Pension scheme funding in the current environment

Royal London Consulting Actuaries

3 May 2012

The Pensions Regulator published its first annual statement on funding at the end of April 2012. 

The statement at a glance

  • Current economic conditions will present challenges to schemes with valuation dates between September 2011 and September 2012.
  • No new flexibility is being introduced to help trustees and employers.
  • The current levels of flexibility remain in place however and these can be used where appropriate.

In the Regulator's view there is already sufficient flexibility in the current funding framework to allow trustees and employers to agree appropriate funding plans to deal with this situation.

The majority of the flexibility resides in the Recovery Plan requirements and the Regulator believes that the majority of schemes will be able to attain full funding within their current Recovery Plan, or with only small increases to either the amount of the current Recovery Plan contributions or its length.

In coming to this conclusion the Regulator is allowing for the one-off beneficial effect of the statutory price inflation measure moving from RPI to CPI. It remains to be seen whether this will be the case particularly for small or medium sized employers' schemes.

Economic circumstances

Over the three years from 31 December 2008 to 31 December 2011, gilt yields have fallen by approximately 1%. As a result liabilities may have increased by up to 30% or more. Gilt values may have risen by approximately 15% and the FTSE 100 Index has risen by 25% over this period. Consequently we expect that significant adjustments will be required for many Recovery Plans.

Risk management

The Regulator expects trustees to take an integrated approach to their scheme funding considerations. Advice on investment, the employer covenant and actuarial matters should be brought together in determining the funding plan. The Regulator has stated that it expects trustees to provide records and be able to explain the interplay between these factors in making their decisions.

In particular, the Regulator has stated that;

Trustees should not try to "cherry pick" the valuation date by bringing forward their valuation dates to utilise more favourable economic conditions. Smoothed discount rates are not, in its view, consistent with the legislative requirements for the calculation of technical provisions.

Recovery Plans and the employer's ability to pay

The Regulator has restated the over-arching principle, that Recovery Plans should be based on what is reasonable for the employer to pay without compromising the employer's long term ability to support the scheme. Where the funding position requires, and the employer is able, Recovery Plan contributions should be increased.

Consequently:

  • Any proposed reduction in Recovery Plan contributions should be justifiable and the reasons documented. Similarly any material extension to a Recovery Plan period will need to be adequately justified.
  • Where an employer's dividend policy is compromising its ability to pay what would otherwise be affordable increased Recovery Plan contributions the Regulator may ask the employer to re-assess its dividend policy.

Conclusion

During the valuation process it will become clear whether schemes will need to significantly increase their Recovery Plan contributions or not.

Trustees will need to integrate the information and advice they receive on investment, the employer covenant and actuarial matters in order to determine a complete financial plan for the scheme. Your scheme actuary will be able to assist you in formulating solutions to these critical issues

Where decreases to Recovery Plan contributions and/or significant increases to the Recovery Plan period are required, the reasons for these should be documented and justifiable. The Regulator will maintain its focus on the importance of Trustees assessing the employer covenant.

Although no new flexibility has been introduced the current flexibility remains available. This includes flexibility in the assumptions chosen for the Recovery Plan and the use of contingent assets.

If you have any questions please contact us.

Notes

Circumstances may have changed since this article was written. It should not be taken as actuarial or legal advice.

Royal London Consulting Actuaries is a service provided by Royal London Corporate Pension Services Limited. Royal London Corporate Pension Services Limited is authorised and regulated by the Financial Conduct Authority and provides pension services. The firm is on the Financial Services Register, registration number 460304.

Registered in England and Wales number 5817049. Registered office: 55 Gracechurch Street, London, EC3V 0RL.

Group Registered VAT Number 368 5244 27