Introduction
On 30 April the Pensions Regulator (tPR) released its 2020 annual funding statement for Defined Benefit (DB) pension schemes. It is primarily aimed at trustees and employers undertaking actuarial valuations with effective dates between 22 September 2019 and 21 September 2020 (“Tranche 15”), as well as schemes reviewing their funding and risk strategies. tPR recognises that these are particularly challenging times due to effects of the COVID-19 pandemic which are still unfolding and is considering issuing further guidance in the autumn.
Some of the key points are:
DB funding code consultation
In March 2020, tPR launched the first of two consultations on its intention to review the DB funding code. This covered the proposed principles and regulatory approach and tPR has announced a three-month extension so that the consultation is now due to run until 2 September 2020. A business impact assessment will follow with the second consultation, which is due to be published in 2021, and tPR does not expect the new code to come into force until late 2021 at the earliest. All Tranche 15 valuations should be undertaken following existing legislation and guidance.
COVID-19 and funding positions
Many schemes and employers will have been affected by COVID-19 and tPR has produced specific guidance, which can be found here. tPR’s expectation is that valuation results at dates around 31 December 2019 should generally show improved funding positions relative to three years prior. However, tPR’s expectation is that many schemes preparing valuation results at dates around 31 March 2020 (which accounts for around 50% of Tranche 15 valuations) will show a deterioration in the funding position due to the unusually depressed market conditions. Schemes which have pro-actively reduced their investment risks are likely to have fared better than others.
Scheme specific considerations
- Post-valuation experience – tPR does not require schemes which are close to completing their valuations to account for post-valuation experience in their assumptions but expect it to be considered in their recovery plans. Any post-valuation experience should be applied consistently so that both positive and negative aspects are considered.
- Changing the valuation date – Trustees are expected to consider carefully whether bringing forward the valuation date (to mitigate the current unusual market conditions) is in the best interest of members and take legal and actuarial advice before making such a change. In any case, trustees would have to consider taking account of changes in investment markets and the employer covenant. tPR is likely to question trustees who change their scheme’s valuation date.
- Calculating technical provisions – tPR recognises that setting assumptions for Technical Provisions (TP) is challenging in the current climate and believes it reasonable for trustees to delay making decisions about TP assumptions until the economic future is more clear. However, they expect schemes to proceed with as much preliminary valuation work as possible and to consider a range of possible future outcomes when considering the TP assumptions.
- Recovery plans and affordability – Trustees should work with the employer to formulate recovery plans that consider any changes in affordability due to current circumstances but also include mechanisms for contributions to increase as the employers covenant improves. Working collaboratively with the employer is more important than ever before.
- Shareholder distributions – tPR expects that for many employers these have ceased or significantly reduced. Trustees should be open to requests to reduce or suspend Deficit Reduction Contributions (DRCs) but the treatment of the scheme should be equitable with other shareholders and subject to the principles set out in tPR’s COVID-19 guidance. If alterations to DRCs are made this should be properly documented including how deferred contributions are to be repaid.
Long-term funding targets
As set out in the 2019 statement, tPR expects trustees to agree a Long-Term Funding Target (LTFT) with the employer, which will set-out a strategy for achieving a specific long-term goal recognising how the balance between investment risk, contributions and covenant may change over time. tPR expects that schemes with a LTFT in place should be able to cope in the current climate with suitable short-term modifications and that trustees of schemes without a LTFT in place should be discussing this with the employer in advance of it becoming a mandatory aspect of scheme funding.
Covenant assessment and monitoring
Assessing an employer’s ability to support the scheme was already an important part of the funding process but due to the current COVID-19 pandemic and the UK’s impending departure from the E.U. uncertainty around covenant assessment has increased.
COVID-19 has resulted in considerable uncertainty over some employers’ covenant strength and their affordability to address deficits in schemes. However, the impact will be varied across the landscape and tPR anticipates some businesses will recover more quickly than others.
tPR expect trustees to consider obtaining independent specialist advice, particularly where an employer has been significantly affected in the current climate. tPR expects trustees who undertake their own covenant assessment to have sufficient expertise and to fully document their reasons for not taking professional advice as well as their conclusions.
Trustees should already have in place processes to monitor changes in employer covenant as part of their understanding of the risks that their scheme is exposed to. In the current climate, tPR expects that the frequency and intensity of such monitoring should be increased and that trustees should identify key aspects of employer covenant to monitor and set appropriate triggers or thresholds to identify what actions may be required. Trustees should discuss key risks with the employer and potential options on the breach of a trigger and be prepared to evidence such discussions to tPR.
Covenant leakage
tPR stresses the need for trustees to be vigilant of employer covenant leakage, which reduces the ability of the employer to support the scheme, and take appropriate actions where necessary. Forms of covenant leakage include:
- dividend payments
- cash pooling and inter-company lending arrangements
- group trading arrangements
- management fees, royalties and similar charges
- transfers of business or assets at undervalue
- excessive executive remuneration
Schemes with long recovery plans and limited employer affordability are more likely to be exposed to covenant leakage.
Managing risks
tPR continues to stress the importance of developing a framework which covers the integrated management of the three key risks (covenant, funding and investment) as well as considering the risks arising from scheme maturity.
Last year tPR introduced tables setting out its expectations and to help trustees match individual scheme circumstances with their guidance.
In the current context, tPR suggest that trustees should first decide how their employer covenant has changed because of COVID-19, how it could be impacted by Brexit, and how good their funding position is relative to their LTFT. This should enable them to find the table closest to their situation, tPR’s expectations of the risks they need to focus on, and the actions it expects.
Regulatory initiatives
Although tPR has suspended the regulatory initiatives announced in the 2019 annual funding statement, the principles behind these initiatives remain important and tPR will keep these under review.
Other interventions
Protecting members’ benefits remains the focus of tPR and it will continue to risk-assess valuation submissions and remind trustees and employers that they should be prepared to justify, explain and evidence the approach they have taken. tPR also took the opportunity to remind trustees and employers of the various powers it can use if good outcomes are not achieved for schemes.
The 2020 annual funding statement can be found here.
If you would like any further information in relation to the above, please get in touch with your usual Quantum Advisory contact or contact us at info@quantumadvisory.co.uk