16 September 2020
With everything that has been going on recently, housing associations could be forgiven if the forthcoming SHPS valuation was not top of their agenda. However, we are now less than one month away from the effective date of the valuation, and the continuing fall in real gilt yields since 2017 may have a material impact on housing associations’ costs in the next few years. So what do we expect from the valuation and what will it mean for associations and their staff?
What has happened since the last valuation?
At the last SHPS valuation in 2017, the total deficit was just over £1.5bn, and this was to be met by contributions totalling c.£160m per annum initially, payable until 2026. If experience since 2017 had been in line with the assumptions, we might now be looking at a deficit of around £1bn. However, based on our estimates, the actual figure may still be around the original £1.5bn. This means that the position hasn’t improved even though employers have paid in around £0.5bn of deficit contributions and several employers have transferred out and taken their share of the deficit with them (see below for more details).
Whilst SHPS’s assets have performed well, we estimate that they have not been able to keep pace with the increase to liability measure as a result of the fall in real gilt yields, meaning we expect lower asset returns in the future.
What might this mean in financial terms? Well, based on very round numbers overall deficit contributions may need to increase by around 50%. Now this could be achieved in a number of ways, whether that be increasing the total amount payable and keeping the same end date for the deficit recovery period, or extending the period out into the future, or a combination of the two. But it does give an idea of the magnitude of the additional cash contributions employers may be facing.
Will the cost of new benefits accruing increase as well?
The short answer is “yes”; all else being equal, we expect the total cost of the benefits to increase significantly, maybe by up to 5% of salary in some cases. This increase would need to be met by a combination of increases in contributions payable by the employer and by staff. In many cases staff are already paying significant contribution rates and more increases may be unaffordable.
If we do see cost increases at this level then we would expect to see more employers either opting for a lower value, and hence cheaper, benefit structure (for example moving from 60ths to 80ths, or from Final Salary to Career Average benefits) or potentially closing to defined benefits completely. This was very much the outcome of the 2017 valuation, and there is no reason that it won’t be the same this time.
What about employers that have transferred out?
Since the last valuation a number of employers have transferred their assets and liabilities out of SHPS. On the one hand this should be positive for the SHPS funding position, as those employers will have taken their share of the SHPS deficit with them into their new arrangements. In addition, they may well have paid a “covenant protection premium” into SHPS, in recognition of the fact that SHPS can no longer rely on their support in the future.
The flipside is that the existing deficit is now being shared out over a smaller group. To the extent that the existing recovery plan will no longer include contributions from employers who have subsequently left, the increase for the remaining employers will be that bit higher again.
Will there be any surprises in this valuation?
On the one hand, we are not expecting wholesale changes compared to the approach used in 2017 (which is what the above estimates are based on). There are likely to be a few updates to accommodate movements in financial markets, changes in life expectancy, and potentially a technical change that affects how the value of the liabilities is calculated but may not have a material impact on the final answer.
However, there may be regulatory factors that make this time a bit different. The Pensions Regulator was heavily involved with discussions in 2017,but more recently they have issued material around a proposed new funding regime for DB pension schemes, which may influence their view.
The clear message of this material is that pension schemes need to be treated fairly in relation to other creditors and, in particular, if cash is available the Pensions Regulator’s preference would be to get it into the scheme sooner rather than later. This could mean that SHPS is reluctant to extend the Recovery Plan contributions much beyond 2026.
So what next?
Given the volatility of financial markets and the unpredictability of everything post pandemic it makes sense to wait to see if there any significant changes over the coming month before taking any action. Assuming there are no significant movements, I think that employers should then start having conversations with their Boards and planning on the basis that there is likely to be an increase in contributions from April 2022. Preparing for an increase in deficit contributions of the order of 30-50% would be a sensible planning estimate.
Any employers with employees earning defined benefits in SHPS should start to think about their approach to any increase in required contributions, particularly if past policy has been for the employees to meet the entirety of any change. Will contributions at the new rate be affordable for the individuals involved, or will changes need to be made? Again, starting to think through some of the high level principles behind those decisions now will be time well spent as, when the results ultimately come out, decisions will need to be made and actions taken potentially within a short timeframe.