Itchy Triggers?

In February this year, The Pensions Regulator published its code of practice on funding defined benefits, providing practical guidance for those involved in scheme funding – principally trustees, actuaries and employers – on complying with the new scheme-specific funding requirements.
The Pension Regulator’s recent statement, indicating how it intends to regulate a new scheme funding framework for defined benefits, follows consultation on a draft statement published back in October 2005.

Purpose of the statement
We believe that the statement, as well as explaining the regulator’s approach, will help those involved in scheme funding to make informed choices. The statement does not, however, set targets or standards.
Under the new requirements, trustees are required to calculate their scheme’s technical provisions – an estimate of the assets currently needed in order to pay benefits as they fall due – on prudent actuarial methods and assumptions, rather than aim at a prescribed target.
Having established the technical provisions, trustees must develop a realistic, workable recovery plan to correct any shortfall in the scheme assets as quickly as the employer can reasonably afford.

Focusing on risks
Given that we regulate around 10,000 schemes with defined benefit liabilities, and that the majority of these are likely to have a shortfall, we intend to use “triggers” to filter out those schemes whose funding plans seem more likely to be based on inappropriate or imprudent assumptions (and whose members are therefore at highest risk).
The use of these triggers – which are based on readily available information – will help us to focus our attention and resources on schemes that may merit further investigation.

Technical provisions and recovery plans
The first and most important trigger relates to the level at which trustees have set the technical provisions.
We will initially compare this figure with a range between two liability values for the scheme (irrespective of which of the two is higher), the section 179 valuation of PPF liabilities and FRS17 liability (or IAS19 liability where available).
Schemes whose technical provisions lie below this range will certainly trigger our attention.
Where the technical provisions lie within this range, whether the scheme triggers or not will depend on our assessment of the maturity of the membership and the strength of the employer’s covenant, which we will initially judge using externally available information including that from credit rating agencies, first applying a sense check to these two values using other available information such as buy-out valuations.
The second set of triggers relates to the recovery plan. Broadly speaking, schemes will trigger if this is longer than 10 years or has a significantly higher level of contributions towards the end of the period.
And while we recognise that assumptions on likely investment returns may allow a greater degree of equity outperformance than implied in the technical provisions, a further trigger will apply if the recovery plan appears to be based on unrealistic investment assumptions.
Whatever may cause a scheme to trigger, our primary focus will be to ensure that technical provisions have been calculated using methods and assumptions that are prudent given the scheme’s circumstances. However, we will be prepared to be more flexible when considering the appropriateness of the recovery plan.
In deciding what action to take – if any – where a recovery plan has triggered, we will take into account the impact any alteration to the recovery plan might have on the employer’s viability, including its ongoing ability to fund the scheme and its long-term health.
Our position is that the best means of delivering members’ benefits is, in the great majority of cases, for the scheme to have the continued support of a viable employer.

Regulatory action
As already emphasised, triggers are not targets, and it is important schemes do not rely on our trigger mechanisms to tell them whether or not they have set prudent technical provisions or appropriate recovery plans.
If a scheme does trigger in any of the ways described above, it does not mean that regulatory action will necessarily follow. In all cases, we will carry out a further assessment of the scheme’s circumstances before taking any decision about contacting the scheme or intervening further.
Equally, we may decide to investigate a scheme that has not triggered but that has come to our attention through other channels such as the notifiable events framework, reports of breaches of the law or other sources of intelligence.
The full regulatory statement, along with our code of practice on funding defined benefits and examples of the documents required under the new funding framework, are available on The Pensions Regulator’s website, www.thepensionsregulator.
gov.uk.

John Ashcroft is head of strategy at The Pensions Regulator