17th February 2021

Expected surge in Covid-19 insolvencies may mask true health of DB landscape

Featured in PensionAge

Despite several recent high-profile corporate failures, and some of the most challenging operating circumstances imaginable for many companies throughout 2020, insolvencies in the UK have remained relatively subdued.

This is widely expected to change once the government support measures introduced in response to the Covid-19 pandemic are withdrawn, but how many corporate insolvencies would be a significant deviation from historic norms and be a serious cause for alarm?

The Insolvency Service recently published details of the number of company insolvencies in the UK in 2020, noting that for England and Wales “the total number of registered underlying company insolvencies in 2020 decreased to the lowest annual level since 1989” and this was “likely to be partly driven by the government support measures put in place in response to the coronavirus pandemic”.

It is important to keep these historic levels in mind as we move through 2021 and beyond. Moreover, there will need to be some adjustments in any assessment of the impact of Covid-19 on corporate insolvencies to allow for those businesses that would have gone insolvent in 2020 in the absence of the pandemic, as this is likely to distort any overly simplistic year-on-year comparator.

In other words, the Covid-19 support measures will likely have extended the lifespan of businesses that were destined to fail in more normal market conditions, so we may get a surge of two years’ worth of insolvencies showing up in the data this year.

If the number of company insolvencies in 2021 were to revert back to pre-pandemic levels, with no allowance for the ‘catch-up’ element, that would mean a year-on-year increase in company insolvencies of greater than 30 per cent.

This would seem to be an alarming statistic when we consider that there have been annual increases in company insolvencies in excess of 30 per cent in only three years since 1984 (1990, 1991 and 2008), but the artificially low position in 2020 is important context.

Of course, any figures on total corporate insolvencies mask the significant variation in the level of insolvencies by industry that occurs. We have seen the hospitality, travel and traditional retail sectors hit particularly hard by lockdowns and we don’t yet know how those sectors will fare as restrictions are loosened. Meanwhile, other sectors, such as pharmaceuticals and tech solutions, have shown impressive growth because of the pandemic.

Research from EY suggests that nearly two-thirds of UK listed companies with defined benefit schemes issued profit warnings last year. However, we are in unchartered waters and indicators that might have provided a reliable prediction of future corporate health in the past may no longer provide such a good guide to the future. Whether these companies can recover or not this year, it increases the pressure on trustees to focus on their endgame strategy and how they will secure their members’ benefits.

This can be particularly challenging for smaller schemes that lack the resources or economies of scale to limit the burden on their sponsors. However, individual schemes’ funding levels and strength of covenant will dictate the best course of action. If the sponsor is struggling, trustees need to seek advice and consider whether the underlying fundamentals of its employer covenant have truly been changed by the pandemic.

We may well see many headline-grabbing figures on corporate insolvencies this year, but only by looking at the underlying data more carefully will it be possible to tell if they are really a cause for alarm.

See the original article on PensionAge