Employer’s Covenant ReviewThe Pensions Act 2004 places a requirement on trustees to assess the strength of the employer’s covenant at the time of the actuarial valuation and indeed at any time when they might be concerned that the employer is no longer a going concern. The Pension Regulator’s guidance to trustees of a scheme having a deficit is that they should negotiate with the employer in much the same way as would a bank having a large unsecured debt. The report to be requested is called an Employer Covenant Review (ECR).
The principal ingredient of the ECR is a forecast profit & loss account, cashflow and balance sheet. The latter is of the most use to check on how the other forecasts gel together. For example, how does the cash aspect of debtor and creditor movements in the balance sheet compare with the forecast turnover, cost of sales and operating costs? (see "How to read and interpret a profit & loss account"). The second most vital forecast is of the anticipated cashflow. Starting with the reconciled bank balance, examine critically all the forecasts of days in debtor recovery and days in creditor payments to test the feasibility of achievement. Especial emphasis must go on the "capital" elements of the expected forward cash such as interest rate changes, debt repayment deadlines or roll-overs and not least capital payments and commitments. It is vital to reconcile forecast profits with forecast cashflow.
No figures are better than the underlying assumptions on which they are based. Test these for realism rigorously. This means a shortish timeframe, usually only 1-2 years when compared to the maturity profile of a pension scheme. Where danger signals appear, liquidity outcomes are of the essence as is the pecking order of lenders to the company. An independent Business Review commissioned by a bank will always have payout priorities as a fulcrum. So also must the ECR.
jgs- 2009
