- The Pensions Regulator (TPR) has published its annual funding statement for defined benefit (DB) schemes.
- The statement is relevant to trustees and employers of all DB schemes, but is primarily aimed at those undertaking valuations with effective dates in the period 22 September 2016 to 21 September 2017.
- In its statement, TPR gives notice it will be taking a more proactive and interventionist approach in future to its supervision of scheme funding.
TPR estimates that 85-90% of schemes undertaking 2017 valuations have employers who can manage their deficits and currently have no long term sustainability issues. In contrast, TPR believes that 8% of schemes are taking too much risk, which does not appear to be supported by the strength of the employer.
TPR expects trustees to take action depending on which group the employer falls into:
- Schemes with strong or tending to strong employers where the scheme’s funding position is on track and where technical provisions are not unduly weak and recovery plans not unduly long: trustees should, as a minimum, continue with their current pace of funding and not extend their recovery plan end dates unless there is good reason to do so.
- Schemes with strong or tending to strong employers with a combination of weak technical provisions and long recovery plans: trustees should seek higher contributions now to mitigate the risk of the employer covenant weakening and other scheme risks materialising in the future.
- Schemes with weaker employers who assume they have a strong covenant because they are part of a stronger and larger group of companies, but have no formal support in place: trustees should reduce risk to an appropriate level or secure additional funding or seek legally enforceable support.
Trustees of the 5% of schemes which are ‘stressed’, with a weak employer at risk of becoming unable to adequately support the scheme, should reach the best possible funding outcome taking into account the members’ best interests and the scheme’s specific circumstances. They need to fully evidence to TPR that they have taken appropriate measures (e.g. sought to maximise non-cash support).
VALUATION DISCOUNT RATE ASSUMPTIONS
TPR recognises that there is an ongoing industry debate about how to set valuation discount rates in current market conditions (i.e. very low gilt yields). Trustees should seek and duly consider robust advice from their scheme actuary on valuation discount rate assumptions. Trustees must ensure that the assumptions are prudent and should document clearly their rationale for retaining or changing the method used to set the discount rate.
Trustees should have a contingency plan in place detailing actions they would take in the event of a downside risk materialising. This is particularly important for trustees who decide to continue to run significant risk levels. This contingency plan needs to be agreed with the employer in advance and should be legally enforceable.
Trustees of schemes that are in a worse funding position than expected should check and, where necessary, implement the scheme’s contingency plan and take action when agreeing the next recovery plan (e.g. increasing contributions). Trustees should take ‘decisive action’ where the funding position has declined for more than one valuation, or if there have been significant adverse impacts. Trustees should also reassess the scheme’s exposure to risks and set an acceptable risk management plan.
TPR reminds trustees that investment and risk management solutions for small schemes have improved in recent years and encourages trustees to re-assess the possibilities. TPR also says that it will be increasing its focus on the protection of members in smaller schemes.
Trustees should focus on the ability of the employer to contribute additional cash to the scheme where the covenant suggests that this is feasible.
FAIR TREATMENT BETWEEN SCHEMES AND SHAREHOLDERS
TPR is likely to intervene where it believes that schemes are not being treated fairly (e.g. where recovery plan end dates are being extended unnecessarily or where total payments to shareholders are being prioritised and are restricting or reducing the level of contributions being paid to the scheme). Trustees need to ensure that contributions to the scheme feature prominently in their employer’s considerations and that its legal obligations to the scheme as a creditor are recognised ahead of shareholders. Where an employer’s total distribution to shareholders is higher than its deficit reduction contributions, TPR expects the scheme to have a relatively short recovery plan underpinned by an appropriate investment strategy that does not rely excessively on investment outperformance.
TPR will take a tougher approach to late valuations, particularly when delays could have been predicted or where trustees do not engage with TPR regarding the breach.
TPR has given notice it will be taking a more proactive and interventionist approach to its supervision of scheme funding, by improving the way it identifies cases that present the biggest risks to members, intervening early before recovery plans are submitted and quickly escalating its actions.
- Trustees and employers should use the statement to identify good practice approaches for their scheme.
- Trustees should identify the risks to which their scheme is exposed and take appropriate action.
- Trustees should ensure they have a contingency plan in place in the event of a downside risk materialising.
For further information, contact your usual JLT Consultant or Julian Rowe at email@example.com.