Summary
The Pensions Regulator has published its annual funding statement, providing guidance for those schemes whose actuarial valuation dates fall between 22 September 2021 and 21 September 2022 (“tranche 17”), although it should be of interest to other schemes as well.
TPR notes that these valuations are being carried out in a period of high inflation, high energy prices, higher interest rates and slower economic growth – all of which may impact both scheme funding and employer covenant. Trustees should be aware of significant uncertainty arising from the situation in Ukraine, ongoing Brexit effects and the impact of Covid-19 on future mortality rates. Such uncertainty underlines the need for robust contingency planning.
Tranche 17 valuations may reveal an improved funding position, relative to expectations at the last valuation, and the statement reminds trustees that they should consider:
- their long-term funding target the journey towards it and
- the scheme’s liquidity needs should contributions cease.
TPR expects trustees whose schemes are undergoing valuations between these dates to comply fully with the existing version of Code of Practice 3 (scheme funding), as well as reading the guidance on investment, integrated risk management, assessing and monitoring employer covenant, the Ukrainian conflict and climate change.
Current valuations
TPR expects the funding position of schemes having valuations as at 31 December 2021 or 31 March 2022 to have improved since their last valuation. However, the position of individual schemes may be different from this and will depend on scheme-specific factors including the extent to which schemes have hedged their interest rate and inflation risk.
The statement provides guidance on the considerations to be borne in mind when trustees are setting discount rates, inflation assumptions and mortality assumptions. In particular, where trustees are adjusting assumed mortality rates to reflect the expected impact of Covid-19 in the longer term, TPR expects the resultant reduction in the value of the scheme’s liabilities to be no more than 2%.
When setting the journey plan to their long-term funding target, trustees should consider the extent of their reliance on the employer covenant over time, as this may involve a significant period of time.
Employer covenant
For smaller schemes TPR recognizes that the main source of information is likely to be company management, who should provide trustees with financial projections and business plans. Trustees should continue to undertake stress testing or scenario planning to understand the impact on the covenant of possible future economic environments. Such scenarios may include prolonged high inflationary and high interest rate scenarios and (where relevant) any impact from the ongoing conflict in Ukraine.
Trustees should consider the impact of current market volatility on the employer covenant and assess which of three categories applies to their employer. This categorisation should then inform decisions about deficit-reduction contributions.
- Current market events have had limited impact on the business, with no balance sheet weakening and strong cash flow. In such cases, TPR expects no reduction in deficit contributions and no extension to recovery plan end-dates.
- Current market events have had a material impact but trading has recovered strongly and the impact is expected to be short-lived. Any weakening of the balance sheet can be repaired over a short period and medium-term prospects have not been negatively impacted. Trustees should consider requests from the employer for short-term reductions in contributions as long as these can be offset by higher contributions later within the current recovery period. If contributions are reduced TPR expects there to be no dividends paid.
- The impact of current market events continues to be material and recovery may take years. Short-term affordability is stressed, the balance sheet has weakened and medium-term prospects are unclear. Where trustees agree to the deferral of or reduction in contributions, TPR expects them to obtain suitable mitigation.
Trustees should continue to be alert to covenant leakage, including the payment of dividends, especially if the covenant is weak and/or there is a long recovery plan in place. To provide context, TPR points out that the average recovery plan length for these schemes at their last valuation was 5 years.
In relation to corporate transactions TPR expects trustees to take a rigorous approach to assessing the impact of the transaction and to negotiate mitigation (where relevant) to protect the interests of members and ensure fair treatment with other creditors. If this happens at the same time as the valuation, mitigation for any negative aspects of the transaction should be considered separately from the valuation.
Risk Management
TPR continues to promote integrated risk management (“IRM”) of covenant, funding and investment, taking their scheme’s maturity into account.
The statement repeats the tables that appeared in the last three years’ statements, 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. However, references to 7-year recovery periods have been changed to 6 years, to reflect the fact that recovery plan lengths have reduced in recent years.