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Failure to assess this could leave trustees liable to claims of negligence, if the employer defaults.

Christopher Murray, a director at Smith & Williamson, the accountancy and financial advisory group, highlights the importance of evaluating the employer's financial position.

He says that any trustees who have been faced with a recent actuarial valuation of their scheme will know that identifying the scheme's "technical provisions", in order to set a scheme-specific funding objective, must go hand-in-hand with assessing the employer's ability and willingness to fund the scheme into the future i.e. the strength of the sponsoring employer's "covenant".

Recovery period 

Murray warns that it would be unwise to select a funding objective that is based on potentially optimistic - yet still acceptably prudent - actuarial assumptions, unless the employer's covenant is quite strong. 

The Pensions Regulator might well ask questions even then, so Murray says that it is important to be able to come up with some satisfactory answers.

The Regulator does not set out to force companies into insolvency by insisting on shorter deficit reduction ("recovery") periods than might normally be considered "reasonable" by sponsoring employers.

If trustees activate any of its published "triggers", however, for example by agreeing to a recovery period of greater than 10 years, they need to have good justification for doing so.

Murray says that the strength of the employer's covenant is rather more important than many trustees might have thought.

The financial relationship with any parent or group company will also have a significant bearing on how strong a funding plan must be.

Any change in the perceived strength of the employer's covenant should be considered by trustees, in case there is a need to adjust the funding plan. Regular review is therefore essential.

Covenant assessment 

Real potential for conflict exists within trustee boards that are comprised mainly of senior management of the sponsor.

It is even more important in such situations to be able to demonstrate that a covenant assessment has been made, so Murray believes that independent third party analysis should be high on the agenda.

Some firms of chartered accountants offer a covenant review service, typically led by corporate recovery teams, who are perhaps better placed than most to form an opinion about whether or not an employer is likely to be able to meet its financial commitments, of which pension scheme funding is one.

There is no legal requirement to have the employer's financial position evaluated by a third party. Few trustee boards possess the necessary accounting skills, however, to be in a position to make a valued judgement. 

"Failure to assess the ability and willingness of the employer to meet its scheme funding commitments can leave trustees exposed, if things go wrong," Murray concludes.

Related links

• Smith & Williamson