TPR funding statement flags uncertainty impact for valuations

The regulator added that the impact the war in Ukraine will have on the global economy is likewise unclear, with the potential to have significant implications for scheme funding positions beyond the immediate effects on liquidity demands and cyber risks.

Expanding on Ukraine in its executive summary, TPR suggested that sanctions and supply chain issues could have a bearing on employer covenant, compounded by the lingering effects of Covid-19 and Brexit.

By developing their longer-term objectives and establishing a clear framework for decision-making, trustees and sponsors may be able to take advantage of unusual market conditions

Paul Houghton, Barnett Waddingham

Of the former, the regulator stressed that the pandemic’s impact on mortality trends “continues to be an area of uncertainty” that attracts “different views”.

Given this broad array of risks, the regulator took the opportunity to stress the importance of “robust risk management” across “all levels” of schemes’ assets, liabilities and covenant, adding that it expected to see a “wider dispersion of outcomes than usual” as some schemes cope better than others, based largely on factors including inflation hedging.

TPR encouraged trustees to consider their long-term funding targets and their journeys towards them, with schemes in deficit told to prioritise recovering that deficit, while schemes at or near their funding targets have been reminded to consider their liquidity needs and how these would change in the absence of employer contributions.

Contingent funding plans with “suitable triggers” should also be considered, while trustees concerned about longer-term covenant risks should explore alternative funding and investment strategies to reduce covenant reliance.

David Fairs, TPR’s executive director of regulatory policy, said: “Favourable investment conditions over the past three years mean that many schemes’ funding levels are ahead of plan, but now is not the time for complacency.

“Conditions remain challenging for some schemes and employers, and so we urge trustees to continue to focus on their long-term funding target and strategy.

“An actuarial valuation is an opportunity for trustees to review their funding plans and it may be a good time to seek future protections such as contingency plans and dividend-sharing mechanisms.”

TPR sets out guidance

As part of its annual funding statement, TPR set out guidance for trustees and schemes focusing on a number of areas, including how market uncertainty could impact employer covenants and what the regulator expects of trustees should these effects materialise.

The guidance also looks at how high and rising inflation, coupled with volatility in investment markets, could impact scheme assets and liabilities. Additionally, the regulator laid out its views on reasonable long-term mortality assumptions “in the absence of sufficient evidence or a robust assessment of the long-term effects of Covid-19”.

TPR stressed the importance of employers providing trustees with funding projections and business plans in order to mitigate the impact of the significant uncertainty outlined previously, allowing trustees to plan as thoroughly as possible for all eventualities.

Regarding mortality, TPR said that, despite the significant uncertainty, trustees could consider making changes to their mortality assumptions where they feel it is “appropriate and justifiable”, stipulating that “any reduction in liabilities due to such changes [should] be no more than 2 per cent, unless accompanied by strong supporting evidence”.

LCP partner Steven Taylor noted that there is now “significant scheme and national level data to help trustees and sponsors form views on the potential longer-term impact of Covid-19, and TPR has now indicated for the first time that liability reductions of up to 2 per cent may be justifiable if properly supported”. 

He continued: “For many schemes, this means that understanding the impact of Covid-19 could have a significant impact on funding requirements at upcoming valuations, and could also feed into contingent funding mechanisms that are designed to reflect areas of uncertainty.  

“For example, our research for FTSE 100 companies shows that a 1-2 per cent fall in liabilities might correspond to around a £1bn per annum reduction in annual contribution requirements, if supported by appropriate contingency arrangements.”

Mike Smedley, partner at Isio, said: “Against the background of the delays in introducing the new Pension Schemes Act funding regulations and revised DB funding code, it is no surprise that there isn’t a great deal of new content in this year’s statement. 

“While a lack of significant changes will be welcomed by trustees and sponsors who are going through a valuation this year, the uncertainty as to the requirements and timescales for the new regime being introduced will continue to frustrate the industry.”

He added that there were a few areas covered in this year’s statement, the most “eye-catching” of which was TPR’s acceptance “that some allowance may be made for a reduction in liabilities of up to 2 per cent due to the long-term impact of Covid on life expectancy. 

TPR nevertheless expects trustees to ‘remain alert’, to think about their long-term funding target and journey towards it, and to consider risks in an integrated way

Adrian Kennett, Dalriada Trustees

“Aligned with the general withdrawal of Covid support across the economy, the regulator has also returned to its more explicit 2019 views on how deficit payments should compare with dividends,” Smedley said.

“Stronger employers can pay dividends if they have recovery plans of less than five years, weaker employers should not be paying dividends in excess of deficit payments, and the weakest sponsors should not be paying dividends at all. 

“There are likely to be some difficult conversations for those sponsors who are significantly impacted by some or all of the worry-list items.”

Paul Houghton, partner and head of actuarial consulting at Barnett Waddingham, added that while TPR highlighted the importance of schemes “understanding downside risks”, it was “important for schemes to be alive to opportunities in the current climate. 

“By developing their longer-term objectives and establishing a clear framework for decision-making, trustees and sponsors may be able to take advantage of unusual market conditions,” he said.

Trustees face ‘pressure’ in tranche 17 valuations

Twenty-five per cent of tranche 17 valuations, which are scheme-specific valuations slated to fall within September 22 2021 and September 21 2022, took place around December 31 2021, with a further 50 per cent at around March 31 2022.

TPR’s analysis showed that the aggregate funding level in tranche 17 valuations taking place on these dates was ahead of predictions made three years prior, but the regulator acknowledged that the position of individual schemes varied significantly.

In recognition of the general picture, however, the regulator altered the key tables in its statement, which now refer to a six rather than a seven-year recovery plan length as a measure of funding strategy quality.

TPR acknowledged that schemes currently undertaking tranche 17 valuations are doing so “during a period of significant economic uncertainty”, and encouraged trustees affected by the range of factors outlined previously to consider taking professional advice to help them monitor covenant, as well as to undertake robust scenario planning and stress-testing exercises.

It added that since the high-point of the coronavirus pandemic there has been an increase in employers paying dividends and conducting share buybacks, and TPR stressed that trustees must be “alert to this” and ensure that their schemes are being treated fairly compared with other stakeholders.

The delay to the new defined benefit funding code means that current tranche 17 valuations will be regulated in accordance with existing guidance and legislation. TPR pledged to review guidance and example case studies once the new system is in place, and expects to update its guidance for covenant assessment as part of the second draft DB funding code, expected to be published later this year.

Adrian Kennett, professional trustee at Dalriada Trustees, said the annual funding statement was “particularly relevant” as it “recognises the pressures (eg, economic background) and uncertainties (eg, Ukraine) trustees are facing, and the potential impact of this on their pension scheme funding and employer covenant”.

He continued: “TPR nevertheless expects trustees to ‘remain alert’, to think about their long-term funding target and journey towards it, and to consider risks in an integrated way.”

Kennett welcomed the regulator’s recommendation that employers provide trustees “with financial projections and business plans during these uncertain times”, as ongoing “dialogue and collaboration with scheme sponsors is vital to properly assess the overall impact of the current uncertainties on the scheme’s funding and the sponsor’s business, allowing trustees to act quickly and in the best interests of scheme members and other parties”.