Breaking down the regulator's 2013 funding statement

The latest statement specifically covers schemes with valuation dates that fall between September 22 2012 and September 21 2013. But the statement is interesting reading for all DB schemes.

1.Contributions

The language of the section on setting contributions is softer in tone than last year.

In setting contribution rates, the regulator says "trustees should take into account what is reasonably affordable for the employer", and emphasises that trustees can use the flexibilities in the system. There is also specific recognition that a "strong and ongoing employer" is the best support for the scheme.

This seems to look forward to the introduction of a new statutory objective of affordability. This new objective was announced by the chancellor in his autumn statement and is now included in the Pensions Bill.

2. Assumptions

Although legislation requires that discount rates must be chosen prudently, the statement says 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".

This is a marked contrast to the language of last year's statement, which suggested measurement of investment outperformance should be on the basis of a "near-risk-free return", such as would be assumed if a scheme adopted a substantially hedged investment strategy.

3. Recovery plans

On recovery plans, this year's statement asks that, where there are significant affordability issues and trustees agree to lower contributions and a longer recovery plan, they "document the reasons for any change and indicate they have had due consideration of the risks".

Last year, a "material extension" to the recovery plan would have needed "sound justification".

Also as indicated in its June 2012 webinar on scheme funding, the regulator has confirmed it will move away from fixed triggers for intervening in scheme funding, such as a recovery plan over 10 years, to a "suite of risk indicators".

The new triggers include:

• whether recovery plan contributions and the amount of investment risk appropriately reflects the relative strength of the employer and affordability of contributions;

• the shape of recovery plans including initial low levels of contributions;

• the investment performance assumed over the life of the recovery plan;

• any specific issues and concerns relating to deterioration in sponsor covenant strength or possible avoidance; and

• any significant issues with previous valuation submissions.

The regulator is encouraging schemes to adopt an integrated approach to covenant, investment and funding risks, and to be in a position to demonstrate how they have done this.

In addition, the programme of proactive engagement "to address issues at an early stage", which started last year, will continue. Last year, the regulator contacted approximately 40 schemes with 2012 valuation dates.

The organisation says this early engagement programme will help refine the thinking behind the consultation proposals for a new code of practice to tie in with the new statutory objective.

How the regulatory shift affects your scheme

The regulator will consult on a new code of practice in the autumn. But the regulator has already indicated in the statement that the consultation will include:

• changes made as a result of the regulator's new statutory objective to "minimise any adverse impact" on a sponsoring employer's sustainable growth;

• a new focus on integrated risk management – addressing covenant, investment and funding risks; and

• the watchdog's regulatory approach and how it will assess risk, including the new triggers for involvement with schemes.

This year's statement seems like a stepping stone towards an era of flexibility for DB scheme sponsors to be ushered in with the watchdog's new statutory objective.

When the changes come into force, probably in April 2014, the regulator should, when carrying out its functions in relation to scheme funding, aim to "minimise any adverse impact on the sustainable growth of an employer".

In tandem with the new objective, its new approach will be included in revisions to its code of practice. But for now the organisation must continue to work within its existing parameters on scheme funding, making a major shift in policy unlikely.

Zoe Lynch is a partner at Sackers