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Focus on Dividends and Pension Scheme Funding

Actuaries are being urged to reacquaint themselves with the Pensions Regulator’s expectations with respect to dividend payments and the requirement to treat defined benefit pension schemes equitably (typically as an unsecured creditor of the sponsor).  This follows the publication today of the report by the IFoA Working Party on the Impact of Dividends and other covenant leakage on Pension Scheme Funding.

UK dividends fell by 44% in 2020 to £61.9 billion on a headline basis, according to the Link Group UK Dividend Monitor, reflecting the disruption caused by the COVID 19 pandemic.  This was the lowest annual level of dividend payments in the UK since 2011.  However, there has been a gathering level of optimism regarding 2021 and actuaries should be alert to the issue of dividend payments moving up the agenda, with the potential for dividends to be reinstated and pay-outs partially, or fully, restored.

Jane Ralph, Chair of the Working Party, said:

“In the event of a company failure, the actuary might find its professional judgement under scrutiny if there has been a perceived inequitable treatment between the pension scheme and other creditors.  This includes consideration of dividend payments to shareholders where the pension scheme remains underfunded.  It is therefore essential that actuaries are aware of their professional responsibilities and engage with the covenant advisor wherever feasible.”

The Pensions Regulator increasingly focused on dividends and covenant leakage following high-profile corporate failures and reports of disparity between dividend payments and Deficit Reduction Contributions (DRCs).   This led to a consideration of dividend to DRC ratios.  However, there appears to be very limited existing empirical research on the link between dividends paid and the impact this can have on scheme funding and ultimately outcomes for members. 

According to the Working Party, the focus on dividends should not distract from other forms of covenant leakage that can potentially have a greater impact on scheme funding and security.  This includes share buy-backs, repayment of shareholder loans, asset transfers, and inter-company payments and loans.    

Jacqui Woodward, Deputy-Chair of the Working Party, said

“Other forms of covenant leakage can be much harder to identify and measure and do not lend themselves to simple rules of thumb.  Actuaries need to ensure their clients seek appropriate guidance and advice in this complex area, particularly given the new sanctions in the Pension Schemes Act 2021.”

The report aims to consolidate the information available on the topic at the time of writing by bringing together the relevant background information, implications for actuaries and practical considerations.  It also includes case studies from recent high-profile corporate failures and illustrates practical considerations within 5 example scenarios for consideration and discussion.

Whilst the material was considered prior to the COVID-19 developments during 2020 the importance of the topics discussed are perhaps even more significant given the uncertain economic and evolving legislative environments.