On 5 March the Pensions Regulator (TPR) released its 2019 Annual funding statement for defined benefit (DB) pension schemes. It is primarily aimed at trustees and employers undertaking valuations with effective dates between 22 September 2018 and 21 September 2019 (“Tranche 14”), as well as schemes reviewing their funding and risk strategies. It is longer and more detailed than previously.
Some of the key points are:
1. White paper
The Government’s white paper “Protecting defined benefit pension schemes” contained measures to improve trustees’ focus on long-term funding. TPR intends to review and update its DB funding code of practice as part of this initiative. However, in the meantime it still intends to regulate Tranche 14 valuations in accordance with the existing code.
2. Market conditions
Based on market movements over the last three years, TPR is expecting Tranche 14 valuation results to be fairly unchanged over the period, with schemes that have hedged interest rate and inflation risk likely to have fared better than others.
3. Long term funding target (LTFT)
The white paper sets out the Government’s intention for schemes to have a specific long-term destination. TPR is encouraging trustees and employers to look at journey plans for their schemes beyond technical provisions (TP) and agree a strategy for achieving a long-term goal. This could be, for example, to reach a level of funding where risks are minimised and the dependence on the employer is reduced, or even to aim to buy out benefits. The plan to attain the LTFT would involve aligning investment and funding strategies, firstly to become fully funded on a TP basis, then to go further than that. TPR will expect trustees and employers to provide evidence of this alignment.
4. Balancing risks
TPR continues to stress the importance of integrated management of the three key risks:
– employer covenant
– investment
– scheme funding
TPR stresses that trustees should also consider risks arising from scheme maturity. As more of a scheme’s membership become pensioners, some of the risks become more significant, e.g. investment volatility, and it expects schemes to take this into account in their funding and investment strategies.
TPR states that its focus is not on judging TP assumptions relative to gilt or other indices, but rather assessing how suitable they are in relation to the risks being taken and how the trustees are managing those risks. To do this it assesses the overall risk profile of each scheme.
5. Segmentation
TPR has expanded its approach to segmenting schemes and has defined 10 groups, segregated by:
– covenant strength
– funding strength
– maturity
Trustees are expected to decide which group their scheme fits into, with the help of their actuary if necessary. TPR has highlighted the risks each group faces and explained in much more detail than before what actions it expects from trustees and employers regarding covenant, investment and funding, including the LTFT. It recognises that sometimes different approaches are appropriate but suggests that trustees need to be able to justify this and produce evidence.
6. Equitable treatment
TPR remains concerned about unfairness in how schemes are treated compared with other stakeholders, in particular regarding disparities between deficit repair contributions (DRCs) and dividends to shareholders. It highlights recent corporate failings where recovery plans have been long and dividends excessive.
In this year’s statement TPR has been more prescriptive in its expectations: dividends should only exceed DRCs where the funding target is strong and the recovery plan short, and dividends should cease if the employer is weak and unable to support the scheme.
7. Long recovery plans
TPR intends to contact a selection of Tranche 14 schemes with long recovery periods to set out its concerns, ask questions and explain its expectations. It has defined long as being more than the average recovery plan length of seven years. The schemes selected will have a range of covenant strengths. TPR will form a view on an acceptable length based on maturity and covenant, for example a mature scheme with a strong employer will be expected to have a recovery period less than seven years.
8. Other interventions
TPR will continue to engage with schemes where it has concerns that funding or investment plans are not appropriate in context of their covenant and scheme profile. They will do this by assessing the overall risk profile of schemes. Trustees and employers need to be able to justify their approach and there should be evidence of robust negotiations where inconsistencies appear.
9. Late valuations
Whilst TPR stresses the importance of starting valuation processes in good time and following a project plan allowing for contingencies, it does not want trustees to make inappropriate funding decisions because they are pushed for time. It therefore expects trustees to engage with TPR as soon as they are concerned that the deadline may not be met. Although TPR can impose penalties and enforcement proceedings when deadlines are missed, it may choose not to where trustees have taken all reasonable steps.
10. TPR powers
TPR prefers to achieve good outcomes by engaging with trustees and employers. However, it includes in its statement a reminder of its powers for when this is not possible, which include:
– directing how TPs should be calculated
– directing how and by when a deficit should be funded
– one-to-one supervision
– improvement notices
– penalties
– anti-avoidance investigations
The 2019 Annual funding statement can be found here.