The Pensions Regulator has published its annual funding statement particularly relevant for valuation dates between 22 September 2019 and 21 September 2020 (tranche 15 valuations).
This statement comes at a time when COVID-19 continues to present challenges for the world at large. The regulator recognises that trustees and employers should be working together to manage the immediate impact of COVID-19 before turning their focus onto the long term, particularly around planning and risk management. It recognises that it is not possible to predict how long the current situation will continue or its further impact on pension schemes and employers. The Pensions Regulator is continuing to monitor the position and says that it will issue further guidance where needed.
The regulator comments on market movements during March 2020 and notes that many schemes may have been sufficiently hedged meaning they have been resilient to current conditions. Conversely, schemes which are heavily exposed to equities and not sufficiently hedged have experienced a sharp fall in funding levels. The regulator says it expects schemes in this situation to implement any contingency plans which they have in place.
Valuation assumptions and post-valuation experience
Where schemes are close to completing valuations, the COVID-19 guidance published by tPR in March does not require an allowance for post-valuation experience in relation to valuation assumptions but instead this can be allowed for within recovery plans. The AFS says that allowance for post-valuation experience will vary depending on the scheme’s valuation date. Schemes with valuation dates around 31 December 2019 or earlier, may be advanced with provisional valuation results and therefore when preparing recovery plans taking account of post valuation experience and particularly the impact on scheme assets and liabilities.
The statement recognises that schemes with effective valuation dates on or around 31 March 2020 may be concerned about the impact of unusual market conditions. Schemes in this situation could consider whether to bring forward the effective date of the valuation to an earlier date when conditions were considered more normal, for example, 31 December 2019). In doing so, trustees should take legal and actuarial advice and consider whether such a change is in members’ interests. Trustees should also consider taking account of changes in investment markets and employer covenant since the new date of the valuation. Where trustees move the valuation date, the Pensions Regulator will want to know the trustees’ reasons for that change.
In calculating technical provisions, the statement recognises that March 2020 valuations will be challenging not least because it might not be possible to form a view regarding long-term future returns. Similar challenges will arise in relation to employer covenant and affordability. The statement confirms that it will be reasonable to delay taking decisions about technical provisions or assumptions until more clarity emerges. Trustees should consider a range of possible future outcomes when considering technical provisions assumptions including: the rate at which economic recovery occurs, the period over which it occurs and additionally longer-term effects. These should be discussed with the scheme actuary.
It may be that trustees are comfortable with the underlying assumptions and can work with preliminary results, but these may need to be refined during the valuation period as the trustees are able to develop a view on investment returns and financial assumptions.
Recovery plans and affordability
In terms of recovery plans and affordability, trustees should carry out additional due diligence in line with the Pensions Regulator’s COVID-19 guidance. This is in order to form a view of the employer’s covenant and how it has been affected.
Trustees then need to deal with changes in the funding position alongside the assessment made of the employer’s financial position. The Pensions Regulator’s view is that trustees should be planning to recover the deficit focussing on employer affordability but balancing this against fair treatment of the scheme and sustainable growth of the employer.
The regulator’s expectation is that in addition to deficit repair contributions, trustees should incorporate appropriate incremental increases in contributions which track corporate health recovery particularly if the scheme has taken an additional funding risks whilst supporting employer recovery. Additional contributions should be based on appropriate triggers such as free cash flow and payments to creditors. In addition, additional contributions could be linked to investment performance.
Long-term funding targets
The Pensions Regulator also expects trustees to look ahead and set clear long-term funding goals, balancing investment risk, contribution and covenant support as well as considering how this balance may change as the scheme’s funding position changes and the Scheme becomes more mature.
Schemes which already have long term plans in place should continue to focus on those long-term plans albeit with suitable short-term changes. Schemes which do not have long-term funding plans in place should consider doing so. The Pensions Scheme Bill introduces a legal requirement for schemes to have a specific long-term strategy so those schemes who do not currently have a long-term funding target should consider putting plans in place in advance of the changes in legislation.
The statement emphasises the need for trustees to consider obtaining independent specialist advice, particularly where the employer covenant is complex, deteriorating or where the scheme has a high degree of reliance on the covenant because it has a large deficit. Where trustees take their own covenant assessment, they should fully document reasons for doing so. An audit trail of trustees’ considerations and decisions should be compiled and the Pensions Regulator may ask to see this.
In the context of covenant monitoring, trustees should recognise that employer covenant strength can change materially over a short period of time even outside of the current climate. Trustees should identify key aspects of employer covenant to track. Trustees should have contingency plans in place so that they can react appropriately, with agreed trigger points or thresholds.
Integrated risk management
The statement expects trustees to continue to manage the following areas of risk: employer affordability, investment risk and scheme funding. Trustees should work with advisers to develop an integrated risk management framework which provides a backdrop for trustee decision-making.
In the 2019 annual funding statement, the Pensions Regulator introduced tables setting out expectations depending on a scheme’s funding position, employer covenant and maturity of a scheme. These tables continue to apply and identify some of the key risks for trustees to focus on.
What should trustees be doing now?
For trustees with valuations covered by the statement, they should be starting to talk to their scheme actuary and any other advisers about the valuation timetable, and what impact the COVID-19 situation has on the valuation process. Trustees should consider the Pensions Regulator’s guidance regarding long-term funding, particularly given that this will become a statutory obligation in the future.