Summary
The Pensions Regulator has published its annual funding statement, providing guidance for those schemes whose actuarial valuation dates fall between 22 September 2019 and 21 September 2020, although it should be of interest to other schemes as well.
TPR clarifies that, although it is currently consulting on a new version of Code of Practice 3 (scheme funding), schemes with valuation dates between 22 September 2019 and 21 September 2020 (known as “tranche 15” valuations) remain subject to the current legislation and guidance.
There is additional guidance in this year’s annual funding statement about issues affecting the employer covenant, scheme funding positions and recovery plans, in the light of Covid-19. (See also our news article on the guidance.)
Current valuations
TPR expects the funding position of schemes having valuations as at 31 December 2019 to be better than three years ago. The position for schemes with valuations as at 31 March 2020 is less certain and will depend on the extent to which the schemes have hedged their interest rate risk and to which they invest in equities. Schemes with significant levels of equity investment and low levels of hedging are likely to see a deterioration in their funding level, while those whose investments are more de-risked are likely to see less of a deterioration or possibly a slight improvement.
For those schemes whose funding level has fallen significantly, TPR expects contingency plans to be triggered or, where there are no contingency plans, for trustees and employers to develop strategies to get back on course to meeting their long-term objective.
Post-valuation experience
For tranche 14 valuations (those with effective dates between 22 September 2018 and 21 September 2019) TPR does not expect trustees to revisit their valuation assumptions in the light of experience since the valuation date. However, it does expect trustees to take this into account when setting their recovery plan, in terms of whether proposed contributions remain affordable for the employer.
Schemes with tranche 15 valuations have more time to finalise their valuation and the Regulator expects them to take account of subsequent experience when setting the level of deficit contributions.
TPR notes that it will be reasonable for trustees with March/April 2020 valuation dates to delay taking decisions about their valuation assumptions until there is more clarity on future investment returns and on how the employer’s covenant might develop. They should consider the rate at which recovery happens and any longer-term effects of Covid-19 on the economy.
Changing the valuation date
TPR is not in favour of trustees adopting a different valuation date in order to achieve a different valuation result. Where trustees do decide to change their date:
- they should consider why they believe such an option is in the members’ best interests;
- they should evaluate the impact of any such change on member security, for example if the current conditions were to prevail for a long period;
- they should obtain and consider legal and actuarial advice,
- they should consider taking account of changes in employer covenant and investment markets since the new valuation date and
- TPR is likely to question their reasons for the change.
Recovery plans
TPR expects trustees to build in increases to deficit-reduction contributions, as employers recover from the effects of Covid-19, especially where the scheme has taken on additional funding risk while supporting the employer’s recovery. Additional contributions should be based on appropriate triggers such as free cash flow and payments to other creditors. Schemes may decide also to adopt additional triggers based on investment performance.
TPR expects also that dividends and other distributions to shareholders should cease while employers rebuild balance sheets and invest in their recovery.
TPR expectations for tranche 15 valuations
Ahead of the new funding code of practice, TPR repeats its expectation that trustees will develop a clear long-term plan for delivering benefits to members with minimal dependence on the employer’s covenant by the time their scheme is significantly mature. For most schemes this will be a plan to reach self-sufficiency or to be in a position to secure all the benefits with an insurer. TPR expects these long-term plans to cover schemes’ investment strategy as well as a funding plan. Technical provisions should then be stepping stones towards the long-term funding target.
In current conditions, TPR expects the frequency and intensity of covenant monitoring to be increased significantly until covenant visibility and strength is restored. Where the monitoring identifies adverse changes in the covenant, trustees should have contingency plans in place – ideally drawn up in conjunction with the employer – with agreed trigger points that will result in specified actions being taken (for example, additional contributions if the funding level deteriorates beyond a specified level). TPR may ask to see evidence that such interactions with the employer have taken place.
Where the employer is seeking a long recovery plan because of limited affordability, trustees should ensure that affordability is not constrained by covenant leakage, such as dividends or inter-company lending, and should seek appropriate agreement to prevent this.
Although TPR has suspended, temporarily, many of its regulatory initiatives, it will assess the risk in valuation submissions in a proportionate way. These risk assessments look at the overall risk profile of a scheme relative to the ability of the employer to support it and trustees should be prepared to justify their approach.
Risk Management
TPR continues to promote integrated risk management (“IRM”) of covenant, funding and investment, taking their scheme’s maturity into account, noting that, as schemes mature, benefit payments each year are likely to represent a larger percentage of a scheme’s assets.
TPR expects schemes to use scenario planning as part of their IRM framework, to assess risks and inform their decisions, including setting contingency plans. Smaller schemes should explore with their advisers how this might be achieved in a cost-effective way.
The statement repeats the tables that appeared in last year’s statement, in which TPR sets out its expectations in relation to funding, investment and covenant for schemes of different levels of covenant, funding position and maturity. In the current environment, TPR suggests that trustees decide first how, if at all, their covenant has changed because of Covid-19, how it could be impacted by Brexit and how good their funding position is relative to their long-term funding target given the period over which they are aiming to achieve it.