The Pensions Regulator publishes guidance on DB pension funding

The Pensions Regulator (TPR) has published guidance on how funding valuations should be approached in the current economic climate.

It applies to approximately one-third of the UK’s 6,500 defined benefit (DB) pension schemes, and about 4 million of the 12 million DB memberships. 

The guidance is aimed at employers and trustees of DB schemes that are undertaking their scheme valuations with effective dates between September 2011 and September 2012.

The aim of the guidance is to encourage employers and trustees to work with their advisors to begin the process of implementing the approaches to their scheme funding valuations.

The statement provides guidance to trustees and employers as follows:

  • There is significant flexibility in the funding framework to enable schemes and employers to meet their long-term liabilities, including, where necessary, filling deficits over longer periods, taking account of improvements to market conditions post-valuation, and the use of contingent security and intra-group guarantees.
  • As a starting point, TPR expects that current deficit recovery contributions should be maintained in real terms. It will seek strong justification where a reduction is proposed.
  • Capital expenditure, servicing other debts and making dividend payments have an important role to play in encouraging investment in a healthy, sponsoring employer. However, in some cases, dividend payments may need to recognise the shareholders’ subordinate position to the scheme. Where available, cash is used within an organisation that might otherwise have been used to increase contributions it should have the demonstrable effect of strengthening the employer’s ability to support the scheme.

Based on the information TPR holds on schemes, including their previous valuations, it estimates that a significant majority of employers of schemes in deficit will not need to make changes to their existing plans; or will only need to make small increases to their deficit recovery contributions and/or length of recovery plans.

The remainder divide into two groups:

  • Employers of significantly underfunded pension schemes for which affordability of contributions is not a major barrier. Employers in this group will need to make larger increases in contributions and/or provide security in the form of contingent assets.
  • Employers, with deficits, that are expected to find affordability a challenge. Employers in this group are likely to need to significantly increase their existing deficit recovery plan length and/or make full use of the other flexibilities within the scheme funding framework.

Bill Galvin, chief executive at The Pensions Regulator, said: “The economic climate continues to be challenging, but the majority of schemes and sponsoring employers should be able to meet their promises to members without major adjustments to their current plans. Trustees must produce credible recovery plans in light of all the risks, including employer insolvency.

“Employers that are struggling have greater breathing space to fill deficits over a longer period. However, we will draw a distinction between this group and those cases where schemes are substantially underfunded and employers are able to afford higher contributions. In such cases, we will expect pension trustees to be taking steps to put their scheme on a more stable footing.

“There are a number of economic factors impacting gilt yields, such as quantitative easing (QE) and demands for UK sovereign debt from the international banking sector.

“We have been in a low-interest climate for some time. Yields have fallen further in the last nine months, and it is unclear when and to what extent there will be a market correction. The net effect across DB schemes is not uniform and will vary greatly depending upon the extent to which their risk-management, investment and contribution strategies have insulated them from the effects.”

Stephen Soper, executive director for DB regulation at The Pensions Regulator, added: “We are taking a more segmented approach to regulation and will proactively engage with those schemes where we believe there is greatest risk to member benefits and PPF levy payers, based upon experiences of previous funding cycles.

“Schemes in a stronger position can expect less intervention by us, but we will place more focus on schemes in a weaker position. In those rare situations where the sponsoring employer is so weak that trustees are not able to put together a viable plan, we urge them to contact us as early as possible in the process.”

Joanne Segars, chief executive at the National Association of Pension Funds (NAPF), said: “Tough economic conditions, QE and falling gilt yields have been causing a huge headache for organisations providing DB pensions, many of which have seen their pension deficits go up significantly.

“Pension trustees and those running pension schemes have a difficult job. The Pensions Regulator’s statement will help by giving some much-needed clarity on what they expect from them and the employers who are going through their valuations.

“It is good that TPR will look sympathetically on employers that have experienced significant deficit increases by allowing extensions in recovery periods and, in some cases, allowing recovery plans to take on board any potential improvements in economic conditions.

“However, as the negative growth figures this week have shown, the outlook for the economy remains highly uncertain and there is the possibility that more QE will unfold. While TPR is optimistic that the majority of pension schemes will not need to make significant increases in their contributions, it will need to stand ready to adjust its expectations if the real experience of pension schemes turns out to be far worse.

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“While TPR’s statement is helpful, we hope that its dealings with pension funds and their employers are consistent with what it has outlined. Ultimately, the proof of the pudding will be in the eating.”

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