Covenant Checks

The Covenant Check section of the website contains information on our annual covenant reviews, why we do them and what they achieve.

If you are a pension fund looking for more information on the ways LPP can assist you with the issue of employer covenant checks then please visit the What We Do section to find out more and  to view a short video presentation.

  

LPFA hosted a joint webinar with Eversheds on the 5th September 2014 to consider what funds can do to prevent pension liabilities falling on other fund employers. 

A copy of the webinar slides can be downloaded here.

What is a covenant check?

A covenant check is a review of a number of different areas, and which helps to establish if an employer is able to meet its pension obligations now and in the future.  
 
The areas reviewed include some of the following; 
  • audited accounts
  • financial forecasts
  • credit ratings 
  • governance


Why do we do them?

Following the insolvency of a number of employers in the Fund, and with no guaranteed pension recovery mechanisms in place, the LPP, under its risk management strategy, has a responsibility to conduct annual covenant checks on all of its employers to determine its covenant strength in the Fund.

This is to ensure that every employer’s liability in the Fund can be met now and in the foreseeable future, and prevents the risk of any unrecovered liabilities having to be spread across the Fund to other employers at a subsequent Triennial Valuation.

The risk of having unrecovered liabilities in the Fund can have an adverse impact on other fund employers and so the LPP has a duty to ensure that this risk is mitigated.  

It also gives the LPP the opportunity to engage with employers and ensure that they are aware of their pension obligations when certain changes take place within their organisation, such as mergers or outsourcing exercises.



The Risk Based Strategy

At the 2013 Valuation, the LPFA developed and implemented a new risk based strategy, which involved using the outcome of the employers covenant check to determine LPFA’s perception of ‘risk’ associated with that employer. 

When the risk is determined the LPFA then groups the employer’s according to its ‘risk’ into a sophisticated categorisation system. The category system ranges from Category A, B and C with sub-categories within each category for added definition (please see our Funding Strategy Statement for details ).  Category A is deemed the most secure and Category C is deemed the least secure employers in the Fund. The LPFA’s actuary then assigns different discount rates for each of the Categories. 

At the 2013 Valuation, the discount rates applied ranged from 4.5% to 5.9%, with 4.9% being used for employers deemed at most risk (Cat C) and 5.9% being used for employers deemed most secure (Cat A).  

The discount rate categorisation helps to target the employer’s liability on a more prudent basis and this helps to ensure that the liabilities across the fund are minimised and there is minimum risk that these liabilities will not fall on other fund employers and ultimately tax payers.

The strategy also takes into consideration the recent changes in Local Government Pension Scheme Regulations which allows for Funds to review the cessation position for employers prior to them ceasing in the fund.  

One of the main purposes of the risk based approach is to mitigate the risk of employers remaining with large deficits and  for the fund to aim to become fully funded on an ongoing basis over 17 years. 

LPFA believes that this approach will be adopted by other Local Government Pension Funds in the future.



When do we do them?

The LPP conducts its covenant checks on an annual basis. The process consists of sending a declaration form to a key contact of a Fund employer (e.g. Finance Director), which is to be  completed and returned along with its latest audited accounts, forecasts and management accounts where applicable.

The returned information is then prudently reviewed by the LPP’s covenant specialist and actuarial team.



What do we check?

Once an employers completed declaration is received, then the LPP ‘s covenant specialist team will compare it to the declaration form from the previous annual covenant check, to determine if there are any material changes.
 
The LPP will also review the employer’s:
  • Dun & Bradstreet credit rating and the reason for any low score;
  • Annual financial statements and financial projections;
  • Most recent indicative cessation we hold for your organisation;
  • Active membership numbers for you organisation;
  • Any changes which may affect the validity of admission agreements and guarantees;
  • Any ongoing work we are carrying out for the organisation.
If any of these checks highlight potential risks then the LPP will contact the employer to discuss this, and either ask for further information, to provide us with the reassurance we need or look at ways to minimise any risk identified.  
 
More importantly, the outcome of the covenant check will determine the risk category an employer will be assigned to for the next Triennial Valuation.


What does it mean for you?

Carrying out annual covenant checks allows us to protect LGPS employers from potentially having to cover the liabilities of other organisations. 

To assist us in this we ask you to complete and return within 2 weeks the declaration form we send to you.

We may also ask you to provide us with further information or to work with us to look at different ways of minimising any identified risks.



How can you help?

You can help us to protect your organisation and the fund in a number of ways:

  1. Return your completed declaration form to us as soon as possible.

  2. We may ask you to provide further information to Dun & Bradstreet to look to improve your credit rating, which should be beneficial to you.

  3. We may ask you to work with us to find ways of improving your organisation’s risk by investigating options such as a one-off payment, paying money in to an escrow account, entering into a first charge arrangement or obtaining a guarantee from a parent company, funding body or Government department.

In general, you can also help us by informing the LPP of any material change to your organisation as soon as you are aware of it. Some key reportable events are:

  • A requirement to notify LPP of any matter which may affect, or is likely to affect, an employer’s participation in the LGPS.

  • A requirement for an employer to notify LPP of any actual or proposed change in its status which may give rise to terminating participation in the fund, including a take-over, reconstruction or amalgamation, liquidation or receivership and a change in the nature of the body’s business or constitution.

  • Breach of a banking covenant, except where the bank agrees with the employer not to enforce the covenant.

  • An employer deciding to cease business in the UK.

  • An employer who has plans to make changes to its organisation’s membership, for example large-scale redundancy exercises, or outsourcing tenders.



Working with other organisations

In developing covenant checks, we have established relationships with a number of other LGPS and Private Sector Funds to use industry best practice which is reviewed with our legal representatives on an annual basis.



New Developments

To develop the covenant checks further, the LPFA has recently developed wider sector covenant checks for Social Housing Associations, Charities, Schools, Academies, and Universities. The surveys will be issued to employers for completion at various points of the year to fit in with when financial information is submitted to Regulatory & Funding bodies. The new covenant wider sector checks  will ensure that the Fund highlights all risks that need to be addressed in a specific sector.