Defined benefit (DB) pension schemes need to take steps to be prepared for the possibility that their sponsoring companies will find themselves in financial difficulties, as UK business insolvency rates remain persistently high, LCP has said.

In light of the concerns, the consultancy urged trustees to take extra precautions in case their scheme sponsors reach "tipping point".

In a blog post, LCP partner and head of covenant Jonathan Wolff suggested that the number of companies that could become insolvent by the end of this year could reach levels not seen since 2009 in the aftermath of the global financial crisis.

He cited figures from The Insolvency Service, which recently reported that there were 6,208 registered company insolvencies between 1 July and 30 September 2023.

This figure was 2 per cent lower than in Q2 2023, but 10 per cent higher than in Q3 2022. The last two quarters saw the highest quarterly insolvency numbers since Q2 2009 — and the highest numbers of creditors’ voluntary liquidations since the start of the series in 1960.

The five industries that experienced the highest number of insolvencies in the 12 months ending in Q3 2023 were construction, wholesale and retail trade, accommodation and food service activities, administrative and support services, and manufacturing.

"Times are tough for businesses in the UK at the moment," Wolff wrote. "The high inflation environment continues to increase costs, and is also impacting company revenues as consumers have less disposable income to spend. Plus, increasing interest rates mean that borrowing costs have increased dramatically following a period of historically low levels."

With the UK base interest rate remaining at its highest level since 2001 at 5.25 percent, Wolff warned that the prospect of cheap debt returning anytime soon to provide companies with any respite appears unlikely.

And as many sponsors survived the first national lockdown by taking on cheap debt in the hope that better days would soon return, there is now a real prospect that a significant number of them will struggle to stay afloat over the next few coming months.

To prepare for worst-case scenarios, LCP said that trustees should take three practical steps to give schemes the best prospects of protecting themselves through these difficult times.

Firstly, in terms of governance, it is vital, according to the consultancy, that trustees have transparency and strong lines of communication with sponsors regarding financial data.

Given this, it said that documenting what information trustees will receive from sponsors, and when they will obtain this data, will help to get "everyone on the same page".

Secondly, trustees and their covenant advisers should use the information they receive from sponsors to understand when potential pinch-points could occur which may impact upon their position.

"This could include when cash flow forecasts project minimum headroom on borrowing facilities or when borrowing facilities are due to be renewed," Wolff stated.

"By considering the timeline of possible events in tandem with planned milestones on a scheme’s journey plan, strategies can be formulated to put the trustees in the strongest possible negotiating positions."

Finally, early engagement is crucial, as Wolff argued that trustees need to be proactive in raising their concerns with sponsors and how they propose that the scheme is protected.

Trustees should also think about what non-cash support is available. Early engagement can also provide time to consider innovative options — such as superfunds or capital-backed journey plans.

“In our day to day work we are seeing the macroeconomic environment playing out in practice in a number of situations," commented Wolff.

"Many sponsors who just about managed during Covid and were hoping for better days, are finding that there is currently no light at the end of the tunnel.

"While base rates look to be stabilising, they are still high compared to the recent past and so the prospect of cheap debt returning soon to help highly leveraged businesses appears unlikely.

“This means that many trustees and sponsors need to be braced for potentially tough times ahead. Taking our three steps and making sure that the right plans are in place is crucial.”

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