Out-Law News | 07 Mar 2019 | 2:28 pm | 3 min. read
Trustees should set a long-term funding target for the scheme, and should respond more readily to the impact of adverse investment performance on their ability to meet that target, according to this year's TPR DB annual funding statement (AFS) (22-page / 178KB PDF).
The AFS is an annual TPR publication in which it sets out its funding expectations of trustees and sponsoring employers, particularly those with three-yearly scheme valuations due before 21 September 2019. However, its contents are not binding. TPR is planning to publish a revised DB funding code of practice for consultation later this year, which will be binding.
As the majority of DB schemes are now closed to new members, TPR expects that "scheme maturity issues" will become a much more significant factor to be borne in mind by trustees when setting the scheme's funding and investment strategy. In particular, trustees should now be considering the scheme's ability to meet its funding commitments from investments and new contributions in a reasonable timeframe, according to the regulator.
David Fairs, TPR's executive director of regulatory policy, said: "In order to support schemes we are a setting out what we expect trustees and sponsoring employers to consider on funding, investment and covenant. The AFS will help them think about the risks facing their scheme, to consider what levels of risk are acceptable and how to mitigate risks where appropriate."
DB schemes, which include 'final salary' schemes, promise a set level of pension once an employee reaches retirement age, no matter what happens to the stock market or the value of the pension investment. The percentage of these schemes open to new members has fallen considerably over the last 10 to 15 years while increased life expectancy, changes to working patterns and the economy mean that those which remain are operating in a very different environment from the one that they were designed for.
The primary objective of a DB scheme is to pay the promised benefits for all its members. According to the AFS, the schemes which are most successful at this are those with a clear strategy, agreed by the trustee and employer, which recognises how the balance between investment risk, contributions and 'covenant', or employer support, may change over time as the scheme becomes better funded. This typically requires an agreed long-term funding target, and a 'journey plan' setting out how the trustees intend to get there.
The government, in its 'white paper' on DB pension schemes, indicated its intention to require all schemes to have a specific long-term plan in place, which may include buy-out or consolidation. With this in mind, TPR expects all schemes to set a long-term funding target "consistent with how the trustees and employers expect to deliver the scheme's ultimate objective", and to be able to provide evidence that their shorter-term investment and funding strategies are aligned with this target.
As part of a new regulatory approach, TPR is becoming more proactive about working with schemes to identify potential risks which could impact on their members before they submit their triennial valuations. As part of this, it intends to particularly focus on the length of a scheme's recovery plan and whether the sponsoring employer is treating the scheme fairly. As a general rule, employers' deficit reduction contributions should exceed dividends and other shareholder distributions "unless the recovery plan is short and the funding target is strong". Employers which are "weak and unable to support the scheme" should not be paying dividends at all.
Pensions expert Stephen Scholefield of Pinsent Masons, the law firm behind Out-Law.com, said that TPR's focus on dividend payments "is no surprise and adds welcome clarity to the regulator's thinking". However, its emphasis on long-term funding targets was potentially even more significant, for both trustees and sponsoring employers, he said.
"Trustees and employers need to think carefully about what being fully funded really means for them, and what they will do if they reach that position," he said. "There can be a big gap between being 'fully funded' and being able to say that members' benefits are secure. We look forward to continuing to help trustees and employers to work together to bridge that gap."