The Pensions Regulator (TPR) has set clear expectations from UK pension fund trustees regarding their long-term funding targets, depending on their iabilities, funding strength and covenant support. 

According to its Annual Funding Statement (AFS) 2023 published today, the funding positions of defined benefit (DB) pensions schemes have improved in general but there is variation between schemes and future funding challenges remains uncertain.

TPR estimates around a quarter of all DB schemes may have sufficient funds to buy out their liabilities with insurance companies. Trustees of those schemes will need to consider if their long-term targets remain appropriate, whether that is to buyout, or to examine other endgame options, teh Regulator stated.

The majority of remaining schemes are estimated to have funding positions that are ahead of their funding plans. In these cases, trustees should consider whether the existing strategy and level of risk is in the best interests of members. If not, this may be a trigger for trustees to review their pace of funding and level of risk, or to re-order their long-term targets and set new, more ambitious objectives.

“Funding levels will have fallen for a small number of schemes, including some invested in pooled funds and others unable to meet the necessary liability-driven investment (LDI) collateral calls when gilt yields spiked in 2022,” TPR said.

The statement explains how pension funds will need to reset funding and investment strategies to reach their long-term targets and should review their operational governance processes to ensure future resilience.

Lou Davey, TPR’s interim director of regulatory policy, analysis and advice, said: “For the first time in many years, our 2023 AFS highlights how most DB pension schemes are ahead of their funding target. Long-term targets, and associated funding and investment strategies set in an era of low interest rates, should be reviewed.

“Despite improved funding levels, uncertainty remains, and economic challenges persist and so schemes should not be complacent about covenant assessments.”

She added that the level of risk that trustees decide to build into their scheme’s funding and investment strategies should align with the level of support the employer can provide.

The current DB funding regime applies until new regulations and TPR’s revised DB code come into force in April 2024.

Economic landscape is different

Tyron Potts, associate and head of pensions research at Barnett Waddingham, said: “TPR recognises the economic landscape is very different to this time last year – and for most schemes, the result is positive news. However, it is clear TPR retains a little nervousness particularly around sponsor covenants and, as a result, is urging trustees to ensure that they use their improved funding positions to reduce risk in the scheme rather than necessarily allowing the sponsor to benefit.”

Potts also said that this should not come as a surprise to trustees, as “TPR isn’t really adding a lot here to what has already been said – particularly as part of its Code of Practice consultation”.

Isio’s head of research and development, Iain McLellan, added that most schemes should be ahead of the plans set at their last valuation, and their future service costs should have lowered.

Getting ready for buyout

Commenting on the increased focus on buyout and improved funding levels, LCP’s head of pensions strategy Michelle Wright said, “TPR estimates that around 25% of schemes can now afford to buyout their liabilities in full, but is quite rightly suggesting schemes respond in a measured way – taking time to consider the full range of strategic options and to carefully prepare in order to achieve the best outcomes for members.”

She said that in a busy insurance market, thorough preparation is more important than ever. “TPR has noted that buying-out liabilities can be a lengthy process, so it will be important that pension schemes understand how to prioritise their preparation activity and resources on those areas that will deliver the greatest value.”

Barnett Waddingham’s Potts added: “And while TPR is openly encouraging schemes to de-risk if their funding level has improved, in spite of its warnings of potentially limited capacity in the buyout market, the Regulator rightly suggests that well-funded schemes nevertheless ensure they are “buy-out ready”. Being in a position to transact quickly will give a scheme a much-needed competitive advantage when a short-lived window of capacity opens up with an insurer – and so using advisers’ knowledge of the buyout market will now become even more important.”

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