On 15 May 2017, the Regulator published its annual funding statement.
The statement is primarily aimed at schemes undertaking valuations with effective dates in the period 22 September 2016 to 21 September 2017, but is relevant to all defined benefit schemes. Following the collapse of BHS, the Regulator's approach to scheme funding issues came under scrutiny. The overall tenor of the statement is that the Regulator intends to be clearer about its expectations of trustees in relation to scheme funding and will take a more proactive approach to scheme funding issues, including late valuations. The Regulator is particularly likely to intervene if it considers that payments to shareholders are being unduly prioritised over contributions to an underfunded scheme.
The statement says that many schemes are likely to have larger funding deficits than projected in their last valuation, and that all schemes need to put contingency plans in place to address potential risks. Where schemes find themselves with a worse funding position than anticipated, the Regulator expects them to implement their contingency plans.
Regulator expectations dependent on scheme and covenant strength
The Regulator has segmented schemes according to their risk profile and has the following expectations:
- schemes in a relatively strong position in terms of funding position and employer covenant strength are expected, as a minimum, not to extend their recovery plan end date "unless there is good reason to do so";
- schemes with reasonably strong employers, but long recovery plans, are expected to seek higher contributions now to mitigate against the risk of the employer covenant weakening;
- schemes that assume they have a strong covenant despite a weak employer due to support from stronger group companies are expected to seek legally enforceable support.
For schemes where the employer is unlikely to be able to support the scheme ("stressed schemes"), the Regulator recognises that the option with the least detrimental impact on members' benefits may be to continue the scheme notwithstanding the potential cost to the PPF. Where trustees have little or no scope to make further use of flexibilities in the funding regime, the Regulator expects them to "reach the best possible funding outcome taking into account members’ best interests and the scheme’s specific circumstances".
The Regulator says that trustees of stressed schemes need to be able to fully evidence that they have taken at least the following measures:
- the employer closing the scheme to future accrual where it has not already done so;
- testing the strength of the employer covenant to support scheme risks and considering whether any dividend payments made or due to be made limit the ability of the employer to support the scheme and invest in sustainable growth;
- maximising non-cash support and security available to the scheme from the employer and, where there is one, the wider group;
- identifying scheme risks and improving the scheme’s ability to control these risks; and
- where scheme rules allow, considering whether the scheme should be wound up.
The Regulator states that it expects employers to provide scheme trustees with early warning of employer-related events, eg a decision by an employer to cease business in the UK.
Discount rate assumptions
The Regulator says it is not prescriptive about the approach trustees should take when setting the discount rate for a scheme's valuation, provided the outcome is consistent with legislation and the Regulator's DB code. The Regulator expects trustees to document their rationale for selecting the method used to set the discount rate.
The Regulator expects trustees to take decisive action where the scheme’s funding position has been on a downward trajectory for more than one valuation or if they have faced "any significant adverse impacts". The Regulator says trustees need to have a contingency plan in place detailing actions they would need to take to correct the scheme’s position in the event of a downside risk materialising. The plan should be agreed with the employer in advance and be legally enforceable.
The Regulator says it will be "placing more focus on proactive casework" and improving the way it identifies cases that present the biggest risks to members, intervening early before recovery plans are submitted. In particular, the Regulator intends to intervene where:
- recovery plan end dates are being extended unnecessarily; and/or
- the employer covenant is constrained, and payments to shareholders are being prioritised at the expense of contributions to the scheme.
Specifically, where an employer’s total distribution to shareholders is higher than deficit reduction contributions to the scheme, the Regulator expects the scheme to have a relatively short recovery plan. It also says that the investment strategy should not rely "excessively" on investment outperformance.
The Regulator plans to take a tougher approach where schemes fail to submit valuations on time. The statement says trustees should plan to avoid unnecessary delays. It is more likely to take enforcement action where delays could have been predicted or trustees fail to engage with the Regulator.