TPR's 2017 Funding Statement: A Shift In Approach? - Employee Benefits & Compensation

The Pensions Regulator (TPR) has issued its Annual Funding Statement for defined benefit schemes (the Funding Statement). The Funding Statement identifies some of the key issues facing schemes with valuations in the period 22 September 2016 to 21 September 2017 (which it refers to as 2017 valuations).

The Funding Statement is aimed primarily at trustees and employers undertaking 2017 valuations, but it is relevant to trustees and employers of all defined benefit schemes, particularly the need to put in place a contingency plan. The Funding Statement is clearly influenced by TPR's experience on BHS: there appears to be a theme of putting greater pressure on employers to fund schemes more quickly.

Key points

1 Risk Management

Trustees need to monitor risks and take action when required regardless of a scheme's funding position. TPR expects trustees to take 'decisive action' where:

funding has been on a downward trajectory for more than one valuation; or
they have faced any significant adverse impacts.

2 Contingency plans

All trustees need to have a contingency plan in place detailing actions they would take to correct the scheme's position in the event of a downside risk materialising. This is particularly important for trustees who decide to continue to run significant risk levels.

3 Valuation assumptions

When setting valuation assumptions, trustees need to consider the extent to which changing market conditions affect the longer-term view of expected risk and returns, and how this interacts with the scheme's funding plans and risk appetite. Trustees need to have a sound rationale for the assumptions and to document clearly the reason for the choice.

4 TPR's approach

Trustees can expect TPR to be tougher and get more engaged earlier in funding negotiations. TPR wants valuations to be completed within the 15 months, so trustees need to start earlier with a clear timetable which moves quickly. TPR will take a tougher approach where schemes fail to submit their valuations on time.

5 Fair treatment between schemes and shareholders

TPR is going to focus on dividends to make sure pension schemes are being treated fairly in comparison to shareholders. They may investigate situations where dividends are greater than the pension contributions if recovery plans are not sufficiently short.

Who is the Funding Statement relevant to?

The Funding Statement is aimed primarily at trustees and employers undertaking valuations of defined benefit schemes with effective dates in the period 22 September 2016 to 21 September 2017. TPR refers to any such valuations as 2017 valuations. It also includes comments which are relevant to trustees and employers of all defined benefit schemes.

What does the Funding Statement mean for trustees and employers?

The Funding Statement sets out the points which trustees and employers should consider when carrying out 2017 valuations but it also includes points which are relevant to all trustees and employers.

Affordability and Managing Deficits

TPR has grouped defined benefit schemes based on their risk profile. Trustees should consider which category their scheme falls into and then take appropriate action. Where the employer is weak, TPR will not take into account the wider group covenant in its risk assessment where the scheme cannot rely upon it. Where there is no legally enforceable support, trustees should not rely upon the covenant of the wider group to justify agreeing to higher levels of risk in their valuation.

TPR specifically refers to stressed schemes. It recognises that the course of action that has the least detrimental impact on members' benefits of stressed schemes may be for the scheme to continue, even if doing so represents a potential cost to employers and the Pension Protection Fund (because scheme liabilities may continue to increase).

TPR expects trustees of these schemes to reach the best possible funding outcome, taking into account members' best interests and the scheme's circumstances. Trustees in these circumstances must be able to show TPR that they have taken appropriate measures, for example, that the scheme has closed to future accrual and that they have sought to maximise security from the employer.

Valuation Assumptions

When setting the valuation assumptions, TPR expects trustees to consider the impact of changing market conditions on the longer-term view of anticipated risk and returns, and how this sits with the scheme's funding plans and risk appetite. Scenario planning should be considered.

Trustees are expected to seek and consider robust advice from their scheme actuary on the valuation assumptions. Whether or not trustees change the method used to set the discount rate, TPR expects trustees to have a sound rationale behind the change or decision not to switch and to document clearly why the method is or remains prudent.

Risk Management

Regardless of a scheme's funding position, trustees need to monitor risks and take action when required. If the funding position is worse than expected, trustees should refer to and, where necessary, implement the scheme's contingency plan. They will also be expected to take action when agreeing the next recovery plan, for example by seeking to increase employer contributions.

Importantly, if the scheme's funding position has been on a downward trajectory for more than one valuation or if they have faced any significant adverse impacts, TPR expects trustees to take decisive action. This marks an important shift - the days of simply extending the recovery plan are gone.

Trustees must be prepared for a downside risk occurring: trustees need to have a contingency plan in place setting out what steps they would need to take in order to correct the scheme's position. This plan needs to be agreed with the employer in advance and should be legally enforceable.

If the funding position is on track or better than expected TPR still expects trustees to be proactive and check that the scheme is on track to meet its long term funding objective and risk management plan.

Investment Strategy & the Employer Covenant

TPR will intervene and engage with schemes where it believes that the scheme's investment strategy is inappropriate. Trustees need to focus on the ability of the employer to contribute cash to the scheme while there remains good visibility of the covenant.

TPR's approach

We can expect to see a tougher approach from TPR. Trustees should be ready for:

a focus on proactive casework as TPR seeks to improve the way it identifies cases that present the biggest risks to members;
earlier intervention before recovery plans are submitted;
escalation of actions more quickly; and
use of the full range of TPR's powers to achieve the right outcome.

TPR is clearly keen to avoid another BHS scenario.

For 2017 valuation submissions, in particular, TPR will focus on fair treatment of schemes and late valuations. This is something which we would expect to see continue after 2017. So what will this mean in practice?

Firstly TPR expects fair treatment between schemes and shareholders and is likely to intervene where it believes schemes are not being treated fairly. Alarm bells for TPR include extending the recovery plan end date where there is sufficient affordability to increase contributions to the scheme and prioritising payments to shareholders (where the employer covenant is constrained and so restricting or reducing the level of contributions to the scheme).

Trustees need to ensure that pension contributions are a key employer consideration. If an employer's total distribution to shareholders is higher than deficit reduction contributions then TPR will expect the scheme to have a relatively short recovery plan and that the recovery plan does not rely excessively on investment outperformance. Trustees and employers can expect investigations where this is not the case. If TPR believes that there is sufficient affordability to increase contributions it has said that it will take steps to ensure that an appropriate balance is struck by employers between the interests of the scheme and the shareholders..

Secondly, if schemes are having difficulties meeting the valuation deadline, they should engage with TPR and provide a clear timetable for completing the valuation, agreed by all parties. Enforcement action is more likely when delays could have been predicted, or where trustees have not engaged with TPR.

Smaller schemes

Smaller schemes are asked to reconsider all options, even if they previously thought an avenue was not open to them because of their size. TPR notes that the industry has moved on and developed products which are more efficient for smaller schemes. TPR will develop its approach towards smaller schemes so that the protection of scheme members of small schemes receives increased focus.

Next steps for trustees

Any scheme which is already working on a valuation should discuss the Funding Statement with its advisors immediately to ensure the above points are covered. Trustees starting work on 2017 valuations should ensure that the points outlined above are appropriately addressed.
Ensure the employer is familiar with the Funding Statement so that it understands the environment the trustee is operating in.
Use the Funding Statement to identify which category their scheme falls into and take appropriate action.
If funding has been on a downward trajectory for more than one valuation or if the scheme has faced any significant adverse impacts think about what decisive action can be taken.
If the scheme is in a worse funding position than anticipated, implement the contingency plans.
Challenge their advisors on the valuation assumptions.
Put in place a legally enforceable contingency plan for downside risks, an action plan for dealing with unexpected cash flow requirements, and document the consideration of the suitability of discount rate assumptions.
Only take into account legally enforceable recourse to wider group companies.
Understand the total level of payments to the employer's shareholders.
Engage with TPR early if trustees expect to miss valuation deadline.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

UK: TPR's 2017 Funding Statement: A Shift In Approach?