Well, you get a surety bond being used in an innovative way by a FTSE100 company to manage its pension scheme, funding issues and helping towards the stability of its pension scheme.
OK, that isn’t much of a joke – however well you tell it – but it is a great solution and a significant addition to the toolkit of pension schemes’ alternative financing solutions.
We recently acted for eight surety providers in a transaction brokered by Aon and in this guest blog Aon Hewitt partner Lynda Whitney shares her thoughts on this innovative strategy.
So what is a surety bond when used for a pension scheme?
A surety bond is a guarantee from an insurance company to pay a fixed sum to a pension scheme on conditions such as company insolvency, or non-compliance with the scheme’s deficit recovery plan. The term of the bond is typically one to five years, although the surety bond can be on the basis of “extend or pay” at the end of the term.
Why do companies like a surety bond?
Companies would often like to put less money in their pension scheme, either to control company cashflow or because they just believe the pension scheme has enough money. The company would like to convince the trustees simply to accept less cash, but rightly the trustees want some security in exchange.
The nearest competitor to the surety bond, in the wide range of non-cash solutions, is the bank letter of credit. Companies prefer the surety bond because they are accessing a different pool of capital, providing separation of day-to-day business from providing support to the pension scheme. In contrast, provision of a bank letter of credit is taken into account by the banks in their consideration of the availability or price of other finance available to the company as working capital.
Why do trustees like a surety bond?
Trustees often start from the idea that – as JFK is reputed to have put it – “The one unchangeable certainty is that nothing is unchangeable or certain”. So however much they believe that their sponsoring company will be there to support the members’ benefits, they have to consider what would happen if it was not. The surety bond gives them security in that worst case scenario. This allows them to be more flexible in their dealings with the company, for example around the length of the recovery plan or the level of risk in the investment strategy. Trustees also prefer the surety bond to the bank letter of credit as the surety providers generally have a notch or two better credit rating.
For more details on the use of surety bonds by pension schemes, click here.