The Pensions Regulator (TPR) published its 2021 Annual Funding Statement (AFS) on 26 May 2021. The statement is relevant to the trustees and sponsors of all private sector defined benefit (DB) schemes but particularly for those with a valuation date between 22 September 2020 and 21 September 2021 (referred to as "Tranche16" or "T16 Valuations") and schemes undergoing significant changes that require a review of their funding and risk strategies.
It outlines how trustees should consider the long-term funding and investment of their scheme depending on the impact of COVID-19, Brexit, scheme maturity and the scheme’s funding position relative to its long-term target. The statement includes guidance on addressing these issues and sets out actions TPR expects trustees to take.
Overall, the key messaging is consistent with last year's statement, focussing on long term planning and risk management - with a particular emphasis on employer covenant.
Funding Positions generally
Encouragingly, the AFS states that over the three-year period to March 2021, it expects that funding levels for Tranche 16 schemes on their technical provisions basis will have improved. However, the position for individual schemes will vary depending on scheme-specific experience, valuation dates, funding assumptions and investment strategies and so each scheme will need to consider its position individually depending on its own circumstances.
Considerations for scheme undertaking a valuation
The AFS emphasises that Trustees should work with their advisers to understand the key underlying variables and how sensitive the valuation results are to different assumptions. The use of scenario planning is encouraged as part of their integrated risk management (IRM) framework to help trustees decision-making, assess risks and set up mitigation strategies.
The AFS also specifically outlines the key considerations for Trustees in relation to:
- Inflation – as result of the UK Statistic Authority's plan to align the Retails Prices Index (RPI) with the Consumer Prices Index including owner-occupier housing costs (CPIH), from 2030.
- Mortality – acknowledging the uncertain impact the COVID-19 pandemic will have on mortality for pension schemes and noting the impact is likely to be scheme specific.
The AFS notes that whilst short-term covenant visibility may have improved, trustees of DB pension schemes must remain alert to the risk of weakening employer covenants as uncertainties remain following a challenging year for businesses.
Reflecting a message that will be already be familiar to many, the AFS emphasises that trustees should consider obtaining independent specialist covenant advice where the covenant is complex or deteriorating, where the impact of Brexit appears significant or any COVID-19 related recovery is unclear.
TPR expects trustees to monitor employer covenant leakage and trustees are encouraged to ensure that they are familiar with TPR Guidance aimed at helping trustees protecting their schemes from sponsoring employer distress, discussed in our previous blog.
The AFS also stresses the importance of employers providing trustees with the information they need to assess covenant to enable appropriate and swift decision-making. The thinking is that this should benefit employers and scheme members alike. It may be the case, in our view, that this presents an opportunity for trustees to ask scheme employers to formalise information sharing arrangements, perhaps by putting in place written information sharing agreements or protocols.
Impact of COVID-19
The degree to which COVID-19 has affected a scheme employer is likely to be scheme specific and as the UK economy emerges from the pandemic, TPR envisages that employers will fall into one of the following categories:
- COVID-19 has had limited impact on the business.
- The initial impact of COVID-19 was material but trading has, or is, recovering strongly.
- · The impact of COVID-19 continues to be material.
Trustees will need to take a view on their employer's covenant, and their approach to the current valuation could vary depending on which category their assessment falls into.
For schemes falling into the third group, trustees should not assume there will be a full recovery in covenant support without good justification. For such schemes, appropriate review of the funding and investment strategies should be considered to reflect the updated views on the covenant and the current uncertainty.
For schemes falling into the first group, trustees are expected to take a 'business as usual' approach to setting recovery plans, and TPR would not expect to see deficit recovery contributions (DRCs) being reduced or recovery plan date extended.
For schemes in the middle group, trustees should carefully consider any requests to lower DRCs but would expect such requests to be short term with higher contributions in subsequent years limiting any extension to recovery plan end dates. Noting that all dividends and other forms of shareholder distributions, must stop while DRCs remain at the lower level.
The commitment to integrated risk management (IRM) remains as important as ever and trustees are encouraged to work with their advisers to develop and maintain the IRM framework and associated governance to assist with decision-making. This should focus on three broad areas of risk:
- the ability of the employer to support the scheme;
- the investment risks; and
- the scheme's funding plans.
Trustees are also reminded to consider the potential impact of Climate Change, Long-term funding targets, Scheme maturity and Governance (following implementation of the new single code of practice (expected to be late 2021)).
DB Funding Code Consultation
TPR confirms that it will await the conclusion of the DWP's consultation on the new funding regulations detailing the requirements in the Pension Schemes Act 2021 before publishing its second consultation on the new DB funding code of practice, to ensure that the code is consistent with the new legislation.
It does not expect the new DB funding code to be in place until late 2022 at the earliest. Until then, scheme valuations will continue to be submitted in accordance with the existing legislation and guidance.
With the consultations on the new funding regulations and the new DB funding code expected to take place later in 2021, scheme funding will remain firmly in the spotlight for the rest of this year. We will provide further updates on developments.
If you would like to discuss anything raised in this blog, please get in touch with a member of the pensions team or your usual contact at Brodies.