As the early spring bank holiday falls upon us, the Pension Regulator's Annual Funding Statement sets out clearer guidance for both Trustees and Sponsoring Employers of final salary schemes as to what to expect in the next round of valuation and funding negotiations.
Although the Regulator has particular concern for schemes with valuations between September 2017 and September 2018, it is clear the key points it sets out in its paper, coupled with the points already set out in the white paper, Protecting Defined Benefit Pension Schemes, determines the full landscape upon which pension schemes and their employers will operate for the next few years.
Prepare now for the likely reactions
As expected, the Regulator expects Trustees to focus on the integrated risk management process already in place, looking at employer covenant (and ability to support the scheme), investment risk and scheme funding plans. In addition, the Regulator also expects Trustees to pay greater attention to scheme maturity i.e. more members becoming pensioners, creating cash flow risks in terms of schemes underlying investments. The Regulator produced a table with different employer characteristics, scheme funding characteristics, key risks and a clear message as to what they expect Trustees to do in each of those scenarios. In short, where employers’ covenants are strong, the Regulator’s expectation is Trustees will need to strengthen technical provisions, increase contributions and reduce recovery plan lengths which may be coupled with short term security; and where dividends are paid to shareholders or there is other “leakage” (inter group loans, inter group asset transfers, etc.,) appropriate other measures would need to be taken.
Where employers’ covenants are weaker, the Regulator expects trustees to press the sponsoring employer to prioritise scheme liabilities over shareholder payments; and put in an active monitoring process for any employer covenant risk including putting in place contingency plans (which we think should be discussed with any sponsoring employer) to address future risk. Given the negative press generated in relation to recent entrants to the Pension Protection Fund, unsurprisingly, the Regulator is also suggesting trustees need to undertake a greater analysis of the level of contributions versus distribution of dividends within any sponsors business. One new area the Regulator is calling upon trustees to consider is the level of senior management pay, and highlights this in particular to smaller employers, stating trustees should consider senior management pay levels in the same context as potential shareholder distribution; in the Regulator’s view high senior management pay can weaken the employer covenant.
Finally, the Regulator underpins their message saying they think that they are being clear as to what they expect from trustees and employers, therefore they will be quicker to act, and tougher, on those who failed to act in accordance with the guidelines. The Regulator talks about being more pro-active and using their range of powers more often. In particular, extending their reach to smaller schemes. While the new guidance reflects a clear toughening of the Regulator’s position, if schemes and employers are used to an open dialogue, the new guidance should not present an insurmountable hurdle. Indeed, it is an opportunity for both employer and trustee to look at the areas where they could work together to reduce risk and volatility, secure member benefits, and reduce the impact of the final salary scheme on the sponsoring employer’s balance sheet.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.