Each spring, the Pensions Regulator (“tPR”) publishes its Annual Funding Statement on what it expects for defined benefit pension scheme actuarial valuations. With the recent 2020 publication, it is of particular interest to employers because of the COVID-19 pandemic.

Whilst aimed at pension schemes with valuation dates between 22 September 2019 and 21 September 2020, it is also relevant for schemes experiencing significant changes and which have to review funding and investment risk.

The importance of trustees and employers working together to manage immediate COVID-19 issues, while retaining a focus on the long-term is a key theme. The best support for a pension scheme is a strong employer.

Scheme specific issues

Each scheme is different so employers and trustees should consider the specific issues of their scheme. Recent market conditions may have impacted the scheme in different ways, depending on the scheme’s funding and investment strategy. Among the issues to consider are:

Post-valuation experience. Trustees need not adjust actuarial assumptions in the light of post-valuation experience (e.g. the impact of market conditions on scheme assets and liabilities and on the employer covenant). But tPR expects them to consider such experience in their recovery plans – with a focus on employer affordability.

Recovery plans and affordability. Trustees should carry out due diligence on the covenant in line with tPR’s COVID-19 guidance and their deficit recovery plan should focus on affordability, fair treatment and sustainable growth of the employer. As well as deficit recovery contributions, tPR expects trustees (where possible) to incorporate incremental contribution increases (linked to appropriate triggers and/or investment returns) that track the employer’s corporate health.

Shareholder distributions. If significant reductions in deficit repair contributions have been agreed by the employer and trustee (to support the employer), trustees are expected to:

  • ensure additional liquidity is not used to support associated companies unless this is beneficial to the employer supporting the scheme;
  • agree (and properly document) the payment of contingent contributions when shareholder distributions recommence and/or agree dividend blocks during the reduction period; and
  • understand how deferred contributions are to be repaid in line with protections.

TPR’s expectations of trustees (and therefore to be anticipated by employers)

Long-term funding targets. Many schemes have a long-term funding target, aimed at ensuring that the scheme is ultimately able to pay its members their promised benefits. TPR encourages employers and trustees to work together to develop a strategy to achieve their long-term funding target that recognises how the balance between investment risk, contributions and covenant support may change over time as the scheme gets better funded and more mature.

Covenant assessments. Covenant assessments by trustees should take account of both COVID-19, and the possibility of exiting the EU on WTO terms at the end of December 2020. Stress testing or scenario planning which reflects possible future economic environments might be appropriate for employers and trustees to undertake jointly, with affordability being assessed under each scenario.

Covenant leakage. There is a warning about covenant leakage. Trustees have to be alive to this. Dividend payments to shareholders, group trading arrangements or transfers of business or assets at an undervalue are typical examples. If the employer wants to propose a long recovery plan, they need to anticipate trustees checking for covenant leakage and seeking mitigation for the scheme.

To read our full update on the Pensions Regulator’s Annual Funding Statement 2020, please visit our website:

https://www.mayerbrown.com/en/perspectives-events/publications/2020/05/uk-pensions-regulator-publishes-annual-funding-statement-2020

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