The Pensions Regulator (“tPR”) has published its Annual Funding Statement 2020 (“Statement”). The Statement is especially relevant to pension schemes with a valuation date between 22 September 2019 and 21 September 2020 (these are Tranche 15/T15 valuations). It is also relevant to pension schemes experiencing significant changes and which have to review funding and investment risk. Unsurprisingly, COVID-19 and covenant feature throughout. As a general statement, tPR says it is important for trustees and employers to work together to manage immediate COVID-19 issues, but retaining a focus on the long-term.
Scheme specific issues
Key points on scheme specific issues for trustees and employers of defined benefits schemes to consider are set out below.
1. Post-valuation experience. Whilst trustees who are close to completing their valuation are not required by tPR to take account of post-valuation experiences, trustees are expected to consider post-valuation experience in their recovery plans with a focus on employer affordability. Post-valuation experiences should be applied consistently, taking account of positive and negative experiences. Factors include the significant impact of market changes on assets and liabilities and employer covenant.
2. Changing the scheme valuation date. Trustees thinking of changing the valuation date due to the unusual market conditions should consider this carefully, particularly whether this is in the interests of scheme members and how such a change will impact on the security of members benefits. TPR can be expected to question the reasons for any change.
3. Calculating the technical provisions (“TPs”). For schemes with March and April valuation dates, it may be reasonable to delay making decisions about TPs on the basis of the considerable market uncertainty and lack of information to form views on, for example, long term future investment returns and employer covenant. TP assumptions should be based on a range of potential future outcomes and the different paths of economic recovery. Trustees should understand the underlying assumptions, so that they can understand underlying economic variables, sensitivities around the preliminary valuation results and long-term effects.
4. Recovery plans and affordability. Trustees should carry out due diligence on the employer covenant as set out in tPR's COVID-19 guidance, and there is a recognition that the impact on the employer’s corporate health could vary considerably from partial deterioration to a complete shutdown. Having done this, trustees should look at the deficit alongside the covenant assessment and plan deficit recovery focusing on affordability, fair treatment and sustainable growth of the employer. TPR also expects trustees to apply incremental additional contributions (linked to appropriate triggers and/or investment returns) that track the employer’s corporate health.
5. Shareholder distributions. Where trustees have agreed significant reductions in deficit repair contributions to support the employer, the trustees should consider the following:
- Additional liquidity should not be 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
1. Long-term funding targets. Schemes with long-term funding target plans are encouraged to continue focusing on those plans with short-term modifications that take account of the current environment. Other schemes are encouraged to set long-term funding targets in line with how the trustees and employer plan to deliver the benefits.
2. Covenant assessments. When assessing covenant, trustees should take into account both COVID-19, and the likelihood of the UK leaving the current transition period with the EU in December 2020 without there being a UK/EU trade deal. Stress testing or scenario planning might be appropriate for trustees and employers to undertake, with trustees considering affordability in different scenarios. Independent specialist advice should be taken to support covenant assessments (in particular where the covenant is deteriorating or complex). Trustees should only carry out their own assessments where they have the expertise. There should be a full audit trail and tPR may ask to see this documentation.
3. Covenant monitoring and contingency planning. Trustees are expected to significantly increase the frequency and intensity covenant monitoring until covenant visibility and strength is restored. Covenant tracking with appropriate triggers and thresholds is encouraged. Trustees should have contingency plans in place so they can react appropriately.
4. Covenant leakage. Whilst on-going employer support is key, trustees should be diligent about covenant leakage. Examples of covenant leakage include dividend payments to shareholders, group trading arrangements, and transfers of business or assets at an undervalue. Where a long recovery plan is proposed, trustees should check covenant leakage and get the right mitigations for the scheme.
5. Managing risks. Trustees are expected to continue focusing integrated risk management. As was the case last year, tPR has produced tables setting out the key risks that trustees and employers should be focusing on although they are not exhaustive. Scheme maturity, high levels of transfer activity are specific risk areas that are mentioned. To identify the table that is closest to the scheme in question, trustees should consider how the covenant has changed as a result of COVID-19, the impact of EU departure, the funding position relative to the long-term funding target (taking into account the period of the long-term target).
Comments. The Statement repeats and expands on many aspects of the recent COVID-19 guidance issued by tPR. The focus on the long-term target plans is in line with the legal requirement in the Pension Schemes Bill for trustees to have long-term strategies and reflects the DB Funding Code consultation. Many trustees and employers will be familiar with the key messages in the Statement and will be meeting tPR’s expectations. Nevertheless, these are highly challenging times for trustees and employers, and we agree that collaborative working will be key to achieving good outcomes.