The Pensions Regulator (TPR) recently issued its 2019 annual funding statement. For trustees and sponsors of schemes undergoing – or about to embark upon – an actuarial valuation, it is a document of great importance and relevance.
Pulling no punches
This statement is the most prescriptive approach we have seen from TPR in recent years. In it, TPR outlines how it believes trustees and sponsors should deal with covenant, investment and funding risks for schemes with differing:
- covenant strengths;
- strengths of technical provisions; and
- maturity profiles.
The guidance is welcome, but there are a number of sub-categories to consider and it may prove something of a challenge for some schemes to determine which applies to them.
New regime on the horizon
The statement offers an insight into TPR’s new ‘comply or explain’ regulatory regime that will evolve as part of consultation on a new DB Funding Code.
The key requirements TPR sets out in the statement are that schemes should:
- set a long-term funding target (LTFT) and set a strategy in order to achieve it;
- adopt an effective integrated risk management (IRM) approach;
- account for risks arising from scheme maturity;
- account for liquidity risk – for instance as a result of potential transfers out;
- employ proportionate covenant monitoring; and
- ensure fair treatment of schemes with other sources of “covenant leakage”, for instance shareholder dividends.
Long-term funding targets
The long-term funding targets (LTFT) should be aligned to a long-term plan for paying benefits with a high degree of certainty and is considered a priority for more mature schemes.
TPR expects investment strategies to be consistent with the LTFT and show how shorter-term strategies are aligned with it.
Investment strategies should now include consideration of the asset allocation that is consistent with the LTFT, set a roadmap of the journey to achieve it and determine how poor investment performance will impact the funding.
Consideration of how any increased future deficits will be caught up should also form part of schemes’ advanced planning. This could include tress testing how the covenant might support adverse investment outcomes. TPR also notes that extending the recovery plan should not be the default action in these cases.
Managing risk and reducing recovery periods
Trustees need a comprehensive approach to IRM and this must take into account the scheme’s maturity.
TPR wants to see recovery periods reduced below the current median of seven years, particularly for schemes with stronger employers.
Setting high standards
At TPT, we are confident that the approach we use to set funding and investment strategies is fully compliant with – or even exceeds – TPR’s expectations as outlined in the statement.
We are pleased that the actions we have taken over the past 18 months to review our approach to covenant, funding and investment are fully consistent with the approach TPR is now stating is best practice.
If this document does indeed indicate the direction for the future regulatory regime, then our employers can rest assured that we are maintaining the highest levels of governance.