Employer Covenants research project

Background

The Institute and Faculty of Actuaries is commissioning a research project on the topic of how employer covenants are best taken into account when assessing the capital supporting Institutions of Occupational Retirement Provision (IORPs).

The impetus for this project is provided by the review of the IORP directive and in particular by the Holistic Balance Sheet (HBS) option. This was described in the consultation document issued on 25 November 2011 by the European Insurance and Occupational Pensions Authority (EIOPA) in its draft advice to the European Commission.

Rationale

The rationale for the project is to further the understanding of the issues surrounding, and the practicalities of expressing, 'reliance on employer covenant' as a single figure in a HBS.

The project should also examine what information relating to the assessment of covenant is already accessible to trustees.  This should include information on how intangible assets are valued in balance sheets such as brand, goodwill etc.

We envisage that a member of the Profession will work closely with the successful applicants to facilitate access to relevant information and contacts and to ensure that the questions addressed are relevant to the review of the IORP directive.

Questions to address in the research

• What are the desirable qualities of a covenant assessment methodology for the purpose of managing and regulating an IORP?
• How could the frequency of covenant assessments/monitoring be optimised?
• What are the key features (including pros and cons) of the different approaches that are currently used and that might be adopted in future? In particular:
  • to what extent do they possess the desirable qualities?
  • what are the implications for standard setters?
  • how can they be adapted tobe proportionate for small scheme and small sponsoring entities?
  • what are the potential implications for compliance costs?
• How do ratings agencies use the publicly available data in company accounts to assess and rate company debt?
• What additional information do lenders seek and how do they assess how much to lend?
• What additional information, over and above that used to assess debt, would be needed to assess the security of a company’s pension promise bearing in mind the typical differences in term between these obligations?
• Are there intrinsic differences between the employer covenant per se, and the value of the covenant that is available to the pension scheme and if so, can they be identified and measured?
• How do companies assess their own financial strength? (For example how is enterprise value established in merger and acquisition work?) How do analysts assess the impact of a DB pension scheme/liability on the value of i) the equity and ii) the debt of acompany? Does this offer any insights into how an employer covenant could be valued for the purpose of financing pension schemes?
• What potential areas of conflict with accounting principles are there in valuing the covenant?
• What extra issues arise in groups of companies and multinationals (i.e. when companies have option to move funds across jurisdictions)?
• Are there useful lessons to be learned from the work going on for IFRS4 in insurance accounting?
• Do other countries have data sources and processes that it would be useful to replicate in the UK for the purpose of covenant assessment?