Summary
The Pensions Regulator has published its annual funding statement, providing guidance for those pension schemes whose actuarial valuation dates fall between 22 September 2022 and 21 September 2023 (“tranche 18”), although it should be of interest to other schemes as well.
TPR suggests that most schemes will have improved funding levels, as a result of investment out-performance from return-seeking assets and a significant rise in gilt yields. It expects trustees to consider whether their long-term target remains appropriate and, indeed, whether buy-out is viable.
If funding levels have improved significantly, for example because of an unhedged position against interest rates, trustees should consider whether it would be appropriate to apply some of the funding gains towards a less risky funding and investment strategy. The level of risk that trustees decide to build into their scheme’s funding and investment strategies should be supported by the support available from the employer covenant.
Current valuations
TPR expects the funding position of most schemes having valuations as at 31 December 2022 or 31 March 2023 to have improved since their last valuation. However, the position of individual schemes may be different from this and will depend on scheme-specific factors including the extent to which schemes have hedged their interest rate and inflation risk.
Most schemes should find themselves ahead of their long-term plan and, in many cases, to have exceeded buy-out funding levels. While stating that it will review valuations in the context of the existing legislation, TPR also urges trustees to consider whether their long-term targets remain appropriate, whether buy-out is viable or to examine other end-game options.
Where trustees do have a long-term funding and investment strategy, they should review where they have reached on their plan and, if beyond where anticipated, consider whether the risks inherent in their funding basis and investment strategy remain appropriate.
Pressures on trustees
It notes that some schemes will be facing calls from employers to reduce contributions, as well as from members for discretionary increases, given that pension increases may not have kept pace with inflation. In the face of such pressures, trustees should consider their overall position, the resilience of their investment strategy to future financial market movements and the level of covenant support.
Trustees should recognize the economic uncertainty that will continue to impact investments and employer covenant in different ways, including:
- further increases in interest rates, which could affect their scheme’s asset and liability values, as well as increasing borrowing costs for the employer,
- high rates of inflation and their knock-on effects on pension scheme liabilities and investment returns, as well as their effect on other employer costs,
- volatile commodity and energy prices affecting the profitability of employers and fuelling inflation in the wider economy and
- the potential for ongoing or new geopolitical instability to affect the employer’s supply and distribution chains.
Employer covenant
TPR suggests that covenant assessments be less focussed on uses of free cash flow – if no recovery plan is required – and more on the longevity of the covenant, any re-financing risk and the potential impact of environmental, social and governance (ESG) risks on the employer.
Revising recovery plans
For trustees of schemes ahead of plan, who may be considering whether to reduce or stop deficit-reduction contributions (DRCs) as part of an actuarial valuation, TPR expects them to consider the following:
- if the covenant has weakened, or was already weak, trustees should ensure that the level of prudence in TPs remains appropriate and the level of investment risk is supported by your current assessment of the covenant;
- if there is a TPs deficit, trustees should consider reducing the remaining length of the recovery plan before reducing the level of DRCs. This is particularly important if the recovery plan is longer than six years, or the scheme is mature or there are concerns about the longer-term ability of the employer to support the scheme;
- if the recovery plan makes an allowance for asset returns in excess of the TPs assumptions, trustees should first consider reducing the additional risk from this before reducing DRCs.
As in previous years, there is a suite of tables setting out TPR’s expectations of schemes with different characteristics.