Is the pension scheme being treated in a reasonable and equitable manner when compared to shareholders and other stakeholders?
The Pensions Regulator is putting increased focus on this issue and it is important for employers and trustees to work together to reach a balanced outcome.
Dividends are a hot topic
Recent high-profile corporate failures have put a spotlight on whether the sponsors should have paid more into their pension schemes and less to their shareholders and other stakeholders.
The Work & Pensions Committee has been asking some searching questions where sponsors pay large dividends, and The Pensions Regulator (TPR) has highlighted the growth in dividends relative to changes in pension deficit contributions and its expectations of how trustees will approach this when setting valuation assumptions. Dividends are likely to remain a key area of scrutiny by the Pensions Regulator – who may intervene where dividends are judged to be excessive.
What is the truth of the matter? How should we judge what is equitable? Is a large dividend necessarily inequitable?
Balancing multiple stakeholders
Every business has to manage its resources across a number of priorities including:
debt service costs
reinvestment in the business (potentially enhancing covenant strength)
pension deficit contributions
dividend distributions to shareholders.
TPR has had an increasing focus in recent years on ensuring the equitable treatment of stakeholders, and in particular the balance between dividends and deficit reduction contributions.
How should we assess what is equitable?
Quantifying what is equitable can be a matter of considerable judgement. It is not always easy to move beyond broad judgements of what seems ‘right’ or ‘fair’, and to reach a balanced quantitative conclusion.
To begin with, 'equitable' does not mean 'equal'. A 1:1 ratio of dividends to deficit contributions will rarely make sense, taking into account factors such as:
the covenant strength available
the size and track record of stakeholder investment in the business
the relative size of the scheme and sponsor, as well as the scheme’s maturity and investment strategy.
Matters can be complicated more by irregular or one-off dividends, or other forms of value extraction from a business, for example management charges or the sale of a business.
Whilst there are no hard and fast rules, there are a number of ways of analysing dividends to show whether pension schemes are being treated fairly. Importantly, we have used these successfully in discussing client cases with TPR.
What action should I take as a scheme trustee or corporate sponsor?
The risk is clear, whether regulatory, political or legislative. Where dividends are obviously out of line with long-run sponsor performance, or where there is a large disparity between dividends and pension contributions, trustees and sponsors alike should expect ever greater scrutiny, with all that means in terms of management time and effort, PR risk and scope for intervention.
The upcoming Pensions Bill could well pave the way for increased powers for TPR and it seems likely that the question of dividends will be among their priorities. This is not going to go away.
The answer is simple – engage in meaningful dialogue; understand the potential for perceived imbalance; analyse whether the dividend is indeed equitable; consider the potential implications if the analysis suggests that there is an argument that the dividend is not equitable; and reach a rational and agreed position between sponsor and trustees.
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