Strong employers should consider contributing more money to reduce pension deficits over a shorter period of time, especially where they are paying out excessive shareholder dividends, the watchdog has said.
In its annual defined benefit (DB) funding statement published today, The Pensions Regulator (TPR) called on trustees and employers to do more to protect members' benefits and work together where there is a weak employer to secure a fair deal for the scheme.
It is still concerned about the growing disparity between dividends and deficit-reduction payments and that it expects fair treatment between shareholders and trustees. It warned it will act if a scheme is not treated fairly by using its existing powers, and is also working with government to implement new proposed powers in the white paper.
It is TPR's first announcement since the government's DB white paper, which set out its intention to review and update the funding code over the next two years.
The watchdog set out five different scenarios to help guide trustees and employers. For example, it said where the sponsoring employer is weak, and funding is on track to meet targets, scheme liabilities should be prioritised over shareholder returns, and the company should retain cash to address the deficit.
Interim executive director of regulatory policy Anthony Raymond said the statement shows how TPR is being clearer about what it expects of trustees during valuations.
"Recent corporate failures have shown the risks of long recovery plans while payments to shareholders are excessive, relative to deficit-repair contributions.
"Trustees should negotiate robustly with the sponsoring employer to secure a fair deal for the pension scheme, while employers should balance the interests of pension savers with returns to shareholders and investors. We are working more closely than ever with trustees to support them in this process."
According to the statement, trustees should consider performing analysis of the relative amounts of dividends and deficit repair contributions, and expect to receive sufficient access to the employer's budgets and cash flow forecasts to enable this. Where distributions appear unreasonable relative to contributions, it expects trustees to negotiate robustly with the employer to secure a fair deal. Dividend payments may not be the only form of leakage of value from sponsoring employers; other examples include intra-group loans and transfers of business assets at less than fair value.
It comes as the regulator has been adopting a 'clearer, quicker, tougher' approach, which has seen its proactive casework increase by 90% over 2017/18 period.
The watchdog's statement is particularly relevant to schemes with valuations between 22 September 2017 and 21 September 2018 - which it refers to as 'tranche 13'. Its assessment of funding positions of these schemes suggests a marginally better funding level compared with three years ago, although it expects wide variations between individual schemes of all sizes. Funds that have not hedged their interest rate and inflation risks are likely to have done worse than others that have, it said.
Brexit and transfers
The statement also sheds some light on dealing with issues such as market conditions and the impact of Brexit, which may be of particular concern to the tranche 13 schemes.
The regulator expects trustees to have open and collaborative discussions with sponsors and to consider how uncertainty may affect the sponsor's ability to provide support. If there are material concerns, TPR expects sponsors and trustees to assess the impact on the sponsor's balance sheet and cashflows in the short and long term.
Where sponsors are reasonably holding back cash by extending the recovery plan because of Brexit uncertainty, trustees should ensure shareholders are also sharing the burden proportionately. They should also seek other forms of security where available or establish contingency plans with specific actions for how the scheme's funding position will be recovered.
The watchdog also revealed it is being more proactive with smaller schemes on valuations and employer covenants. Recently it contacted "a number" to explain how it rates their covenant and the issues trustees should address before their 2018 valuation is finalised.
TPR is also mindful of the impact of member transfer requests, which have risen from a combination of the pension freedoms and depressed gilt yields. Transfer requests should be closely monitored in light of the potential impact on the scheme's funding and investment strategy and to ensure the right quality of advice is available to members, it said. This is especially important for smaller schemes, where members with very large transfer values could have a disproportionate impact.
Aon partner Matthew Arends said there are two big messages in the statement: "First, actuarial valuations need to go beyond simply setting contributions to include implementing plans to manage risks to the scheme. Second, "fix the roof while the sun is shining" either now or in the future.
"The regulator expects higher contributions or more security from employers now - if they can afford it - but otherwise enforceable plans for contributions to increase, if and when that becomes possible in the future. The regulator recognises that on average schemes will be better funded this time round - but rather than resting on laurels, now is the time to get busy with long-term plans."
Hymans Robertson partner Patrick Bloomfield said the statement marks a "strong shift towards protecting scheme members, primarily at the expense of shareholders". While TPR has been consistent in advocating fairer treatment for pension schemes relative to shareholders for some time, he said it is being "more vocal" about its view of what 'fair treatment' means, "with the threat of using its powers to intervene where trustees don't do what's necessary."
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