“Trustees will welcome this guidance from tPR. It’s the first time the Regulator has provided comprehensive guidance in one place on how to assess and monitor covenant.
“Consistent with this latest practical guidance, we’ve been working with trustees and sponsors for some time now to understand the impact of covenant risk, the interaction between covenant, contributions and investment risks and to help them maximise the value from any assessment – to ask the right questions, understand when specialist help will add value and to robustly evidence the approach.
“While the guidance highlights that a long-term outlook is important, it doesn’t offer much practical advice on how to quantify long term covenant risk so that it can be integrated with analysis of other pension risks.
“We’ve recognised that understanding the impact of long term covenant risk is important but difficult to achieve in practice. We’ve developed a model which allows trustees and sponsors – for the first time – to properly quantify and integrate covenant risk into funding and investment decisions.
“The main risk to members not receiving their full benefits is sponsor default at a time when there’s a scheme shortfall. You can calculate the premium needed to protect the scheme in that situation.
“We do this for the proposed contribution and investment strategy. We then recalculate it for alternative strategies. This can highlight the benefits of previously unexplored strategies. For example, accepting a longer recovery plan with less investment risk can lead to better outcomes. Even though a scheme could be in shortfall for a longer period, you’re reducing the chance of that perfect storm of sponsor default at a time when market volatility has increased the deficit.”
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