Pension trustees urged to scrutinise ABC arrangements amidst regulator's fears over exposure to risk

It called on trustees that decide to enter into ABC arrangements to first "critically and carefully" scrutinise the deal and warned of the potential for pension scheme funding shortfalls if ABC arrangements fail, sponsoring companies become insolvent or if ABCs are deemed illegal by the courts.

"Given the risks in this area, trustees should examine any proposed ABC arrangement critically and carefully," the Pensions Regulator said in new guidance (19-page / 132KB PDF). "They should consider whether there are any less risky alternatives to support the scheme, such as an appropriate recovery plan, or an appropriate recovery plan coupled with contingent assets to provide additional security."

"If trustees choose to enter into an ABC, they should take care that any capitalisation of the payment stream does not give a distorted view of the scheme’s funding position and its overall risk profile. When making decisions on issues involving funding, strategy or risk, trustees should ‘unpack’ the ABC arrangement and clearly identify the extent to which the value attributed to the ABC in the scheme’s accounts is reliant on payments being made in the future, and assess the likelihood that those payments will be made in relevant scenarios," it said.

The regulator said that it could also decide to "unpack" ABC arrangements to gain an insight into the "real risks" pension schemes are exposed to.

ABCs involve the use of assets held by the company behind a pension scheme to fund payments into that scheme through the income generated from those assets. The arrangements provide for tax benefits and allow for the spread of deficit payments, however the Pensions Regulator has expressed concern about the length of time it can take for payments stemming from the income generated by the underlying assets to fund pension scheme payments.

It has also expressed concern about the lack of certainty around the legitimacy of ABCs and said pension trustees should seek to put in place an "underpin" to account for courts ruling in future that the arrangements are illegal.

"The underpin should be robust and certain, and ensure that a scheme is not made worse off due to an ABC being found to be void," the Pensions Regulator said. "The underpin should cover both: any repayment to the scheme of monies previously received under the ABC but returned, and future payments (reflecting the fact that the scheme would lose the income stream and any security from the ABC). The underpin should be in a separate agreement so that any illegality of the ABC structure does not make the underpin itself void."

Pensions law expert Daniel Shelley said that the increase in popularity of ABCs may have prompted the Pensions Regulator to issue the new guidelines.

"The Regulator warns trustees that they should be prepared to respond to queries from the Regulator where they have entered into asset-backed contribution arrangements," Shelley said. "Any employer who is properly advised and acts according to the Regulator’s guidance should not have a problem in putting in place an asset-backed contribution arrangement."

Geoff Cruickshank, the regulator’s interim executive director for defined benefit pension scheme regulation, said: "Asset-backed contribution structures can lock schemes into a long-term funding deal, so we expect trustees to carefully evaluate proposals and ask probing questions of their advisers. Trustees should explore whether there are better alternatives which do not expose them to the risks and costs involved in an ABC."

"While an ABC can be given a big upfront value which seems to wipe out a scheme’s deficit, in reality the scheme relies on many years of payments before the value is realised. Should the worst happen and the sponsoring company become insolvent, the value of the ABC may be reduced, or even worthless."