Should timing of valuations be based on scheme health?
TPR has called for the time between actuarial valuations to be based on a scheme's health, but is this a good idea? James Phillips asks trustees what they think
- A system based on scheme health would replace triennial valuations
- Trustees often have actuarial data supplied on a regular basis
- The new system could worsen the hardship of schemes in poor positions
Defined benefit (DB) schemes are used to undergoing triennial valuations, introduced in 2004, and knowing the date of when they will be held can help with preparation and ongoing monitoring of funding.
But this could all change soon, as The Pensions Regulator (TPR) has called for the government to allow it to set valuation periods depending on the scheme's perceived health.
This means a scheme could have a valuation more regularly than every three years if it appeared to be in a bad funding position, while others could see valuations fewer and farther between. The idea is to allow the watchdog to scrutinise poorly performing schemes more effectively.
The proposal has been put to the Work and Pensions Committee (WPC) inquiry into DB regulation. However, the Department for Work and Pensions (DWP) will need to legislate for it before the changes can be made.
A recent PP survey found most pension professionals rejected the idea, with reasons ranging from practicality to the necessity for due diligence.
Time and money
Triennial valuations can be costly and time-consuming, so reducing this requirement for well-funded schemes could prove advantageous.
For well-funded schemes, TPR may also only be interested in the figure, so negotiations between the trustee and sponsor that ensue following the valuation could be paused for longer periods of time.
Independent Trustee Services director Peter Askins says this should be the case, as TPR can keep an eye on schemes through less formal methods quite easily anyway.
He says: "This idea will find a great deal of support in the industry. Many consultants and actuaries have been saying it for the last couple of years.
"Triennial valuations are redundant because schemes are doing valuations on a daily basis. With modern actuarial systems, there is a constant stream of data on liabilities and assets, so consultants and trustees can have information when they want. This data should become part of the annual report.
"The need for a formal snapshot of 15 months in the past is diminishing."
For large schemes, at least, actuarial calculations can be quick, while the negotiations take up the bulk of the 15-month period. Relaxing the rules on these valuations could potentially improve the data provided to TPR.
PTL managing director Richard Butcher agrees, arguing the process results in a fictional number anyway, which may not be of that much use.
"Your funding situation is the difference between a fairly factual calculation of assets, and a fictional calculation of liabilities. So, by definition it's also a fictional number. That's a flawed process; it's not a statement of fact.
"Where you've got a really strong employer with a strong covenant, is there any point going through that exercise regularly? It's easy to come up with a proxy, using a far less formal process that costs a lot less money."
Counter-effective
For the smaller schemes in difficult funding positions, however, it could add to the hardship of trustees and employers. The additional onus and cost could potentially cause their scheme's situation to deteriorate further.
Punter Southall Independent Trustees client director James Double says TPR should be able to get all the information it needs from the annual updates published by schemes.
"The crux of the suggestion is that TPR would want more regular updates from those distressed schemes at the greatest risk," he argues. "This heaps more cost on those schemes that are already struggling when there is already a mechanism TPR can use.
"Schemes with over a hundred members have to do annual updates in any event. They're only a simple roll forward of liabilities, but that information should be sufficient for TPR's purposes."
Perhaps the time gap between these valuations should only be moved one way. For schemes in well-funded situations maybe the gap could be lengthened, but for those schemes in dire positions the gap could remain at most every three years.
Butcher argues this is perhaps the best way forward, and still allows for TPR to have closer scrutiny of schemes in hardship.
"Where the employer covenant is weak, there is an argument for this because you need to keep a closer eye on things," he explains. "It's like driving along a motorway. If you're cruising at 60 miles per hour, you don't particularly need to watch the speed limit because you've got leeway.
"But if you're driving at 69 miles per hour, you need to keep a much closer eye on the speed because you've got a lower margin for error.
"In those cases, you do the valuation. I wouldn't suggest you do a valuation more frequently than every three years."
Nevertheless, some safeguards should be in place in case a well-funded scheme is suddenly hit by a rapid deterioration of the sponsoring employer's covenant.
Askins argues that if the proposal is agreed, TPR will need to issue guidance.
"What you would need is regulator guidance on when it might be necessary to adjust repayment periods or amounts in payment, rather than the three-year cycle. This could be either where TPR would say trustees should formally review the process every three years, or trustees and sponsors should consider it within the seven-month period of collating the information for the scheme reports and accounts."
There are certainly some intricacies that need to be considered before putting such a proposal into place. But before any of that can happen, the WPC will need to put the idea to the DWP and the government will need to legislate.
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