that it is too late to take advantage of these opportunities.  However, they should be aware that there may be scope to renegotiate funding plans by taking into account what the company can actually afford to contribute towards the scheme. 

Further, there is a range of liability management options available, many of which offer real solutions. 

Although now may not be the right time for some options, for example moving investments into bonds, it may be a particularly good time to implement others, for example enhanced cash equivalent transfer values. Finance directors would be well advised to get up to speed on the options so they are well placed to take advantage of them when the time is right.

Broadly, the options which finance directors should be aware of are:

• removing all liabilities and therefore the risks altogether (e.g. by buying out benefits with an insurance company, transferring all the benefits to new (defined contribution) arrangements or winding the scheme up); or
• removing some liabilities (e.g. through a partial buy-out of benefits, transferring some of the benefits to new arrangements out (e.g. for active members following a sale or for consenting members through an enhanced transfers value exercise); or
• reducing the liabilities (e.g. closing the scheme, reducing future service benefits or seeking to effectively reduce accrued benefits (e.g. through operating discretions less favourably or pension increase exchanges); or
• controlling the exposure to the liability – (e.g. buy-ins, longevity insurance, use of swaps, review of investment managers in light of market conditions); or
• a combination of two or more

By familiarising themselves with the options, their pros and cons, any potential timing and legal issues, and by engaging constructively with their scheme trustees, finance directors should be well placed to take advantage of opportunities that may be available to them at the appropriate time.