Taylor Swift may not have had the UK pensions system in mind when penning these lyrics, but some of the funding negotiations seen at various Work and Pensions Committee hearings over the last couple of years seem to have been like that. Of course, the Pensions Regulator has an important role to play in ensuring fairness in funding negotiations, and for a number of years has issued an annual DB funding statement to support its aims.
These statements are intended to be of particular relevance to trustees and sponsors about to discuss their actuarial valuation, but always include useful pointers for all schemes. This year is of added significance in providing the Regulator’s first steer since the recent White Paper.
The context of this year’s statement is, typically, slightly improved funding levels, but quite varied experience, usually depending on investment strategy. While some sponsors are clearly struggling, the Regulator highlights the increase in the rewards to many shareholders since these recovery plans were last reviewed. The Regulator also highlights some urgency for schemes that are maturing rapidly (where a large proportion of their liabilities represents pensions in payment), which could be compounded with a high volume of transfers. Here cashflow needs to be managed, and where the funding level is low, more urgent action is needed to repair a deficit as there may not be the time for a long recovery plan.
A significant part of the statement is devoted to how schemes should be treated fairly, and to the Regulator’s concerns around dividends and other shareholder distributions. The statement emphasises that where distributions to shareholders appear unreasonable relative to deficit contributions, the Regulator expects trustees to negotiate robustly to secure a fair deal for the pension scheme.
…the Regulator expects trustees to negotiate robustly to secure a fair deal for the pension scheme.
Schemes with a ‘strong’ or ‘tending to strong’ covenant are expected to consider strengthening technical provisions and reducing the length of recovery plans. Those with a weaker covenant are expected to prioritise the scheme over shareholder distributions and to seek ways to strengthen the covenant through retaining cash in the business or other mechanisms. In all cases, this seems to suggest that the Regulator would normally expect sponsors to be increasing, or at least maintaining, their current funding commitments, even where the funding position has improved.
Integrated risk management (IRM) has been a central part of the Regulator’s guidance over recent years and the statement notes that the Regulator considers documented and workable contingency plans to be a necessary part of IRM. Contingency plans may be less developed in many schemes, particularly where the employer is already struggling to meet its funding obligations.
Continuing another recent theme, the Regulator emphasises that when assessing the appropriateness of a scheme’s technical provisions and discount rates, it considers the levels of risk in the scheme’s funding and investment strategies, and does not focus on a fixed margin over gilts as its yardstick. The Regulator expects trustees to use IRM principles to set discount rates, also taking account of changes in market conditions, and is now expecting Trustees to document the rationale for their chosen discount rate even if the method used has not changed from the previous valuation.
To date the Regulator has preferred to ensure fair and timely negotiations, often by quiet words of encouragement. With the development of some of the themes in the White Paper and reflecting comments in the funding statement, we may see a more active approach in future to ensure a scheme is being treated fairly. …the Regulator expects trustees to negotiate robustly to secure a fair deal for the pension scheme.