The Pensions Regulator (TPR) has issued its 2020 Annual Funding Statement (AFS) setting out their expectations from defined benefit (DB) pension schemes completing valuations with effective dates between 22 September 2019 and 21 September 2020 (Tranche 15 valuations). Paul Brice takes you through the key points.
TPR Annual Funding Statement: collaboration, caution and covenant
The statement is dominated by the impact COVID-19 is likely to have on DB schemes and how TPR expects trustees to take account of this when completing scheme funding valuations. In addition to the detail provided about appropriate funding strategies and formulating recovery plans, the following key messages are recurrent throughout the statement:
It is crucial that trustees and sponsors work together to manage the immediate impact on the pension scheme
The additional uncertainty, both in terms of short-term affordability and long-term economic impact increases the emphasis on sponsor covenant
Long Term Funding Targets (LTFT) remain important, albeit journey plans can be modified to reflect the current environment
The effective date of a valuation can have a significant impact on a scheme’s funding position and this is particularly true for Tranche 15. Schemes with a 31 December 2019 valuation date are expected to be slightly better funded than they were three years ago, whereas schemes with a 31 March 2020 valuation date are not likely to be in as favourable a position. TPR does not expect the full effect of coronavirus on the markets to be reflected in the funding position, however, the extent of the impact will be heavily influenced by the level of hedging in place and the scheme’s exposure to equities.
Although, for Tranche 15 valuations that are close to completion, trustees are not expected to revisit their actuarial assumptions. They are, instead, expected to reflect the current uncertainty in their recovery plan decisions, paying particular attention to sponsor affordability. Where valuations are further from completion, TPR expects trustees to take account of the current markets when considering the value of the scheme’s assets and liabilities, as well as any potential impact on the sponsor’s covenant.
In recognition that funding valuations with March and April dates will be challenging due to the difficulty trustees will have in forming a view on long-term asset returns, the strength of the employer covenant and affordability, TPR has suggested that trustees delay making decisions about their technical provisions until further clarity emerges. TPR does, however, make clear that any requests by sponsors to change the effective date of a scheme’s valuation to avoid quantifying the impact of the current climate will be questioned by TPR and should, therefore, be considered very carefully by trustees.
TPR has recognised in the AFS that the best support for a pension scheme is a strong employer. It expects recovery plans to be constructed with a focus on the affordability of the employer, while ensuring the scheme is being treated fairly.
Although back-end loaded or increasing-contribution structures have historically not been favourable, TPR acknowledges that it may see more recovery plans with increasing contribution structures linked to corporate recovery and with triggers based on factors such as free cashflow and payments to creditors. TPR also comments that the use of additional outperformance within recovery plan calculations should be considered very carefully given the uncertainty around predicting and achieving long-term investment returns at this time.
The TPR Annual Funding Statement makes it clear that, in TPR’s view, the current climate creates the need for trustees to carry out additional due diligence of the employer covenant to be able to form their own assessment of it and, unless they have the necessary skills to allow them to do this internally, they should appoint an independent advisor to provide this advice. Furthermore, TPR expects the frequency and intensity of covenant monitoring to be significantly increased.
The importance of stress-testing and scenario-planning to understand the impact on affordability is drawn out in the AFS and it is recommended that, where the sponsor also produces stress tests, that these are aligned with any Integrated Risk Management (IRM) scenario planning. Trustees are also advised to be vigilant of possible covenant leakage taking place, particularly for schemes that have long-term recovery plans due to current affordability issues. Where covenant leakage is not justified, TPR expects trustees to seek suitable protection for the scheme.
Despite the dominating message in this year’s AFS, there is also a reminder to trustees not to forget about the UK’s exit from the EU and the need to understand the impact any trade agreement negotiations could have on the level of covenant available.
In terms of involvement in scheme-funding valuations, the AFS states that TPR will risk assess valuation submissions, taking into consideration the overall risk profile of the scheme, as well as the sponsor’s ability to support it. It also reminds trustees that, despite the on-going consultation into the new DB funding code and the Pensions Bill, that is progressing currently through parliament, valuation submissions will be assessed against the existing legislation and guidance. The new DB funding code is not expected to come into effect until late 2021 at the earliest.
How we can help
Our pensions advisory team includes covenant, actuarial and IRM specialists, who can support you with your DB pension scheme. We also have our own software, IRM Gateway, which can be used to help trustees and sponsors understand in a visual way how all the components of their integrated funding strategy react individually and collectively to a variety of scenarios.
If you would like to discuss your upcoming valuation, the impact of coronavirus on the support available to your scheme or any other DB pension issue, contact Paul Brice.