The Pensions Regulator has issued its annual funding statement, setting out its expectations of valuations with effective dates between 22 September 2016 and 21 September 2017.
Market conditions
The Regulator notes that Gilt yields have remained very low and that liability values are likely to have risen compared with schemes’ previous valuations. Asset values should also have increased strongly over the last three years, though not sufficiently to match the rise in liability values for schemes that have not hedged their interest rate risk.
Managing deficits
The Regulator expects schemes to put contingency plans in place to mitigate any downside risk. Its analysis indicates that between 85% and 90% of schemes undertaking 2017 valuations have employers who can manage the scheme deficits and currently have no long-term sustainability issues.
However, it recommends that schemes that have strong employers but weak technical provisions and/or long recovery plans should seek higher contributions to mitigate the risk of the employer covenant deteriorating. Also, trustees of schemes with a weak employer covenant, but whose employers are part of a stronger corporate group, should seek legally enforceable support from the wider group, to provide a stronger covenant for the scheme.
Trustees of “stressed” schemes are urged to reach the best possible funding outcome taking into account members’ best interests and the scheme’s specific circumstances.
Discount rate assumptions
In this year’s statement the Regulator has taken steps to avoid being seen to prescribe a “Gilts-plus” approach to the setting of discount rates. Instead it urges trustees to consider their plan for achieving their long-term objective, and their current position relative to it, when considering how to set their discount rates.
Risk management
The Regulator suggests that schemes whose funding position has worsened should implement their contingency plans – which may include seeking higher contributions to recover their funding position. They should also consider whether they are taking an appropriate level of risk in the light of the employer’s covenant.
Scheme maturity
The Regulator reminds all schemes of the necessity of a cashflow management policy, including a plan for how unforeseen cashflow requirements will be met.
Fair treatment between schemes and shareholders
The Regulator advises that it is likely to intervene in schemes where either:
- the end-date of the recovery plan is being pushed further back or
- payments to shareholders are being prioritised over contributions to the scheme.
It expects schemes where an employer’s total distribution to shareholders exceeds deficit reduction contributions to the pension scheme to have a relatively short recovery plan and an appropriate investment strategy that does not rely excessively on outperformance.
Analysis
As usual, the Regulator has also published its analysis of the expected funding positions of the schemes performing valuations during the year. It notes that, of the FTSE350 companies who paid both deficit repair contributions (DRCs) and dividends in each of the previous six years, the ratio of DRCs to dividends declined from around 10% to around 7%. This was driven mainly by a significant increase in dividends over the period, without a similar increase in contributions.
The analysis suggests that deficits may have more than doubled since 2013/14 for many schemes. If trustees are to keep the same end date for their recovery plans, the median increase in DRCs would be between 75% and 100%, although schemes that have hedged their interest rate risk may see a lesser impact. The Regulator believes that 50% of employers can afford to at least maintain their current rate of contribution. On the other hand, there may be 5% of “tranche 12” schemes where there is little prospect of additional support from the employers and for whom the best course of action may be to continue to take a reasonable level of unsupported risk.