Verity v Wood: Why sponsors should keep their options open

As trustees and sponsors consider how to prepare, a key question is emerging: should employers be asked to commit today to contingent funding arrangements that may only become relevant if the judgment is unfavourable?

My view is that caution is needed.

Trustees are understandably seeking to manage uncertainty and protect member benefits. However, asking sponsors to sign up to contingent cash commitments before the court's decision is known risks locking organisations into a funding response before they have fully understood the strategic implications of the case.

This is because the Verity judgment is not simply a funding issue. It has the potential to influence the entire long-term direction of a pension scheme.

For some sponsors, an increase in liabilities could affect the affordability, viability or timing of a risk transfer exercise. Organisations that are currently considering a Superfund or insurance buy-in transaction may reach very different conclusions once the impact of the judgment becomes clear. Additional liabilities could alter the route and require a reassessment of endgame plans.

For schemes intending to run on, the implications could be equally significant. Higher liabilities may affect the pace at which funding levels improve and therefore delay the emergence of surplus. This could influence decisions around investment strategy, funding targets, journey plans and the whole surplus release framework.  With the forthcoming changes arising from the new surplus regulations, defined benefit schemes could potentially be the biggest donor to a not-for-profit organisation over the next 10 years so these decisions could prove critical.   

In other words, the appropriate response to the judgment may not simply be "pay more cash".

Sponsors may instead conclude that a different investment strategy is appropriate. They may wish to revisit valuation assumptions, covenant support arrangements or longer-term funding plans. Some may decide that a combination of measures provides a more balanced outcome than a straightforward increase in contributions. These are strategic decisions that should be taken once the facts are known, not before.

The issue is particularly important in the not-for-profit sector, where pension decisions have direct implications for an organisation's ability to deliver its wider purpose.

Through our work with affected employers, we have seen examples where the potential additional funding requirement being discussed runs into the tens of millions of pounds. While the eventual impact of the judgment remains uncertain, liabilities of that scale cannot be considered in isolation.

For charities, additional pension contributions could compete directly with spending on frontline services, grant-making activities and support for beneficiaries. Housing associations may need to balance pension funding against investment in new housing developments or improvements to existing homes. Independent schools could find themselves reconsidering capital investment plans or other strategic priorities.

These organisations exist to deliver social value. Any decision that involves committing significant resources towards pension funding should therefore be made with a full understanding of the available alternatives and the wider consequences for the organisation.

That is why flexibility matters.

Preparation ahead of the judgment is sensible. Boards should understand the issues. Finance teams should model potential outcomes. Sponsors should consider how different scenarios could affect funding, accounting and strategic planning.

But preparation should not be confused with commitment.

Agreeing contingent funding arrangements before the impact of the judgment is understood may inadvertently narrow future options. Once the outcome is known, sponsors and trustees should be able to have a broader discussion about the most appropriate response, considering funding, investment strategy, endgame objectives and the organisation's wider priorities.

In my view, sponsors should be preparing now, but they should also be preserving flexibility. The right response to the Verity judgment can only be determined once the outcome is known and its consequences are properly understood.  While it is prudent to plan for the potential consequences of Verity v Wood, sponsors should be wary of committing to contingent funding arrangements before they have had the opportunity to assess the full strategic implications of the court's decision. The judgment should inform future funding strategy, investment strategy and endgame planning, not the other way around.