The Pensions Regulator’s Annual Funding Statement 2020 – emphasis on covenant assessment

The Pensions Regulator (TPR) has published its Annual Funding Statement (AFS) for 2020 for defined benefit pension schemes. This is particularly relevant for schemes with valuation dates between 22 September 2019 and 21 September 2020.

TPR notes the very challenging times brought about by the impact of the coronavirus pandemic; it recognises the importance for trustees and employers to work together to manage the impact whilst noting the need to retain a focus on the long term.     

In the statement, TPR highlights the following: 

New funding code

This is to be introduced after two formal consultations, supported by changes to legislation. Consultation on the proposed principles and regulatory approach has already been extended to 2 September 2020; a business impact assessment to coincide with the second consultation is to be published next year. TPR does not expect the new code to come into force until late 2021 at the earliest.

Coronavirus and funding

See our summary of the key themes in TPR’s coronavirus guidance issued on 20 and 27 March and how trustees should respond here.

TPR is not requiring schemes, which are close to completing their valuations, to consider post valuation experience in their assumptions, but does expect them to consider it in recovery plans with a focus on the sponsor’s affordability. 

TPR sounds a note of caution if trustees consider bringing forward the effective date of the valuation to a date (such as 31 December 2019) when conditions were considered ‘more normal’. 

TPR however: 

  • notes many schemes have plenty of time to complete their valuations; 
  • says it is reasonable to delay taking decisions until there is more certainty, given the limitations on information to form a reliable view on long-term investment returns, covenant and affordability; and
  • encourages trustees to seek input from their advisers and consider a range of scenarios for the recovery in the economy so as to inform trustee decisions, as well as continuing to use scenario planning as part of their integrated risk management (IRM) framework. 

In terms of repairing deficits, the focus is on affordability while maintaining equitable treatment and balancing the employer’s sustainable growth. In addition to deficit reduction contributions, TPR suggests appropriate incremental increases in base contributions which track recovery in corporate health or linked to investment performance.  

TPR expects any recommencement of shareholder dividends to signal that any liquidity or affordability constraints are largely restored and recovery plans to reflect this.  

Expectations of trustees

  • Long term funding targets
    TPR encourages schemes with such long-term plans already in place to continue to focus on their Long Term Funding Targets with suitable short-term modifications; it notes the forthcoming legal requirement set out in the Pension Schemes Bill for schemes to have a specific long-term strategy and encourages those without such a target to start to put such plans in place.
  • Covenant assessments
    The focus should be on the ability of the employer to make cash contributions to the scheme to achieve and maintain full funding over an appropriate period, including addressing downside risks. The AFS notes it may be more appropriate, given current circumstances, to undertake some stress testing and scenario planning(for example reflecting possible future economic environments) and how affordability may be affected. Trustees are also expected to assess the potential impact of different outcomes of the trade agreement negotiations following the UK’s departure from the EU.
  • Covenant and contingency plans
    In light of coronavirus, TPR expects the frequency and focus of monitoring to be significantly increased with contingency plans in place so trustees can react as necessary   
  • Covenant leakage
    TPR continues to expect trustees to be vigilant where there is ‘covenant leakage’, such as dividends and other intra-group arrangements, to look at the intention of the arrangements and ability to retrieve funds, and to seek protections where the leakage is not justified.  
  • Managing risks
    TPR continues to expect trustees to focus on IRM and references the tables introduced last year in setting out expectations depending on funding strength, covenant and scheme maturity introduced last year.

TPR sets out clearly its expectation that trustees consider obtaining independent specialist advice to support covenant assessment, particularly where the covenant is complex, deteriorating, distressed or where the scheme has a high degree of reliance on the covenant, for example because it has a large deficit. Trustees are cautioned only to undertake their own covenant assessment where they have the expertise and the necessary objectivity and TPR may ask trustees to see the documentation which supports their assessment. 

The current consultation on the new funding code draws a distinction between schemes for which a ‘fast track’ approach towards valuation assumptions is to be applied and those for which a ‘bespoke’ approach is to be applied. A key issue with the ‘fast track’ approach is that it is potentially no longer really ‘scheme specific’ (or tailored to the scheme’s own circumstances), and arguably at odds with the development of the scheme specific regime since 2005 and IRM. Perhaps unsurprisingly given the current situation, the 2020 AFS emphasises the importance of: 

  • the need for specialist advice in assessing and monitoring covenant;
  • IRM in managing risks; and 
  • the use of tools such as stress testing and scenario planning to manage uncertainty. This is to be welcomed. 

For more information, please contact Guy Mander or Donald Fleming

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