DB funding - Pensions Regulator 2022 annual statement

The Pensions Regulator (the “Regulator”) has published its 2022 annual funding statement which is targeted at schemes undergoing valuations with effective dates between 22 September 2021 and 21 September 2022. It is also relevant to schemes on a more general basis by highlighting risk management practices, regulatory developments and current issues.

Considerations for schemes currently undertaking a valuation
Schemes that are currently undergoing valuations are doing so in a period of significant economic uncertainty with high inflation, high energy prices, higher interest rates and slower economic growth, all of which may impact scheme assets and liabilities and the employer covenant. The conflict in Ukraine and the associated sanctions have added to this uncertainty, while for many employers these factors will be coming on top of the ongoing challenges of COVID-19 and Brexit.

Covenant considerations
Trustees should consider the overall impact that market events may have had on the employer’s business, and categorise this in one of three ways:

• Current market events have had limited impact. For schemes in this category, deficit repair contributions (“DRCs”) should not be reduced and recovery plan end dates should be reduced rather than extended.
• Current market events have had a material impact, but trading has recovered or is recovering strongly, or some impact is anticipated but expected to be short-lived. For schemes in this category, trustees should carefully consider any requests to accept a temporary reduction in DRCs. Any such request should be short term, with higher DRCs in subsequent years limiting any extension to recovery plan end dates.
• The impact of current market events continues to be material. The pace of recovery is uncertain and could take years, or the business may never fully recover. For schemes in this category, trustees should obtain suitable mitigation where employers request DRC deferrals and/or lower ongoing DRCs as part of a revised recovery plan.

Trustees should consider obtaining independent covenant advice and should continue to undertake stress testing or scenario planning to understand the impact on the employer covenant of possible future economic environments.

Following a hiatus during the COVID-19 pandemic, the Regulator has seen an increase in employers returning cash to shareholders. Trustees should be alert to this and other forms of covenant leakage and should consider whether their scheme is being treated fairly compared to other stakeholders. Trustees should also be alert to any corporate activity and seek mitigation where appropriate.

Actuarial and investment considerations
Trustees should consider how to build recent and short-term inflation rates into the valuation calculations to ensure benefit increases are being modelled correctly. Trustees should choose long term inflation assumptions for pre- and post-2030 to reflect the current understanding of the position in relation to the planned alignment from 2030 of the Retail Prices Index with the Consumer Prices Index including owner-occupier housing costs.

The longer-term impact of COVID-19 on future mortality trends continues to be an area of uncertainty. Where trustees feel that changes to their mortality assumptions are appropriate and justifiable, any reduction in liabilities due to such changes should not exceed 2%, unless there is strong supporting evidence.

Managing risk
If they have not already done so, schemes should adopt a long-term funding target, agree it with the employer and set a journey plan accordingly.

Trustees should continue to adopt an integrated approach to risk management by identifying the key risks to monitor and considering these against appropriate funding, investment and covenant metrics. Contingency plans should be in place for when the threshold limits for those metrics are breached.

Where schemes are in surplus against their technical provisions and have appropriate journey plans, trustees should ensure their liquidity needs are covered and focus on managing risks through contingency planning.

What schemes can expect from the Regulator
The Regulator will engage with schemes if it has concerns over corporate distress to ensure that they are following its guidance.

The Regulator will consult on the draft new DB funding code of practice later in 2022. This consultation will also include proposed changes to the Regulator’s guidance on assessing and monitoring the employer covenant and other related guidance.

Key risks and the Regulator’s expectations
The statement includes tables setting out, for each of 10 covenant categories, the key risks the Regulator expects trustees and employers to focus on, and actions to take, depending on the scheme’s funding strength, maturity, and employer covenant strength.