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Article | Pensions Briefing

How are the events of 2020 going to affect pension scheme funding?

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By Graham McLean | October 20, 2020

We explore findings from our latest defined benefit survey and explore why pension scheme funding and investment issues were ranked as a top priority for trustees and corporate sponsors.

As we embrace the final quarter of 2020, few of us will mourn the passing of a year that has seemingly done everything possible to blow pension schemes off course and to make discussions on funding and longer-term objectives more challenging than ever. At the same time, The Pensions Regulator has been sharpening its pencil on a new Code of Practice on funding that is set to put increasing pressure on schemes by introducing the most significant changes to the funding regime since the current framework was introduced in 2005.

Against that backdrop it’s no surprise that our latest research shows funding and investment issues dominating the top five priorities for Trustees and corporate sponsors over the next 12 months and beyond.

Upcoming valuations look set to repeat many of the themes that we have seen in 2020, with volatile funding positions for many schemes, combined with continued pressure on the support that the sponsoring employer is able to provide. Our research shows one quarter of schemes expecting to have to increase the period over which their deficit is paid off, with a similar proportion expecting higher deficit contributions. The Regulator is undoubtedly going to keep a close eye on those kinds of statistics as it starts to reinvigorate its engagement activity with schemes, with those that paused contributions earlier in the year perhaps likely to come under closer scrutiny as they head towards their next valuation.

If those views persist, we could see an increasing number of schemes re-evaluating their longer-term ambitions.”

Graham Mclean
Head of Scheme Funding

Just over a third of schemes believe that the sponsor’s ability to support the scheme has weakened in the short term. Perhaps of more concern though is that one in six believe that the sponsor’s support is going to be weaker in the long term. If those views persist, we could see an increasing number of schemes re-evaluating their longer-term ambitions and whether they are planning to run the scheme off, target buyout with an insurer or explore the option of using a commercial consolidator.

Perhaps the most surprising finding from our research is the difference between trustee and corporate views on how quickly schemes will be able to reach their long-term goals; almost two-thirds of trustee respondents expect to reach their goal within nine years, compared to less than a third of corporates. Almost 40% of corporate respondents now expect goals to be achieved 15 or more years out, compared to only 10% of trustees. With the widespread use of sophisticated funding tracking and projection tools such as our Asset Liability Suite software, that disparity seems unlikely to be down to different views on how funding positions have been affected by events in 2020. It is perhaps instead a signal that trustees’ and corporates’ starting positions at the next round of funding negotiations are going be wider apart than for many years. Whatever the remainder of the year brings, it seems clear that trustees, sponsors and advisers are going to have to work closely together with a willingness to explore creative solutions and embrace more flexibility than ever before if they are to find common ground.

Overview of scheme funding in 2020

Graham Mclean, head of scheme funding, talks us through the impact on pension scheme funding due to the ongoing pandemic and what other factors need to be considered.

Although a new Code of Practice is unlikely to be in force any earlier than the end of 2021, many schemes will still have one eye on the Regulator’s direction of travel when negotiating valuation outcomes. Our research shows a clear difference between trustee and corporate expectations on the key element of TPR’s proposals, with almost a half of trustees thinking that they are likely to follow the ‘Fast Track’ approach, but only 10% of corporates sharing that view. Separate surveys that we have carried out in 2020 also suggest that there could be a very different picture for the largest schemes, with more than two-thirds of those over £5bn likely to follow the ‘Bespoke’ approach. Our experience of current funding arrangements also suggests that unless trustees and sponsors agree to strengthen key elements, the proportion that would be able to meet the Fast Track criteria illustrated in TPR’s first consultation could be somewhat lower than TPR might be envisaging.

Much will depend on how onerous the Fast Track criteria are. We should find out more when TPR publishes its next consultation, expected next year, with the Regulator having said that the Fast Track parameters “must very clearly take account of the economic position that we are in at the time”.

There is, however, a clear consensus between trustees and sponsors that the Bespoke approach should truly be bespoke, with over 70% of respondents to our survey agreeing that it shouldn’t be tied to a prescribed regulatory standard like the Fast Track requirements. The Regulator’s consultation argues that the schemes going down the Bespoke route should have to demonstrate either that that they cannot comply with Fast Track, or that the agreement is as strong as Fast Track overall, or that any additional risks are mitigated. Reducing the evaluation of scheme funding agreements to a yardstick comparison in this way seems at odds with the unique, nuanced and multidimensional nature of each scheme’s circumstances. Moreover, the events of 2020 highlight the difficulty of setting robust Fast Track criteria that do not need updating almost continuously.

It’s also interesting to note that over half of both trustee and corporate respondents expect the new regulatory approach to lead to higher contributions, in spite of the Government having previously signalled that the current system is working well for the majority of schemes and that a tougher approach was only needed for a ‘few’ schemes. The industry will be watching closely to see how political and economic winds affect the Regulator’s position at what could prove to be a critical juncture for UK pension schemes.

Contact

Graham McLean
Head of Scheme Funding

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