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The Pensions Regulator sets out its views on valuations against a challenging backdrop

Retirement|Pension Board and Trustee Consulting|Pensions Corporate Consulting

April 30, 2020

The Pensions Regulator has published its 2020 annual DB funding statement, which is relevant to trustees and sponsors of all private sector defined benefit (DB) pension schemes.

On 30 April 2020, 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 2019 and 21 September 2020. 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 these are very challenging times for many businesses; it notes the importance of trustees and sponsors working together to manage the immediate impact of COVID-19, but stresses that they should also retain a focus on the longer term.

TPR’s research suggests that funding positions at 31 December 2019 will generally have improved compared with three years ago, but that positions at 31 March 2020 are much more variable, with schemes that were heavily exposed to equities and interest rate risk having experienced a sharp fall in funding level compared with schemes with more de-risked asset portfolios.

TPR notes that it will consider issuing further guidance in the autumn as the current economic uncertainty evolves.

Technical provisions and long-term funding targets

TPR notes that March and April 2020 valuations will be challenging and that trustees might reasonably delay decisions until more clarity emerges over the prospects for future investment returns and the employer’s covenant. The statement is, however, silent on how TPR will react to schemes not completing valuations within the statutory deadline of 15 months. Schemes are still expected to proceed with as much of the preliminary valuation calculation and analysis work as possible and to consider their current investment and governance arrangements, rather than delaying everything.

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 economic variables
  • How sensitive the results are to different outcomes
  • Long-term effects.

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. As with last year’s funding statement, other schemes are encouraged to set a long-term funding target consistent with how the trustees and employers expect to deliver the scheme’s benefits in preparation for this being introduced as a legal requirement under the Pension Schemes Bill, which is currently making its way through Parliament.

Recovery plans

TPR suggests that trustees should deal with any changes in deficits alongside their assessment of the employer’s covenant, having carried out additional due diligence in accordance with TPR’s recent COVID-19 guidance, focusing on affordability while maintaining fair treatment of different stakeholders.

Where possible, TPR expects trustees to incorporate appropriate additional contributions that track any recovery in the employer’s financial health, especially when additional risk has been taken while supporting the employer's recovery.

TPR also suggests that it may be appropriate for additional contributions to be triggered based on future investment performance assumptions not being borne out, in particular where the recovery plan is based on more optimistic investment return assumptions than those in the technical provisions.

Shareholder distributions and covenant leakage

The statement emphasises TPR’s recent COVID-19 guidance on deferral of contributions and goes on to note that trustees should be vigilant of covenant leakage from dividends and other corporate activity that could reduce the employer’s ability to support the scheme. Where trustees consider the level of covenant leakage is not justified, TPR expects them to seek protection against the resulting deterioration in covenant, particularly where the covenant is already weak or there is a long recovery plan.

Where the employer seeks a longer recovery plan due to reduced affordability, TPR expects appropriate arrangements to be sought to ensure that covenant leakage to the wider group does not constrain affordability.

Covenant assessment, monitoring and contingency plans

TPR repeats its messages on covenant assessment from recent Annual Funding Statements, but with the added overlay of how COVID-19 has affected the covenant strength and affordability and the uncertainty over how long those effects might last.

TPR also notes that, for some businesses, the uncertainty over employer covenant may be heightened further by the manner of the UK’s departure from the EU – in such cases, it expects trustees to review the employer covenant to understand the potential impact of different outcomes of the trade agreement negotiations.

In current conditions, TPR expects the frequency and intensity of covenant monitoring to increase until such time as covenant visibility and strength is restored. Trustees should decide when action is required based on appropriate triggers, with contingency plans in place so that they can react appropriately. TPR expects trustees to be able to demonstrate that these triggers and contingency plans have been discussed with the employer through relevant documentation.

Managing risks

TPR continues to expect trustees to focus on integrated risk management across funding, investment and covenant.

As in last year’s statement, TPR sets out 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.

TPR expects maturity to assume increasing significance in setting funding and investment strategies, which is consistent with themes included in TPR’s ongoing consultation on its revised Code of Practice on scheme funding that is currently due to take effect at the end of 2021.

Post valuation experience

TPR expects schemes with valuation dates around 31 December 2019 to consider taking 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. TPR notes that positive and negative experience should be treated consistently, but is particularly concerned about consistency in the treatment of experience where trustees are considering requests for contributions to be paid at a lower level or over a longer recovery period due to taking into account a reduction in the employer’s affordability since the valuation date.

Changing the valuation date

In light of recent market conditions, some schemes with a valuation due on or around 31 March 2020 may be considering a change of valuation date. TPR notes that trustees should consider very carefully whether a change in valuation date is in the best interests of members, with legal and actuarial advice. If a change is made the trustees should consider taking account of changes in the scheme’s and employer’s position since the new date of the valuation and can expect TPR to question the trustees’ reasons for making the change.

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