The UK’s automotive sector is undergoing dramatic change, but what does this mean for its defined benefit (DB) pension stakeholders?
We consider some of the implications for both employers and scheme trustees in the sector.
Financial pressures are spreading through the motor industry supply chain
The automotive sector covers a broad range of employers, comprising one – four tier parts providers, original equipment manufacturers (OEMs), dealership networks, and finance and other service providers.
OEMs face pressure to reduce costs to fund the huge capital investment required for electrification, the development of autonomous driving technology and mobility as a service (MaaS). They also need to keep pace with a changing regulatory environment and shifting consumer demands.
This is all driving OEMs to cut costs and this is, in turn, applying financial pressure throughout the supply chain. These pressures may provide clear and present risks to the employer covenant. Areas to be aware of, and pension scheme considerations, include the three areas below:
1 Financial Pressures
A slowing global economy has led to a declining market in China, Europe and the UK (the US has bucked this trend recently)
Brexit and the uncertainty over future tariff arrangements and any impact on the UK’s position in EU supply chains
Increased potential fines from not meeting Co2 emissions targets
Cost reductions have been announced to fund capital investment, including research and development, electrification, autonomous driving, new platforms/powertrains and retooling of plants, and MaaS
DB pension scheme considerations: The impact of these areas may have been to put pressure on the revenue, cash generation and profitability of scheme sponsors in the sector. Ask yourself:
Has there been a deterioration in the covenant strength?
Is security available to underpin the covenant and justify an extended recovery plan? Could support be put in place?
Can the employer continue to underwrite the scheme’s investment risk?
Is there a need to consider the shape and term of the scheme’s recovery plan because available cash is being reinvested in the business?
2 Dealer Networks
Regulatory change and shifting consumer demand means that potential structural changes to dealer networks may be anticipated
We expect to see the continued rise of non-franchised used-car supermarkets, and a continued shift towards more online and direct sales as well as fewer franchise dealers
The consolidation of dealer groups, and other merger and acquisition activity
DB pension scheme considerations: Corporate transactions can change the covenant position quickly and need to be evaluated from the scheme’s perspective. This is particularly relevant in light of the upcoming Pensions Bill, expected to bring in new Pensions Regulator (TPR) powers and other changes. It will likely include a new obligation for scheme sponsors to provide TPR with details of transactions before they take place. New criminal penalties may also be brought in, designed to discourage transactions that weaken the covenant.
Automotive alliances may be required for OEMs in particular to be better placed to fund the large capital expenditure required
DB pension scheme considerations: There may be a corporate transaction as part of an alliance. Does this change the covenant strength available to the scheme?
So, the automotive sector is under pressure, but that is hardly a secret. The industry is sure to adapt, as it has done historically, and there are likely to be many opportunities for growth and diversification along the way.
However, not all employers will come through the industry transformation unscathed, and in the current regulatory environment, there is the need for employers and scheme trustees alike to be alert to the potential for the covenant to weaken very quickly. As always, it is important for sponsors to engage constructively with scheme trustees, and for trustees to monitor their sponsor’s performance and position regularly, so that funding structures are appropriate to the sponsor’s circumstances.
How should trustees make decisions in this environment?
While pension schemes have long-term obligations, the pace of funding, the investment strategy and many other key trustee decisions can only be taken on an informed basis with a sound understanding of your sponsor’s current financial position and prospects
Given the continued expected pace of change in the automotive sector, you may be well served by taking the time to sense-check your scheme’s funding, investment and covenant position now. Planning for different employer covenant, funding and scheme investment scenarios can be facilitated using tools such as our Integrated Risk Management (IRM) Gateway
You may also wish to consider endgame planning for the scheme. Is now the right time to develop a longer-term plan for the future security of members’ benefits? Might this be achieved in conjunction with a third party, such as a consolidator or bulk annuity provider?
What should scheme employers consider against this backdrop?
You should be alert to the impact that corporate transactions could have on your scheme and how trustees might respond. TPR will expect you to consider the interests of the scheme and offer mitigation for any weakening as a result of a transaction or other corporate action.
Having an open dialogue with scheme trustees about the financial pressures you face, or about an upcoming transaction, may help ensure no last-minute surprises that might derail plans later. For example trustees may request:
security as part of a triennial recovery plan agreement, if there has been a general weakening of the covenant
mitigation to compensate for a covenant that has been weakened by a transaction
employer commitment to a long-term funding target, or end-game planning for the scheme
To explore the implications of these massive sectoral changes, join us at our upcoming automotive event sessions for trustees and sponsors of DB schemes in the sector – register for one of our sessions.