Summary
The Pensions Regulator has published its annual funding statement, providing guidance for those schemes whose actuarial valuation dates fall between 22 September 2020 and 21 September 2021, although it should be of interest to other schemes as well.
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 and Covid-19. However, it encourages schemes also to consider their long-term objective, for reducing reliance on the employer covenant, ahead of that becoming a legislative requirement.
Current valuations
TPR expects the funding position of schemes having valuations as at 31 December 2020 to be broadly unchanged (in aggregate) from three years ago, while that for schemes with valuations as at 31 March 2021 is likely to have improved. However, the position of individual schemes may be different from this and will depend on the extent to which schemes have hedged their interest rate risk. Schemes with high levels of hedging are likely to have fared better to December 2020 but less well to March 2021.
TPR expects trustees to consider a range of assumptions, along with analysis of the sensitivity of the valuation results to changes in the assumptions, and recommends the use of scenario planning where proportionate. It notes the arguments put forward about the possible impact of Covid-19 on future life expectancy and encourages trustees to take a balanced approach to setting their mortality assumptions.
Where external developments such as Covid-19 or Brexit have had a limited impact on the employer’s business, TPR does not expect deficit-reduction contributions to be reduced or recovery plan lengths to be extended. Where employers are reporting strong cash flow generation, trustees should try and reduce the length of recovery plans, especially where they are long or where the scheme may be being treated inequitably relative to other stakeholders.
Post-valuation experience
Where trustees and employers are considering taking account of post-valuation experience when setting the level of deficit contributions, TPR reminds them that they should not “cherry-pick” a date to give the most favourable result. The statement points out that, where post-valuation experience has been positive, there is no guarantee that it will not turn negative shortly afterwards.
Employer covenant
TPR continues to expect increased frequency and intensity of covenant monitoring. 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.
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, noting that, as schemes mature, benefit payments each year are likely to represent a larger percentage of a scheme’s assets. This year TPR suggests that trustees should build the impact of climate change into their IRM framework.
TPR reminds trustees of schemes carrying out valuations now that legislation will require them, at some stage before their next valuation, to carry out and document their first Own-risk Assessment. Documenting their key risks at the present valuation and how they are managing them within an IRM framework should make this task easier.
The statement repeats the tables that appeared in the last two 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. In the current environment, TPR suggests that trustees decide first how, if at all, their covenant has changed because of Covid-19 and Brexit, how mature the scheme is and how good its funding position is relative to the long-term funding target given the period over which they are aiming to achieve it.