Earlier this month the Pensions Regulator (“tPR”) released its 2019 Annual Funding Statement (the “Statement“) for defined benefit pension schemes. Its intended target – trustees and sponsoring employers who are undertaking triennial valuations between 22 September 2018 and 21 September 2019. However, in our view (as will become clear) it does no harm for all schemes and sponsoring employers to be taking heed of tPR’s latest thinking.
The Statement sets out specific guidance on how to approach a valuation, tPR’s view on some topical issues (see below) along with what trustees and sponsoring employers alike can expect from tPR over the coming year.
Oh, and it also mentions the dreaded “B” word (Brexit!), although this is more of a passing reference to tPR’s statement of 24 January 2019 which outlined Brexit-related steps that trustees and employers should be taking or at least thinking about. Like the rest of the population, tPR is monitoring Brexit developments and will issue further guidance if necessary.
Key points to come out of the Statement include:
Long Term Funding Targets (“LTFT”)
Trustees and sponsoring employers are encouraged to agree a clear strategy to reach a defined long term goal which balances/aligns the “holy trinity” of investment risk, scheme funding and covenant support over time. tPR calls this a LTFT and sees it as a journey plan/flight path which should go beyond full funding on a technical provisions basis. This thinking (currently best practice) is in line with the Government’s March 2018 white paper “Protecting defined benefit pension schemes” and is likely to become a compulsory requirement for all schemes. Formulating a long term destination now, in anticipation of this requirement being introduced is being actively encouraged.
Balancing Risks
As well as focusing on the “holy trinity” of risks mentioned above (investment, scheme funding and covenant support), trustees are encouraged to broaden their horizons in terms of integrated risk management. Scheme maturity attracts the spotlight as a particular area needing attention. As more members become pensioners, the benefits paid out increase as a proportion of scheme assets or liabilities and this can put a different complexion on the risks. These should be managed, especially investment volatility.
tPR has also pointed out that it does not assess the appropriateness of schemes’ technical provisions or discount rates based on predetermined relationships to gilt yields or other indices. Instead emphasis is placed on judging their suitability on the risks in their funding and investment strategies and how trustees appear to manage them.
The Statement actually includes a useful risk matrix for use by trustees in assessing where their scheme sits and what tPR expects in terms of the three risk areas. The matrix has 10 distinct groups or categories of scheme, each of which applies different expectations re. the three risk areas.
DB Funding Code of Practice
tPR remains on course to review and update the existing (published July 2014) DB funding code of practice by the end of the year. Consultation will begin in summer 2019 on various options for a revised funding framework followed by consultation on the new draft code itself.
Equitable Treatment
tPR remains concerned by the inequitable treatment DB pension schemes are receiving when compared to other creditors of sponsoring employers (i.e. shareholders). In particular, tPR remains concerned about the disparity between dividend growth and stable deficit recovery contributions (“DRCs”) as highlighted by recent high profile corporate failures where payments to shareholders were excessive compared to DRCs.
The Statement details the key principles behind tPR’s expectations as follows:
- where dividends and other shareholder distributions exceed DRCs, tPR expects strong funding targets and recovery plans to be relatively short;
- if the employer is tending to weak or weak, tPR expects DRCs to be larger than shareholder distributions unless the recovery plan is short and funding targets strong; and
- if the employer is weak and unable to support the scheme, tPR expects the payment of shareholder distributions to have ceased.
Long Recovery Plans
tPR intends to contact a number of schemes ahead of their 2019 valuations where existing recovery plans are considered unacceptably long. The schemes to be selected for this engagement will cover the whole spectrum of covenant strengths.
Other Interventions
tPR will continue to engage with other schemes during 2019 and not just those in a valuation cycle. Schemes will come under close scrutiny if there are concerns over funding and investment plans in the context of their covenant and scheme profile.
Trustees and employers: (i) should be fully prepared to justify their approach with evidence of robust negotiations having taken place; and (ii) need to be fully aware of tPR’s guidance set out in the Statement and wider funding materials.
Late Valuations
Trustees are expected to start their valuation process in good time and to follow a project plan that leaves sufficient time for advice, analysis and negotiation with the sponsoring employer. Trustees are reminded that they should not agree an inappropriate valuation merely because the statutory deadline is approaching or has been missed. Interestingly, tPR encourages trustees to make contact if they are pushed to do so by the employer or a third party.
tPR Powers
tPR uses the Statement to remind readers of its wide ranging powers which include: directing how a scheme’s technical powers should be calculated; how any deficit should be funded; one to one supervision; improvement notices; penalties; and anti-avoidance investigations.
The Southern Water case is mentioned as an example of tPR intervening in a situation where there was an imbalance between DRCs and dividends paid in 2016 and 2017. The eventual settlement reached involved Southern Water contributing an additional £50m to its pension scheme and the introduction of an equitable dividend sharing mechanism for the future.
Wedlake Bell comment
At 22 pages the Statement is longer than those issued in the previous three years. The long term journey plan/flight path has never been so important and in challenging market conditions, covenant, scheme funding and investment obviously need close monitoring. A collegiate, joined up approach from trustees and sponsoring employers is also promoted as being the order of the day and one of the optimal conditions for a scheme to be able to pay promised benefits. The high profile corporate failures referred to in the Statement obviously brought with them a certain amount of criticism of tPR’s role and function, hence the reason why dividend returns and equitable treatment features prominently as things that need to be monitored. We suspect also that the gentle reminder of tPR’s powers is more than that – in our view the gloves are off and one can expect a significant flexing of muscles where schemes are not following the spirit of tPR’s guidelines.