Mike Furbank looks at the lessons learned since guidance was issued by TPR on funding DB schemes.
- It has been difficult for trustees to assess how far TPR will support them when asking sponsors for more contributions.
- Guidance on this point was updated in July 2014.
- Collaborative discussion needs to take place with the employer on the pace at which any deficit should be managed.
In the ten years since the Pensions Regulator (TPR) began its mission to implement the changes brought in by the 2004 Pensions Act, it has generally won plaudits for its proportionate and reasonable approach. What's also been interesting to observe is how the Regulator has developed its guidance to trustees as experience (and the political and economic climate) has changed over the decade.
This is particularly notable when it comes to the trustee's duty to assess covenant when determining the pace of funding and the level of investment risk in their scheme's asset allocation.
Although TPR would always support the message that the best way to achieve long-term security for members' benefits in a DB scheme is to ensure the employer thrives and remains in business (at least until any deficit is eliminated), it has sometimes been difficult for trustees to know exactly how far TPR would support them in arguing for more contributions and shorter recovery periods.
I think we can feel optimistic that the code will help trustees reach the right long-term funding decisions for both members' and employers security, working in partnership with the employer and their advisers.
One year ago, in July 2014 (for valuations effective from 29th of that month) TPR updated its guidance on this point. On the back of its new statutory objective to minimise adverse impact on an employer's "sustainable growth" the previous requirement for recovery plans to eliminate any deficit "as quickly as the employer can reasonably afford" was replaced by more wide ranging guidance that should help trustees determine a recovery period that is "appropriate".
So how has this change affected valuations and funding discussions in the year since the code was revised? Firstly, employers have appreciated the recognition that simply because they could afford to pay down a deficit more quickly, where they are strong enough to support the scheme in the medium to long-term, the trustee has to consider whether repayment over a short period is the best use of all of the employer's free cash.
So for example, where the employer could afford to clear the deficit at once but only at the expense of significant capital investment that would yield increased revenues in the years to come, the trustee at least now has to be open to that argument.
Similarly, the trustee can take a more reasonable approach to (say) the normal distribution of dividends rather than identify every source of contribution that is foregone and demand it is directed to the scheme.
The code positively encourages a far wider dialogue with employers to reach the right answer for their business and the DB scheme.
The trustees at The Pensions Trust now ensure that they:
• engage with the employer early and often;
• share the findings of any independent covenant assessment to reach a shared view on the risks faced by the scheme with the employer and their advisers;
• understand the employer's business aims and risk appetite; and
• make decisions about the setting of assumptions and investment strategy only when the covenant risk is fully understood by all parties.
Collaborative discussion also takes place with the employer on the pace at which any deficit should be "managed" (as the code now puts it). The first consideration is what payments are affordable, but how that is judged should be based on the level of payments that are sustainable without risking the employer covenant declining before the deficit is closed. Security and other "non cash" contributions also play their part in getting the right balance.
In short, therefore, experience of how the changes are viewed by The Pensions Trust one year on are:
• Most negotiations about funding with employers and the Trust have been collaborative and the long-term sustainability of the employer has always been a consideration.
• It has helped employers to raise reasonable challenges to the Trustee's "starting position" to have deficits paid off as quickly as possible.
• It has placed ever more emphasis on the need to consider covenant alongside investment and funding considerations.
As we see the first of the valuations under the new guidance reaching their conclusion, I think we can feel optimistic that the code will help trustees reach the right long-term funding decisions for both members' and employers security, working in partnership with the employer and their advisers.
Mike Furbank, trustee services delivery manager at The Pensions Trust
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