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Annual funding statement: helping trustees understand the regulator's expectations

Ref: PN12-12
Friday 27 April 2012

The Pensions Regulator has today published its first annual funding statement (PDF, 121kb, 7 pages) to provide guidance on how pension scheme funding valuations should be approached in today’s challenging economic environment.

It is aimed at trustees and employers of defined benefit (DB) pension schemes who are undertaking their scheme valuations with effective dates in the period September 2011 to September 2012. It therefore applies to approximately one third of the UK’s 6500 DB schemes, and about 4m of the 12m DB memberships.

It is, however, relevant to all trustees and employers with a DB pension scheme.

Trustees and employers that follow the guidance in the statement are more likely to reach funding agreements that the regulator finds acceptable without the need for regulatory involvement.

The regulator’s analysis shows that most schemes and sponsoring employers should be able to meet their pension promises to members with either no change, or only small changes, to their present deficit recovery plans.

The Pensions Regulator’s chief executive Bill Galvin said:

"Pension schemes are long-term undertakings. A resilient economy and a healthy sponsoring employer provide the best environment for delivering pension promises. The economic climate continues to be challenging, but the majority of schemes and sponsoring employers should be able to meet their promises to members without major adjustments to their current plans. Trustees must produce credible recovery plans in light of all the risks, including employer insolvency.

"Employers that are struggling have greater breathing space to fill deficits over a longer period. However, we will draw a distinction between this group and those cases where schemes are substantially underfunded and employers are able to afford higher contributions. In such cases we will expect pension trustees to be taking steps to put their scheme on a more stable footing."

The Statement provides guidance to trustees and employers as follows:

  • There is significant flexibility in the funding framework to enable schemes and employers to meet their long-term liabilities, including, where necessary, filling deficits over longer periods, taking account of improvements to market conditions post-valuation, and the use of contingent security and intra-group guarantees.
  • As a starting point, the regulator expects that current deficit recovery contributions should be maintained in real terms. The regulator will seek strong justification where a reduction is proposed.
  • Capital expenditure, servicing other debts and making dividend payments have an important role to play in encouraging investment in a healthy, sponsoring employer. However in some cases dividend payments may need to recognise the shareholders’ subordinate position to the scheme. Where available cash is used within a business that might otherwise have been used to increase contributions it should have the demonstrable effect of strengthening the ‘employer covenant’ (the employer’s ability to support the scheme).

Based on the information we hold on schemes including their previous valuations, the regulator estimates that a significant majority of employers of schemes in deficit will not need to make changes to their existing plans; or will only need to make small increases to their deficit recovery contributions and/or length of recovery plans.

The remainder divide into two groups:

  • Employers of significantly underfunded pension schemes for whom affordability of contributions is not a major barrier. Employers in this group will need to make larger increases in contributions and/or provide security in the form of contingent assets.
  • Employers, with deficits, who are expected to find affordability a challenge. Employers in this group are likely to need to significantly increase their existing deficit recovery plan length and/or make full use of the other flexibilities within the scheme funding framework.

There have been calls for the regulator to allow schemes to make an allowance for low gilt yields and the effect of quantitative easing (QE) in the assumptions they use, thereby reducing their funding target (liabilities). The regulator does not believe this is a prudent approach as it seeks to second guess future market conditions. However, we will consider additional flexibility in recovery plans where employers are genuinely struggling to support their scheme.

Bill Galvin added:

"There are a number of economic factors impacting gilt yields, such as QE and demands for UK sovereign debt from the international banking sector.

"We have been in a low interest climate for some time. Yields have fallen further in the last nine months, and it is unclear when and to what extent there will be a market correction. The net effect across defined benefit schemes is not uniform and will vary greatly depending upon the extent to which their risk-management, investment and contribution strategies have insulated them from the effects."

The regulator’s executive director for DB regulation Stephen Soper added:

"We are taking a more segmented approach to regulation and will proactively engage with those schemes where we believe there is greatest risk to member benefits and PPF levy payers, based upon experiences of previous funding cycles. Schemes in a stronger position can expect less intervention by us, but we will place more focus on schemes in a weaker position. In those rare situations where the sponsoring employer is so weak that trustees are not able to put together a viable plan, we urge them to contact us as early as possible in the process."

Editor's notes

  1. The statement covers the third of defined benefit schemes that will carry out their triennial valuations between September 2011 and September 2012. It will be their third triennial valuations under the scheme funding framework established under the Pensions Act 2004. They have up to 15 months from their valuation date to agree a deficit recovery plan with their sponsoring employer. The regulator plans to issue a statement each year helping trustees to understand its expectations and acceptable approaches to the scheme funding process within the prevailing economic conditions.
  2. Most valuations being completed at the present time, as opposed to commenced, relate to dates earlier in 2011 where conditions were materially different. The statement does not specifically address these valuations.
  3. The actual outcomes for schemes will be dependent upon the scheme and employer circumstances and on the results of their individual valuations, yet to be carried out, which cannot be fully forecast. The regulator will be monitoring these results as they emerge to understand any divergence from expectations.
  4. The Pensions Regulator is the regulator of work-based pension schemes in the UK. We have objectives to: protect members’ benefits; reduce the risk of calls on the Pension Protection Fund (PPF); and to promote, and to improve understanding of, the good administration of work-based pension schemes. From 2012 we have the additional objective of maximising employers’ compliance with their duty to automatically enrol staff into a qualifying pension scheme.

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