Pensions Regulator sets out funding expectations
The Pensions Regulator has published its 2019 Annual Funding Statement which is essential reading for trustees and employers, particularly those with 22 September 2018 to 21 September 2019 valuation dates. It is the first statement since the Regulator promised a tougher and more interventionist approach. Andrew Patten looks at the Regulator's key messages.
Long-term funding targets
The Regulator's key message is that all pension schemes must now have a long-term funding target (LTFT) and a plan as to how to hit that target. With most schemes closed to new entrants and accrual, LTFTs will generally be targeting funding on a basis which is more prudent than a scheme's technical provisions, with the plan being to reach a position where the scheme can fund members' benefits without material employer support and significant investment risk. As in previous statements, the Regulator emphasises the need for schemes to focus on and be able to demonstrate that they have adopted an appropriate integrated risk management approach - taking into account the 3 key areas of employer covenant, investment risks and scheme funding plans - and to have well-structured and ideally legally enforceable mechanisms to deal with key risks which materialise. High transfer activity is again a risk which is highlighted as one that trustees should take into account. The Regulator helpfully sets out more comprehensive details of the approach it expects in 10 typical situations, ranging from immature schemes with strong funding and a strong covenant to mature, stressed schemes with weak employers.
Shorter recovery periods for strong employers
The Regulator's statement also lays down its expectation that schemes in deficit with strong covenants should be fully funded on a technical provisions basis in a time frame of significantly less than 7 years – the current median recovery plan period. The Regulator will be proactively contacting schemes where it has concerns about recovery plans and expects trustees to be able to show that they have negotiated robustly with scheme employers and justify their funding and investment approach.
Fair treatment with shareholders
Another key message, expanding on previous announcements, is that the Regulator intends to get tougher where it perceives an imbalance between returns to shareholders and the contributions needed to fully fund a company's scheme. It lays out 3 key expectations:
- Employers paying dividends and making distributions to shareholders which exceed deficit recovery contributions (DRCs) should have schemes with strong funding targets and short recovery plans.
- Weak/tending to weak employers' DRCs should exceed shareholder distributions, unless the recovery plan is short and the funding target strong.
- No shareholder distributions should be made by weak employers which are unable to support their scheme.
The new funding statement provides welcome clarity for trustees and employers as to what the Regulator expects of them and further guidance on technical provisions and recovery plans will be in a new DB Funding Code, to be published later in the year. Putting in place long-term objectives and a plan to ensure members get their benefits will be nothing new to many schemes, but requiring all schemes to do this should enhance the prospects of members receiving the benefits they have been promised. So too should the push for strong employers to have short recovery plans and the increased focus on ensuring a fair balance between the interests of members and shareholders. Employers should be particularly aware that, on this last issue, the Regulator has recently shown it means business, with its intervention on Southern Water's dividend policy forcing the company to provide £50 million additional funding.