Offloading pension risk demands tighter rules

The Pension Protection Fund offers a sensible form of insurance. But by its nature, insurance creates opportunities for abuse. A payout owed when an adverse event occurs creates an incentive to bring about that very event.

The PPF pays compensation to members of UK defined-benefit schemes when the company sponsoring their plan becomes insolvent, leaving insufficient assets to pay what is owed. The risk is easy to see. A company in tight financial circumstances, yet still able to make good on its obligations, might see an insolvency that shifts its pension plan to the PPF as a quick way to increase its net worth.

This would not be a victimless bit of sleight-of-hand. The PPF is funded through an annual levy paid by all defined-benefit plans, and it caps the benefits it pays, often well below the amount owed by the original scheme.

So-called pre-pack insolvencies exacerbate these risks by offering companies an accelerated restructuring in which unsecured creditors (usually including the pension plan) have limited visibility and say in the process. The defining characteristic of a pre-pack is that a buyer of the company’s assets has been identified at the outset. Other companies can bid, but often hesitate to do so, assuming that the pre-selected company has the advantage of deeper due diligence.

The board of the selling company nominates an “insolvency practitioner”, usually an accountancy firm or consultancy, to administrate the sale and the compensation of creditors. Crucially, while the courts have to approve it, the practitioner in most cases only has a duty of care to whomever appointed it. It is not required to disclose its working papers until after the fact. Often only the approval of the secured creditors, typically banks or investment funds, is required for the insolvency to go ahead. Other creditors are left out.

Advantages of pre-packs is that they can happen quickly while the company continues to trade. This can protect jobs and avoid the creation of zombie companies where the business staggers on as the liabilities continue to grow.

As a Financial Times investigation shows, however, these advantages must be set against some worrying patterns of behaviour. The FT found that 17 per cent of the schemes that have entered the PPF since 2006 — covering 53,000 workers and £3.8bn in pension liabilities — ended up there as the result of a pre-pack.

Over the same period, 3 per cent of all insolvencies were pre-packs. Most tellingly, in two-thirds of the pre-packs that sent pension liabilities to the PPF, assets were sold to the original owners of the business rather than a third party.

The core problem of the system is that the insolvency practitioner is given incentives to look to the best interests of the board that appointed it, and the board in many cases serves at the behest of the secured creditors. While the practitioner’s fees are paid out of the proceeds of the insolvency, it has an incentive to satisfy the board with an eye to future fee opportunities, whether from the same set of owners and creditors, or another.

Good first steps for reform, then, would be making the practitioner a trustee representing all creditors. There should also be a dispute resolution mechanism available to creditors who take issue with the practitioner’s actions.

Finally, the working papers of the practitioner need to be public. Greater accountability and transparency may not solve all the conflicts inherent to the insolvency process but they would represent a step forward.