The Pensions Regulator has issued a statement on pension scheme funding in the current environment. It had been expected that it would provide some relaxation of his existing guidance and, in particular, allow expected future improvements in the investment climate to be taken into account, particularly increases in gilt yields as Quantative Easing unwinds. In fact, the statement is largely a restatement and clarification of the Regulator's existing guidance and does not suggest a significant change in approach.
In more detail
The Regulator emphasises the continuity of the new statement with previously published guidance and looks at how that guidance might be applied in the current economic environment. The statement does not change the guidance, which the Regulator regards as sufficiently flexible to achieve an appropriate and balanced outcome.
Key points in the statement are:
- Although some commentators believe that gilt yields will return to more "normal" levels, there is no certainty that this will be the case, or what "normal" might be.
- The majority of schemes and employers will be able to manage their deficits within current plans or by modest increases in contributions or extensions to recovery plans. The Regulator points to the change from RPI to CPI as offsetting increases in liabilities due to falls in gilt yields in many schemes. So the majority of schemes, in his view, do not need to rely on increases to gilt yields beyond those implied by the market.
- Trustees should undertake contingency planning so they have viable alternative options if funding assumptions are not borne out.
- Trustees should not adopt an earlier effective date for a valuation reflecting more favourable circumstances in order to reduce deficit repair contributions.
- Economic conditions will continue to develop whilst Trustees are going through the valuation process and, where appropriate, the use of post valuation experience is acceptable.
- Smoothing of discount rates in the calculation of liabilities under the technical provisions is not consistent with the legislative requirement to value assets on a mark-to-market basis. The Regulator's view is that the measure of assets and liabilities should be consistent.
- Any increase in asset outperformance assumed in the discount rate on the basis that current yields are particularly low is equivalent to an increase in reliance on the employer's covenant. Trustees should be convinced that the employer could realistically support any higher level of contributions required if the actual investment return falls short of that assumed.
- It is not prudent to try to second guess market movements by assuming that gilt yields will inevitably improve in the near-term and incorporate an allowance in the discount rate when calculating technical provisions. Any strongly held views about future financial market conditions should be accommodated in the recovery plan where they are more clearly identified and mitigated should the assumption turn out to be false.
- The starting point for recovery plans is that the current level of deficit repair contributions should be maintained in real terms unless there is a demonstrable change in the employer's ability to meet them.
- Where, in exceptional cases, schemes choose to rely on anticipated changes to the current economic climate when setting their recovery plan, they should have viable, documented contingency plans to address the situation where this is not borne out.
The statement is helpful in that it clarifies the Regulator's thinking on how funding settlements might take account of current low gilt yields. But it is not the relaxation that some employers were hoping for.
For further information or tailored advice please contact your usual Fieldfisher adviser or one of our pensions partners, Michael Calvert, Partner or David Gallagher, Partner.