On 26 May 2021, The Pensions Regulator (TPR) published its latest annual DB funding statement, which is relevant to trustees and sponsors of all private sector defined benefit (DB) pension schemes, but will be of particular interest to those undertaking an actuarial valuation with an effective date between 22 September 2020 and 21 September 2021 (referred to as ‘T16 valuations’). TPR also suggests that the statement is of relevance to schemes undergoing significant changes that require a review of their funding and risk strategies.
The statement recognises that COVID-19 and Brexit have presented challenges for some businesses, but it notes that others have not been affected as significantly. Continuing the theme from last year’s statement it notes the importance of trustees and sponsors working together to manage unexpected events, but stresses that they should also retain a focus on the longer term.
TPR’s research suggests that the aggregate funding levels at 31 December 2020 for T16 schemes are broadly unchanged compared with three years ago, but with schemes that had hedged interest rate and inflation risk generally faring better than unhedged schemes. TPR also notes that funding positions are likely to have improved over the first quarter of 2021 due to rising gilt yields and rises in equity markets, resulting in potentially different effects for schemes with December 2020 and March/April 2021 valuations. Experience will however vary significantly from scheme to scheme depending on a number of factors.
The statement includes a reminder that the current funding regime applies until all the new legislation and the revised DB funding code come into force. TPR does not expect the new code to come into force until late 2022 at the earliest and will therefore regulate all T16 valuations in line with the existing legislation and guidance.
When it comes into force, the new funding legislation will introduce additional powers for TPR and deterrents against behaviour that risks members’ benefits. Trustees and sponsors are encouraged to engage with any consultations that are carried out.
A range of possible future outcomes should be considered when setting assumptions and trustees should discuss with their advisers the key assumptions used in any models to understand the key underlying variables and how sensitive the results are to different outcomes.
TPR also encourages schemes to explore the use of scenario planning as part of an integrated risk management (IRM) framework, including the effect that future economic circumstances can have on the sponsor’s covenant and the scheme’s demographics, as well as the effect on investment returns.
The statement draws particular attention to the assumptions made about price inflation following the Government’s November 2020 announcement on RPI reform and about mortality.
For most schemes the effect of COVID-19 on mortality rates to date is expected to have a relatively small effect on liabilities, but TPR notes the possibility of differing views on the course of future changes in longevity. TPR expects any changes to mortality assumptions to be justified and if there is any material weakening of the assumptions that trustees should consider putting in place monitoring and contingency plans.
TPR encourages those schemes that already have a long-term funding target in place to continue to focus on this with suitable short-term modifications. Other schemes are encouraged to set a long-term funding target consistent with how the trustees and the sponsor expect to deliver the scheme’s benefits, in preparation for this being introduced as a legal requirement under the Pension Schemes Act 2021.
As in last year’s statement, TPR notes that schemes can take account of how developments after the valuation date have affected the scheme’s assets and liabilities and the sponsor covenant when preparing a recovery plan. This may include allowance for known mortality experience. TPR notes that positive and negative experience should be treated consistently, but also flags that it expects trustees who have allowed for positive post-valuation experience at a previous valuation to consider any material negative post-valuation changes at subsequent valuations.
Allowing for favourable post-valuation date events is expected to reduce the length of the recovery plan rather than the level of annual contributions.
TPR’s expectations for recovery plans depend on how the sponsor has been affected by events such as COVID-19 and Brexit:
The statement includes a reminder of TPR’s previous guidance on sponsor requests to suspend or reduce deficit contributions; this guidance is also now expected to apply to any requests from the sponsor that are intended to take advantage of the changes to corporate taxation announced in the March 2021 Budget statement that come into effect over the next couple of years.
TPR repeats its messages on covenant assessment from recent annual funding statements, but with additional emphasis on understanding how COVID-19 has affected the covenant strength and affordability both in the shorter and longer term, taking into account the sponsor’s financial projections and updated business plans.
TPR will be engaging with schemes if it has concerns over corporate distress and urges trustees to review its guidance on protecting schemes from sponsoring employer distress.
TPR also notes that, for some businesses, the uncertainty over employer covenant may be heightened further by the UK’s departure from the EU – in such cases, it expects trustees to review the employer covenant to understand whether the impact is short term or represents a more fundamental challenge.
TPR encourages trustees to continue with more frequent and more intense monitoring of the sponsor’s covenant until such time as covenant visibility and strength are restored to more stable levels. Trustees should decide when action is required based on appropriate triggers, with contingency plans in place so that they can react appropriately.
Trustees should be prepared and ready to act in the event of corporate activity, which is expected to increase as the recovery from COVID-19 progresses. Trustees should take a rigorous approach to assessing the impact of transactions and negotiate appropriate mitigation, independently of the valuation.
TPR continues to expect trustees to focus on integrated risk management across funding, investment and covenant.
Trustees are expected to consider the impact of climate change in their IRM strategy; climate considerations could potentially affect valuation assumptions, the scheme’s investment strategy and the sponsor covenant.
As in last year’s statement, TPR has included a series of tables providing additional guidance on the key risks that trustees and employers should focus on and expected actions, depending on the sponsor’s covenant strength, the scheme’s funding and investment characteristics and its maturity. These tables are substantially unchanged from last year’s statement.
TPR expects maturity to assume increasing significance in setting funding and investment strategies, including analysis of a scheme’s liquidity risk.
Trustees are reminded that under current proposals most schemes will need to carry out and document an Own Risk Assessment (ORA) within 12 months of TPR’s new single modular code of practice being implemented, which is likely to be in late 2021. TPR believes that documenting the scheme’s key risks and how they are managed as part of this valuation will make the task of preparing an ORA easier.
