On April 30, 2020, the Pensions Regulator published its 2020 funding statement for defined benefit (DB) schemes with valuation dates between September 22, 2019, and September 21, 2020. However, these COVID-19 times are challenging for all businesses, and the effects of the pandemic are relevant to all DB schemes.
The statement urges collaboration between trustees and employers to manage scheme funding impacts and to maintain a focus on the long term, particularly regarding planning and risk management. With the uncertainty of the COVID-19 crisis, effects will be marked on both the short-term business impact of the lockdown and the longer-term effect on the economy and stock markets. Heavy exposure to markets, and insufficient hedging, will mean a sharp fall in funding levels, and the Regulator expects contingency plans to be implemented where possible.
In all the current economic upheaval , the Regulator has made clear its intention to continue with its publication of a new DB funding code, although probably not until late 2021.
The Regulator sets out the five key areas of analysis for schemes from how post-valuation experience is taken into account, with a potential change to the valuation date, to benefit affordability, funding recovery plans and shareholder distributions. It clearly expects trustees to be front and centre of any employer plans made to deal with scheme funding and any actions taken in weathering the COVID-19 storm. It emphasises that trustee-employer collaboration is essential. It also warns that it fully expects trustees to ensure that the scheme is remembered as a creditor when employers begin to rebuild their balance sheets, having been supported financially by a deferment of scheme contribution payments.
Expectations of trustees
Having detailed its scheme specific considerations, the Regulator turns next to trustees. Paying the promised benefits is the key objective for all schemes, requiring both foresight and an integrated risk management framework. The Regulator expects trustees and employers to agree a clear strategy with this long-term goal in mind, recognising how balancing investment risk, contributions and covenant support may change over time. The first of the principal areas considered is the scheme’s long-term funding target (LTFT) and the Regulator explains its expectations in advance of the future Pension Schemes Bill. The LTFT sits above the scheme’s technical provisions, and will need to be considered for all schemes ahead of the appearance of the revised DB funding code, whenever that may now be.
The Regulator deals with covenant issues, and examines assessment, monitoring and covenant leakage in depth.
It makes clear that in return for the trustees’ bolstering of employers under financial pressure by deferring scheme contributions, it does not expect the scheme ultimately to be disadvantaged. It recognises that ongoing employer support is essential to enable trustees to realise the scheme’s objectives of paying all benefits to members but employers must play their part and compensate the scheme when their financial position improves in time.
Echoing previous statements, the Regulator continues to expect trustees to take an integrated approach to managing the three main areas of risk – investment, funding and covenant. This year, although this focus is continued, the Regulator expects scheme maturity to assume greater significance in setting future funding and investment strategies, as an increasing proportion of the membership reaches retirement age and draws benefits.
As before, the Regulator segments the DB scheme population into 5 categories in tabular form according to covenant strength, with each class then divided further according to scheme maturity. The table should be read in conjunction with both the current DB funding code and the Regulator’s recently published guidance on COVID-19. In the current climate it is likely that the trustees’ assessment of where their scheme now lies in the structure may well have changed from last year. Trustees should assess the impacts of both COVID-19 and Brexit so that they can judge which section of the table best reflects their scheme’s situation, thus indicating future action.
What schemes can expect from the Regulator
Although the Regulator has suspended its other planned initiatives, the principles remain important and will be kept under review when the work is restarted. Focus is now on understanding and supporting trustees in responding to the impact of the pandemic, while ensuring the employer easements it has made are not abused.
The statement concludes by reminding trustees and employers that its suite of powers include directing how a scheme’s technical provisions should be calculated, how a deficit should be funded and over what period. Such power can be used where there is a failure to agree the valuation assumptions or recovery plan, and investigations may be instigated where trustees or employers have not followed the expectations set out in the statement, codes and other guidance.
The Regulator is clear what its expectations are in trustees’ and employers’ approach to scheme funding during the current crisis and beyond. They are warned that they may well be called upon to justify their decisions on their current valuation process, providing evidence of robust negotiations having taken place.
The Regulator reminds trustees and employers of the extent of its moral hazard powers. Schemes must be treated fairly where employers seek to avail themselves of the Regulator’s current easements, with no abuse of the these relaxations being tolerated.
The Regulator packs its usual punch in terms of setting out what will, or won’t, be considered compliant. It explains how it envisages scheme treatment in circumstances of a weakened employer covenant. Trustees and employers need to take advice from their actuaries, lawyers and covenant advisers, in order to best cope with the economic fallout of the pandemic. Various forms of “covenant leakage” affecting the scheme’s funding position may attract the Regulator’s gaze, so decisions and approaches must be justifiable. It is likely that the eventual new DB funding code, together with the increased regulatory powers under the Pension Schemes Bill once it is enacted, will “up the ante” still further.
View the funding statement.