UK: Spot the difference
Mel Duffield notes a positive reaction to TPR’s 2013 Funding Statement, but argues that it remains to be seen what approach the regulator will adopt in practice
On first reading, the latest annual funding statement from the Pension Regulator (TPR) may not look substantively different to the 2012 version. Both are a light-touch, five-page read, intended to guide trustees and employers through their scheme-valuation process and share insight on TPR’s views on acceptable approaches to the valuation process in the current economic environment.
But while some of the differences may be a little too subtle for the lay reader, the consensus among the more hawk-eyed in the industry is that, while the actual content of the statement has not fundamentally changed, the tone is helpfully different. Perhaps not surprising, given that the Chancellor announced in the 2013 budget that TPR would be given a new statutory objective in the Pensions Bill to “shift the balance of regulation in favour of private sector investment and growth”.
TPR will also be alive to the fact that those with a 2013 valuation date are likely to face far more of a shock when their actuaries present them with the latest figures because the economic conditions in 2010, when this group last completed their funding valuations, were far more favourable.
A quick game of spot the difference should shed some light on the subtle differences between TPR’s stance this year compared with last and how this might affect trustee and employer negotiations.
The first shift in tone is around the use of flexibilities by schemes.
Version 2012: “the majority of schemes and employers will be able to manage their deficits within current plans or, if appropriate, by modest contribution increases and/or modest extensions to recovery plans”
Version 2013: “trustees may need to make greater use of the flexibilities available than needed for preceding valuations”
Not vastly different, but Version 2013 has a much more encouraging tone, while Version 2012 sets out TPR’s clear expectation that the majority of schemes shouldn’t need to rely on the flexibilities in the funding system beyond making some minor tweaks here or there. In its latest statement TPR has put more emphasis on the flexibilities open to pension schemes. Many businesses going through their valuations in 2013 are facing much tougher conditions than they did three years ago, so they will be encouraged by this sign of support from TPR.
Also worthy of note is what TPR have said in this year’s statement about the appropriate discount rates for technical provisions.
Version 2012: “it is a requirement for trustees to calculate technical provisions based on prudent assumptions... any strongly held views about future financial market conditions should be accommodated in the recovery plan (rather than the technical provisions)”
Version 2013: “trustees can use the flexibility available in setting the discount rates for technical provisions and the investment return assumptions for recovery plans to adopt an approach that best suits the individual characteristics of their scheme and employer”
The more risk-averse trustee, on reading these, might consider Version 2012 to really be saying do not even think about messing with the technical provisions assumptions. Version 2013, on the other hand, is far more relaxed and open to a scheme-specific interpretation.
The statement has shifted away from last year’s bias of basing investment return assumptions on risk-free assets and Gilts, and instead recognises that pension funds are facing challenging economic times and that a broader view is absolutely necessary.
On investment outperformance, trustees may take some comfort that they can consider changes to their assumptions without attracting the attention of the regulator.
Version 2012: “investment outperformance should be measured relative to the kind of near risk-free return that would be assumed were the scheme to adopt a substantially hedged investment strategy... the regulator views any increase in the asset outperformance assumed in the discount rate to reflect perceived market conditions as an increase in the reliance on the employer’s covenant”
Version 2013: “the assumptions made for the relative returns of different asset classes may rise or fall from preceding valuations reflecting changes in market conditions and the outlook for future returns”
Version 2012 appears to be saying that a bottom-up or ‘Gilts-plus’ approach should be used for setting the discount rates and that any adjustment that might offset the impact of low Gilt yields will need to be fully justified. Version 2013, on the other hand, is far more in line with the guidance in TPR’s original 2006 Code of Practice on DB funding, which makes clear that discount rate assumptions can be changed from one valuation to the next to reflect changes in economic and market conditions.
Finally, TPR changed its tune a little on recovery plans and deficit recovery contributions.
Version 2012: “as a starting point, we expect the current level of deficit repair contributions to be maintained in real terms... a material extension to the recovery end date will require sound justification.”
Version 2013: “as a starting point, trustees should consider whether the current level of contributions can be maintained... where there are significant affordability issues trustees may need to consider whether it is appropriate to agree lower contributions and this may also include a longer recovery plan.”
Version 2013 is much softer and urges trustees to consider what action might be appropriate, rather than placing implicit pressure on them not to cut the sponsoring employer any slack. The response to the 2013 statement from our fund members running defined benefit pension schemes has generally been very positive. This is in contrast to the response to the 2012 statement, which was considered to offer little additional support to trustees trying to navigate their way through funding valuations and negotiations with sponsoring employers. In light of its new statutory objective TPR plans to issue a consultation on its Code of Practice on DB funding in the autumn. In advance of that, the 2013 statement is a positive indication of change in the TPR’s approach. As ever, though, the proof will be in the pudding, and it is the experience of trustees when dealing with TPR caseworkers that will really demonstrate whether this change has been embedded right through the organisation.
Mel Duffield is head of research and strategic policy at the National Association of Pension Funds