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Employer covenant: a focus on corporate longevity

Paul Brice Paul Brice

Following a presentation around the employer covenant at a conference, an audience member asked: “If projected scheme liabilities and asset flows are run out in models for decades, how are long-term horizons dealt with in employer covenant assessments?”

Evaluating market dynamics and corporate longevity is a highly relevant issue – particularly when considering integrated funding and integrated risk management (IRM). Of course, an actuarial valuation every three years allows for a periodic reassessment of the position. But setting investment strategies and recovery plans with a medium and long-term view in mind seems sensible – with the IRM plan setting out how schemes might respond to off-plan performance.

Planning ahead

Businesses often only plan or forecast a year ahead. Some track five-year plans. Listed companies may have projections provided by equity analysts.

A few asset-intensive businesses with contracted cash flows - such as leasing or consumer finance businesses, or those involved in long-term capital intensive infrastructure contracts - can see the contracted flow out of their existing ‘book’ well into the future (albeit that this may be subject to defaults etc). But they may need to make assumptions regarding new business.

Employer covenant discussions routinely consider the dimensions of legal obligations, sponsor profitability, cash flow and balance sheet strength, all referable to a scheme. But looking forward into the medium or long term? What about disruptive technologies, market shifts, M&A or the impact of other social or economic factors such as climate change?

Depending on their agreed scope, employer covenant assessments can consider sponsor longevity, even where formal long-term forecasts may not exist. To do so involves analysing the market the employer operates in and the dynamics of that market. It also requires a consideration of the market’s susceptibility to disruption and other forces – and the resilience of the employer to respond to these. It would need an evaluation of the employer’s competitive positioning – is it a premium provider, an undifferentiated price taker or 'stuck in the middle'? What are the potential political risks to the market – taking account of the strength of public finances? Could the employer be disrupted by technological or event-driven risks? What about climate change?

What can you do? 

These issues and their outcomes can clearly not be predicted with any certainty and business forecasts are regularly proven wrong with the passage of time. But there are a range of tools and disciplined approaches for considering market dynamics and possible corporate longevity. Using these and external analyses, one can arrive at a view of potential strengths and weaknesses, and whether an employer may be a winner in its market, a loser or face gradual decline. This in turn can feed into a scheme’s investment strategy and funding approach on an integrated basis.

We will never pretend to be able to predict the future with certainty, but we would be pleased to discuss with you what we can do to help you understand the longevity of your employer and how this can support your approach to IRM.

If you would like to talk about our approach to considering corporate market positioning and longevity using strategic analysis techniques as part of our employer covenant work, please contact Paul Brice, Head of Pensions Advisory.

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