30 April 2020
The Pensions Regulator (TPR) has just published its 2020 Annual Funding Statement. As a reminder, they publish these statements every year to give guidance to defined benefit trustees and employers currently completing triennial valuations or otherwise reviewing their funding and risk strategies. And even for those not undertaking valuations, the messages are relevant because they signal the direction of travel of TPR’s thinking.
However, the 2020 statement is particularly important because it will apply to valuations with dates such as 31 December 2019, 31 March 2020 and 30 June 2020, which will be completed during the current tough market conditions and may therefore show larger deficits at a time when many sponsors are being impacted by Covid-19 and may have less cash.
What are the headlines?
To the possible disappointment of some sponsoring employers, the statement does not provide any further easements in the current environment to reflect Covid-19. The key messages are an emphasis on the importance of trustees and employers working together to manage the immediate effects of the pandemic with a focus on pension schemes getting a fair share of cash, and long-term planning and careful risk management to protect members.
Once again, the guidance can be best summarised as a call for trustees and sponsors to undertake sensible integrated risk management and contingency planning – looking at covenant risks, investment risk and funding risk together – and thereby making better decisions about the management of the scheme. This integrated approach should lead to action plans that result in risks being taken that can be appropriately supported by the sponsor, and are less likely to get the scheme or the business into financial difficulty.
At the heart of the statement is a large table that sets out TPR’s expectations for schemes that have different funding positions, different maturities and which are supported by sponsors with varying covenants. Helpfully, TPR has simply repeated the table that was in last year’s statement. This certainly makes things simpler, and in itself is no change in expectations. It is good to see that TPR thinks last year’s guidance is robust enough to survive the current Covid-19 crisis.
TPR also briefly discusses whether a scheme might adopt an earlier valuation date (eg to change a 31 March 2020 valuation to a 31 December 2019 valuation), so the valuation can be completed in what might prove to be more “normal” market conditions. TPR says trustees should seek advice and think very carefully about whether making such a change is in member’s best interests before agreeing to it. TPR also says any trustees who take this decision should expect to be questioned by TPR on their reasoning.
Helpfully, TPR explicitly says that their very lengthy ongoing consultation on the future of funding of DB schemes can be ignored for the purposes of current valuations, and only the existing rules apply. But it still feels like this statement is being used to build a bridge to the new regime in some areas.
So what’s changed?
A big emphasis in the 2020 statement is on trustees ensuring they understand the sponsor’s cash position and cashflows, and then ensuring they get a fair share of available cash. This is consistent with the messages in TPR’s 20 March and 27 March emergency Covid-19 guidance, and TPR has said that all their guidance should be considered together. However, I suspect it will feel like a step up in requirements for some trustees and companies.
In particular, the 2020 statement makes clear TPR’s expectation of trustees to look closely at all the different ways in which potential support for the pension scheme can ‘leak’ out of the sponsor, and this goes beyond just dividends. This includes understanding items like the following, which are listed in the statement:
- Cash pooling and inter-company lending arrangements
- Group trading arrangements
- Management fees, royalties and similar charges
- Transfers of business or assets at undervalue
- Excessive executive remuneration
TPR goes on to say that “where trustees consider covenant leakage is not justified, we expect them to seek suitable protections to compensate their scheme for the resulting deterioration in covenant, particularly where there are weaker covenants and longer recovery plans”.
As an example of the level of understanding on these matters required by trustees, where ‘cash pooling’ and inter-company lending occurs TPR says (amongst other things): “we expect trustees to understand the intention behind the arrangements and the expectation and ability of the employer to retrieve funds. In the event amounts are not recoverable or readily available to meet scheme funding requirements, we expect trustees to account for that in their assessment of covenant strength and in scheme funding and investment decisions”.
All this points to it being necessary for trustee boards to have quite a detailed knowledge of the cash management and intra-group relationships regarding their sponsor, and to monitor this more closely in the current environment. This more detailed guidance may be useful for trustees who have struggled to get employer engagement on this in the past. Indeed, TPR says that “in normal circumstances we expect trustees to closely monitor covenant strength and affordability, alongside the key investment and funding risks. In current conditions, we expect the frequency and intensity of monitoring to be significantly increased until covenant visibility and strength is restored”.
TPR also recognises that affordability of contributions for some sponsors will have plummeted. And on this, there is useful commentary that points to pre-agreeing future step ups in contributions as and when the business recovers, whilst accepting that lower pension contributions might be appropriate for the time being.
The 2020 annual funding statement offers further thoughts on how Covid-19 is impacting TPR thinking but makes it clear that TPR’s approach to longer term funding remains consistent with previous messages to the market.
Some employers may have been hoping for additional easements given the current environment, but TPR has reiterated that it expects pension schemes to have a fair share of available cash and has spelt out in more detail what issues the trustees should be considering when forming a view on this.