The UK’s pension regulator has today published its annual funding statement 2021 which sets out specific guidance on how defined benefit (DB) pension funds should approach valuations and their funding positions carefully under current conditions.
The Pensions Regulator (TPR) said that DB trustees “must remain alert to the risk of weakening employer covenants as uncertainties remain following a challenging year for businesses”.
David Fairs, TPR’s executive director of regulatory policy, said: “This has been a challenging period for many employers and so trustees in carrying out actuarial valuations need to review how their covenant may have changed in the past year and then continue to monitor it. We expect them to remain engaged with employers, who in many cases are emerging from a difficult business period.”
He added that the pandemic “has thrown up short-term challenges which heighten focus on areas such as sustainability and climate change and the impact that they can have on sponsors but also scheme assets and liabilities”.
The regulator said that each scheme would need to consider its position individually depending on its own circumstances as the statement is intended to equip trustees and employers with some tools to do so.
“Although it is important for trustees and employers to work together to manage unexpected events, they should also make sure they retain a focus on the long term – most specifically around planning and risk management,” TPR stated.
TPR’s message in this year’s annual funding statement echoes that of last year’s, when the regulator published its 2020 statement weeks after the first lockdown started in the UK.
Tim Middleton, director of policy and external affairs at Pensions Management Institute (PMI), said: “Given the extremely difficult circumstances of the last 15 months and the continued uncertainty for the future, the PMI is satisfied that the annual funding statement has made a pragmatic assessment of what can be expected of defined benefit schemes and their sponsors.
“We agree that weakened employer covenants remain an area of particular concern but are confident that the regulator will continue to work with trustees in a constructive and proactive manner to safeguard members’ benefits.”
The annual funding statement envisages trustees having to deal with employers in one of three broad categories:
- COVID-19 has had limited impact on the business;
- The initial impact of COVID-19 was material but trading has, or is, recovering strongly; and
- The impact of COVID-19 continues to be material.
Laura McLaren, partner at Hymans Robertson, said: “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.”
She added: “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.”
Alan Collins, director at Spence & Partners, believes that the statement is a timely reminder that the ripple effects of COVID-19 may impact scheme sponsors for a considerable time to come and could have substantial short-term effects.
Mercer chief actuary Charles Cowling said that 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,” he added.
Hymans’ McLaren said that trustees will 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,” she noted.
“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,” she added.
“Above all, TPR is clear that the focus should remain on long-term planning and risk management,” she said.