The Pensions Regulator has issued a raft of guidance on how DB schemes should face the current crisis. Here, David Fairs sets out more details in response to common questions.
A number of you have contacted me and my team since The Pensions Regulator (TPR) published guidance for trustees dealing with the coronavirus pandemic. In this article I will look at some of the questions we have been asked. We are not focusing in this article on how trustees should approach their valuations under current conditions. Guidance on this will follow in our annual funding statement, which we will publish at the end of this month. We will also address questions raised in relation to cash equivalent transfer values (CETVs) separately.
How bad is the crisis for defined benefit (DB) schemes? Do all trustees need take up the easements we set out in our guidance, in particular in relation to requests to defer deficit repair contributions (DRCs) or payments for future service by their sponsoring employer?
It is obviously too early to say what the medium to long-term impacts of the pandemic will be, but the crisis has already affected many schemes and employers. Some schemes will fare better than others, depending on how well funded they were at the start of the crisis, their investment strategy and level of hedging and the sector in which their employer operates. We therefore don't expect all employers to need to defer DRCs or payments for future contributions.
But some employers will be constrained, and in these circumstances, trustees should be open to requests for deferrals, provided they undertake due diligence as set out in our guidance. Recognising not all information needed for this due diligence may be available, our guidance provides scope for a short-term deferral of up to three months.
These are difficult decisions to make and trustees and employers, supported by their respective advisers, should approach these discussions openly and in a spirit of collaboration, taking into account the specific circumstances of the scheme and its governing documentation.
Trustees or employers facing difficult negotiations can get in touch with us and we will do what we can to support them. Please contact [email protected] and flag clearly if your query is urgent.
Your guidance said trustees should consider any request to release security very carefully, but some sponsors are saying they may not be able to honour their guarantees. What should trustees do in this situation?
Some schemes benefit from guarantees, ranging from a payment of DRCs guarantee up to a full section 75 guarantee. Giving up a guarantee is unlikely to be in the best interests of members and would mean trustees lose their seat at the table with other creditors.
If the guarantor says it is unable to afford DRCs, then our recent guidance and considerations relating to DRCs is also applicable. Trustees should consider the guarantor's inability to make payments carefully and take legal and financial advice. We would expect the guarantor to provide sufficient evidence that the guarantee cannot be honoured and that the scheme is being treated equitably compared to other creditors.
Trustees should seek advice to understand what enforcement rights they have and what their options are (for instance, should they waive the breach or enforce payment?). In extreme situations, trustees should be prepared to enforce the guarantee to protect member benefits.
Some employers and trustees are telling us it might be unaffordable to take professional advice or not useful given the uncertain outlook.
Trustees are facing challenging decisions and complex issues. Maintaining key governance activities and taking advice in those circumstances is therefore very important and should not be deprioritised. For instance, the need for independent, external advice to assess the covenant may be particularly relevant where the covenant is complex or deteriorating and specialist knowledge will often be required in distressed situations. Further, such advice can assist in difficult negotiations.
However, as always, it's about being proportionate and tailoring advice to what is needed. In our guidance we said that, in the current circumstances, trustees could consider obtaining targeted real time advice (such as verbal advice backed up by short (email) written advice) rather than to commission detailed reports. Trustees should consider all options that may be available to them to pay for necessary advice.
Are there any unintended consequences that trustees should be mindful of when considering deferrals or DRCs or payments for future service?
We expect trustees to take legal and actuarial advice as the consequences and impact will be different for each scheme. For example, a failure to make a payment under the Schedule of Contributions may trigger the scheme's wind-up rule. In relation to investments, trustees should pay particular attention to their expected scheme cash outflows over the short to medium term and the extent to which those cashflows were expected to be met by DRCs. If DRCs are now being deferred, the trustees may find themselves having to sell scheme assets to meet cashflows and may therefore want to review their liquidity to ensure the cashflows are still met. This is likely to be of greater importance for a mature plan where, typically, cash outflow is greater.
In addition to the issue of deferring DRCs, schemes may experience different transfer value activity than previously, and this may lead to additional cash flows and hence a greater focus on liquidity.
At the beginning of March, TPR launched the first stage of its consultation on clearer DB funding standards. Are the consultation and the proposals it put forward still relevant in view of the changing economic conditions?
Pension schemes are long-term propositions and there is sufficient flexibility in the funding regime for most trustees and employers to be able to deal with significant economic fluctuations.
The approach we propose for our revised DB code preserves that flexibility, particularly through the Bespoke route. And the focus on long-term planning, risk management and affordability-driven recovery plans remains highly relevant in light of Covid-19 and should improve DB schemes' resilience to future adverse events.
When we come to firm up the Fast Track guidelines in the code in our second consultation we will take account of prevailing market conditions as well as our assessment of impacts.
We have extended the deadline for response to September 2 so all interested parties are able to give the consultation their attention and have the time and capacity to formulate their response.
David Fairs is executive director of regulatory policy, analysis and advice at The Pensions Regulator
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