Enter to open, tab to navigate, enter to select
Annual scheme funding statement 2012: technical provisions should reflect low yield environment
Practical Law UK Legal Update 2-519-2291 (Approx. 4 pages)
Annual scheme funding statement 2012: technical provisions should reflect low yield environment
by PLC Pensions
| Published on 01 May 2012 • United Kingdom |
The Pensions Regulator has published its first annual funding statement for trustees and employers of DB pension schemes. (free access).
Speedread
New scheme funding guidance from the Pensions Regulator warns trustees and employers that they should not assume current low gilt yields will return to "normal" levels when reaching funding agreements.
The Regulator's first annual funding statement is aimed at DB schemes with effective valuation dates between September 2011 and September 2012. Trustees are encouraged to ensure current deficit-repair contributions are maintained in real terms. While acknowledging the difficult economic environment, the Regulator says the majority of schemes should be able to manage ongoing deficits without making changes to existing recovery plans or by "modest" contribution increases or extensions to recovery periods.
Background
The scheme-specific funding regime for defined benefit (DB) schemes introduced under the Pensions Act 2004 came into effect in September 2005. By now, schemes have undertaken two three-yearly funding cycles. The Pensions Regulator has published a code of practice and past statements about the funding process. In December 2011, the Regulator's chief executive confirmed that additional guidance would be published about trustees' duties in the current economic climate (see News round-up for the week to 15 December 2011: Regulator to issue guidance on funding strategy in low-return financial environment).
For a recent consideration of some of the issues arising during the funding cycle, see Article, The scheme funding cycle: current issues in practice.
For general background about the regime, see Practice note, Scheme-specific funding.
Annual funding statement: key points
On 27 April 2012, the Regulator issued its first annual funding statement. The statement is aimed specifically at trustees and employers of DB schemes with effective valuation dates spanning the period September 2011 to September 2012. But according to the Regulator, its contents are relevant for all DB schemes.
Key points arising from the statement are as follows:
- Trustees should undertake contingency planning about scheme funding. They should prepare a financial management plan that brings together actuarial and investment advice along with advice they have received about the strength of the employer covenant.
- Trustees should document their consideration of the issues during the funding process.
- In valuing a scheme's technical provisions, the starting point for a prudent assumption about investment performance should be the returns on gilts. If employers and trustees conclude that yields are likely to rise in the future, justifying higher assumed returns, this assumption may be reflected in recovery plans (which can be adjusted in future should the assumption prove incorrect).
- The majority of schemes should be able to manage ongoing deficits within current recovery plans. If contribution increases or extensions to recovery periods are needed, these should be "modest".
- Trustees should ensure current deficit-repair contributions are maintained in real terms. Generally, they should not agree to reduce deficit-repair contributions unless the employer's covenant has weakened. A material extension to a recovery period will require "sound justification".
- A DB scheme should be "equitably" treated among the other demands on an employer. This could mean an employer may have to reconsider dividend payments if there is a substantial risk to the likelihood of the pension scheme delivering its promised benefits.
- The Regulator expects most schemes to conclude their funding cycle by reaching agreements the Regulator finds acceptable. The Regulator may intervene in cases where its involvement will have the greatest impact. In a few cases, intervention may occur before negotiations between trustees and employer are completed.
Alongside its statement, the Regulator has published details of three scenarios of scheme funding plans in current conditions.
Comment
Pressure has been building on the Regulator for some months to relax the funding regime in the light of the current economic environment, primarily historically low yields. This statement isn't quite the relaxation some will have been hoping for, but the suggestion that "modest" increases in recovery periods may be acceptable to the Regulator is likely to be widely taken up.