Laura McLaren, Partner, Hymans Robertson says: “With many of the themes familiar from recent TPR guidance, nothing in today’s Annual Funding Statement should come as a huge surprise to trustees and employers. However, TPR outlines how defined benefit schemes should approach 2021 scheme valuations. As consultation on the new DB funding code continues it’s the best indication of how scheme funding will be regulated in the short term and what will attract scrutiny.
“Markets have managed to look past the immediate COVID-19 disruption. Nevertheless, whilst most pension schemes have emerged from 2020 relatively unscathed in funding level terms, the fallout is still likely to be uncertain for some time. With industries and employers affected unevenly, and some hit particularly hard, sponsor covenant and affordability look set to be the factors that will split the valuation pack. Against this backdrop, it’s no surprise to see these being given particular prominence. Each scheme will need to consider its position individually and the importance of a robust audit trail and supporting evidence is mentioned several times.
“TPR is trying to strike a delicate balance between providing protection to members and enabling employers to focus on their business without overly burdening them. For many employers, the last thing they want to deal with after the last twelve months is a pension scheme valuation. Nevertheless, TPR remains apprehensive about companies putting off contributions and exposing members’ benefits to unnecessary risk. Trustees are going to need to be in a position to demonstrate to TPR that the risks they are running can be supported by the business their scheme relies on, that the scheme is being treated fairly and that they’ve explored all appropriate mitigations. Some ideas that were perhaps ‘off the table’ three years ago – such as non-cash security, contingent cash solutions and commitments to the treatment of the scheme compared to other stakeholders – may hold more attraction as companies look for ways to preserve cash.
“Beyond managing covenant impacts, there are some warnings to trustees to take care if building in ‘off market’ inflation adjustments, allowing for post COVID longevity gains that might not materialise or ignoring climate risk.
“Above all, TPR is clear that the focus should remain on long-term planning and risk management. With so much uncertainty surrounding investment markets, covenants and mortality rates, robust contingency planning will be key. Schemes which are fortunate to find themselves in a period of relative calm and recovery would be wise to take the opportunity to revisit long term plans and strategy, making sure these are fit for purpose and considering what actions could be taken to ‘lock-in’ recent gains and avoid any material deterioration.”
John Dunn, pensions director at PwC, said: “TPR notes that schemes with valuation dates around March and April 2021 will have seen an improvement in funding levels since the last valuation, echoing our own analysis of the aggregate funding position for the 5,000-plus corporate defined benefit schemes which showed a surplus of £30bn at the end of April 2021.
“The statement continues to encourage trustees and sponsors to focus on the longer term funding target. As a result of improving funding positions, some schemes with valuations in this cycle may discover that they can reach their long term goal quicker, with less sponsor cash, and by taking less investment risk than previously thought.
“It also highlights two assumptions that will need extra consideration in current valuations: inflation because of the recently announced alignment of the calculation of RPI with CPIH in 2030; and life expectancy forecasts as a result of the uncertainty that Covid-19 brings to setting this assumption. It’s helpful that the regulator is encouraging trustees and sponsors to focus on a range of outcomes and to understand the risk of adopting different assumptions in the valuation rather than point estimates.
“TPR continues to recognise that pension schemes are maturing and more of the assets need to be paid out as pensions from year to year. It’s clear that trustees should pay close attention to asset liquidity risks, stress testing the assets to develop a robust plan to help ensure that cash is always available to pay members pensions.”
Victoria Tillbrook, pensions partner at PwC, added: “The news that the funding code is unlikely to be in force until late 2022 at the earliest leaves trustees and sponsors somewhat in limbo; not being clear how the Pensions Schemes Act will be applied in practice. We are already seeing this impact on the completion of transactions and scheme valuations. Trustees and sponsors are expected to second guess what the code might say and document accordingly - all to be judged, with the benefit of hindsight, at a later date.
“The suggestion that trustees might provide employers with some breathing space due to an uncertain outlook has gone. The statement refers to trustees as the first line of defence in protecting members’ benefits but this may well prove a challenge without the support of the new funding code.”
Matthew Arends, Head of UK Retirement policy at Aon, commented: “This year’s Annual Funding Statement goes well beyond issues only relevant to schemes with valuations this year. It has ballooned by 40% from about 3,300 words in 2020 (even in the midst of a complex COVID-19 scenario) to about 5,500 words in 2021 (both excluding the supporting tables) and the topics covered are a smorgasbord including climate change, liquidity, and distressed sponsors. A better title might be Annual DB Regulatory Statement as it covers such a wide range of important issues, not all of which are directly relevant to a valuation process.”
Lynda Whitney, partner at Aon, commented: “Diligent trustees working through all the items TPR wants them to consider at or around a valuation will face a challenging job. Trustees and their advisers will need to work through carefully which areas are essential to their valuation process, which are best practice (but can proceed alongside regardless of the valuation timeline) and which only apply to some schemes in specific circumstances, so may not apply to them. There is still a strong focus on integrated risk management and planning for the new own risk assessment, but the range of risks being considered is widening. The TPR does provide helpful guidance on mortality assumptions given COVID-19, by requiring justification for any deviation from the CMI approach of removing 2020 from projections. TPR does flag the potential need to have different inflation assumptions before and after 2030. The TPR does suggest that post-valuation experience needs to be considered in the round and if taken account of should typically reduce recovery plan length rather than reduce contributions.”
Matthew Arends continued: “For corporates looking at this Annual Funding Statement it will be hard to tell what TPR thinks are essential components of a valuation outcome and which are ‘nice-to-haves’, that if omitted are unlikely on their own to lead to TPR intervention. Equally, schemes between valuations will be left wondering to what extent the Statement applies to them. Given the important range of topics covered, much of it probably should. Overall, defined benefit schemes will need to read carefully to determine all their follow-up actions.”
Mercer Chief Actuary, Charles Cowling, said: “The Statement gives trustees a clear and strong call to action. On climate change, they will need to take action to consider and mitigate for climate change risks. On covenant risks, TPR is placing more pressure on trustees to consider taking independent advice and actively monitor covenant risks. TPR is also clear that it expects trustees to establish long term objectives and document their plans to meet those objectives, even before the introduction of the new funding code – now not expected before the end of next year. As required by law, TPR is also building on its IRM guidance to trustees to include a new requirement for regular “own risk assessments”, encouraging trustees to begin work on these now.
“Mercer will be working with all our clients to ensure that they are equipped to step up to these new requirements and can effectively manage the multitude of risks facing their schemes and, in due course, demonstrate this to TPR.”
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