Laura McLaren, Partner, Hymans Robertson says: “Today’s Annual Funding Statement is unlikely to cause a major stir, given that TPR’s been trailing many of the key points for some time. Nevertheless, there are some useful prompts on how defined benefit schemes should be approaching 2022 valuations in the current landscape. Recent market performance means funding remains on track for many – and an increasing number of schemes will be approaching fully funded on a technical provisions basis – but events of the last few years are a reminder that things can, and do, change quickly. We’re therefore supportive of the overarching message to trustees and sponsors to focus on developing robust long-term plans and managing risks.
“It’s no surprise that the Russian and Ukrainian conflict, as well as the lingering effects of COVID-19 and Brexit, are notable themes. High inflation and slowing economic growth will impact the outlook for scheme assets and liabilities. They will also be key drivers of employer covenant and how much employers can pay in pension contributions. Whilst there may be limited impact on many businesses and sectors, others will be feeling the squeeze – particularly those that are heavily exposed to Russian or Ukrainian commodity markets or have impacted supply chains.
“With so much uncertainty, it’s hard to see many schemes emerging from 2022 valuations without more defined contingency plans in place. This has been best practice for some time but is increasingly becoming more commonplace. So, expect to see more triggers to kick in cash linked to items like funding falling behind plan or changes in shareholder distributions.
“On the liability calculations themselves, there are warnings to take care if building in ‘off market’ inflation adjustments, but there is now recognition that allowing for a slowdown in longevity relative to pre-COVID expectations can be reasonable. It seems clearer that the pandemic now represents a previously unanticipated headwind – both in terms of mortality directly related to COVID-19 and the knock-on effects on health care systems and the wider economy. As such, we are pleased to see that TPR has softened last year’s early ‘hang fire’ stance on longevity slowdowns, and will accept liability reductions of up to 2% relative to pre-COVID expectations can be justified.
“TPR continues to focus on the equitable treatment of the pension scheme, with clearer steers than in previous years on their view of reasonable shareholder distributions relative to deficit recovery contributions. Shareholder distributions should only exceed deficit recovery contributions if the pension scheme has a strong funding target and a relatively short recovery plan (under 5 years is given as an example). Whilst this provides some more clarity for corporates, uncertainty does remain as “strong” and “relatively short” are not defined.
“Finally, TPR’s new funding code of practice only gets the briefest of mentions and only to confirm that the second consultation on the draft code is still expected to be launched later in 2022. Therefore, whilst TPR continues to consistently signpost its direction of travel in statements such as this, trustees and sponsors will need to wait a bit longer for the long-awaited final detail to emerge.”
Matthew Arends, partner and head of UK Retirement Policy at Aon, said: “The Annual Funding Statement is now established as effectively an Annual Risk Management Statement – containing as much focus on covenant as funding and investment risks. There should therefore be no surprises or significant change for well-governed schemes which have already considered the impact on their risks from COVID-19, Brexit and the geopolitical climate.
“TPR recognises that employer- and scheme-specific circumstances need to be taken into account in setting recovery plans, and it has also given a reminder on the deficits versus dividends debate, emphasising the need for fairness between stakeholders.”
Matthew Arends continued: “As always, schemes will need to consider their assumptions for interest rates, inflation and longevity in valuations, in the light of current circumstances. However, TPR has flagged that it doesn’t expect schemes to make very large allowances for lower life expectancies due to COVID-19.”
Lynda Whitney, partner at Aon, said:
“TPR’s supporting tables of key risks and actions by type of situation remains essentially unchanged. One interesting exception is that for companies with strong covenant ratings, TPR has introduced some extra precision by reducing its expected Recovery Plan length to “six years” from “shorter than seven years”.
“In terms of implications for the Funding Code, it would seem that greater reference to covenant strength and risk is implied, and there is specific reference to a refresh of covenant guidance coming with the second Funding Code consultation. There is also potentially a greater connection with integrated risk management (IRM) – something which was barely mentioned in the first consultation.”
Jon Forsyth, Partner at LCP, added: “This year’s Annual funding statement is very much evolution rather than revolution, and while there is reference made to the current big issues the world is facing and how these risks should be considered by schemes, there is also an element of normal service resuming when it comes to industry and TPR expectations post pandemic. The Regulator is reverting to its slightly harder line around the expectations of fair treatment regarding size of pension contributions versus dividends, compared to its position during the pandemic, and there are more references to shorter 6-year recovery plans.
“The timetable for the much-awaited consultation on the new DB Code is still ‘later in 2022’. For the time being, the current regime applies, and we don’t expect the new regime to apply until valuations later in 2023, but we do expect trustees and sponsors will increasingly have one eye on the expectations of the new regime especially once more detail is known.”
On issues around mortality, Steven Taylor, Partner at LCP, commented: “It’s clear that the long-term impact of Covid-19 will take years to understand but this isn’t unusual in the context of other assumptions made by trustees, such as around inflation. There is now significant scheme and national level data to help trustees and sponsors form views on the potential longer-term impact of Covid-19 and TPR has now indicated for the first time that liability reductions of up to 2% may be justifiable if properly supported.
“For many schemes, this means that understanding the impact of Covid-19 could have a significant impact on funding requirements at upcoming valuations and could also feed into contingent funding mechanisms that are designed to reflect areas of uncertainty. For example, our research for FTSE100 companies shows that a 1-2% fall in liabilities might correspond to around a £1bn p.a. reduction in annual contribution requirements, if supported by appropriate contingency arrangements.”
Graham Newman, Scheme Actuary at Spence & Partners, commented: “The Pensions Regulator (TPR) latest Annual Funding Statement, published today, recognises that current economic uncertainty and events will have an impact on pension scheme management.
“Spence sees short-term impacts for funding level volatility varying from scheme to scheme, so trustees and sponsors should certainly keep up to date with their scheme’s funding position.
“In the medium to longer term, with the new funding code on the horizon and TPR recommending schemes adopt a specific long-term strategy designed to deliver an agreed long-term objective, we would encourage trustees and sponsors to work now on their data cleansing, governance (e.g. making sure benefits are known and decisions are made on discretionary benefits) and investment strategy derisking etc. For schemes that have yet to consider their long-term objectives, now is the time to begin.”
Commenting on the new AFS, PMI President Lesley Alexander said: “The Annual Funding Statement correctly identifies the principal factors which trustees must face at this time. Trustees must address significant economic shocks arising from the continuing Covid pandemic, rising inflation, war in Ukraine and the ongoing consequences of Brexit. We are hugely encouraged that TPR’s message to trustees is pragmatic and constructive. In a period of dramatic shifts in economic conditions, changes to the employer covenant will be of critical importance.
“One significant change in this year’s AFS is the shift of emphasis away from just schemes with long-term deficits to address specifically those schemes which are close to completing buy-out. A comprehensive description of regulatory expectations coving the entirety of the funding journey is very welcome in guiding trustees about TPR’s expectations of them.
“At the same time, the AFS identifies factors which complicate the tasks confronting trustees as they seek to balance the competing priorities raised by the current economic environment. More than ever, this demonstrates the importance of effective trustee education in ensuring that trustee boards are adequately equipped to address the crucial decisions which now confront them.”
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