This update covers the legal position in England and Wales.

The Pensions Regulator has published its Annual Funding Statement 2022.  The statement is particularly relevant to schemes with valuation dates between 22 September 2021 and 21 September 2022.  

Factors impacting employer covenant and scheme funding

The statement highlights that high inflation, high energy prices, higher interest rates and slower economic growth may all impact on a scheme's funding and employer covenant.  Covid-19, Brexit and the situation in Ukraine are also flagged as factors which may affect the employer's covenant, with the Regulator drawing attention to its Conflict in Ukraine guidance.  

The statement says trustees should consider the overall impact these factors may have had on the employer's business and categorise this in one of three ways:

1. Limited impact.  There has likely been no balance sheet weakening and cash flow has remained strong.
2. Current market events have had a material impact, but trading has recovered or is recovering strongly or impact is expected to be short-lived.  Any weakening of the balance sheet can be repaired over a short period and the medium-term prospects have not been negatively impacted.
3. The impact of current market events continues to be material.  The pace of recovery is uncertain and could take years, or the business may never fully recover.  Short-term affordability is stressed.  The balance sheet has weakened due to measures taken to raise additional liquidity and to secure lender support.  Medium-term prospects are unclear.

Where the scheme employer falls within category 1 above, the Regulator expects trustees to take a "business as usual" approach to setting recovery plans.  The Regulator does not generally expect deficit repair contributions (DRCs) to be reduced or recovery plan end dates extended.  Where possible it expects trustees to try to reduce the length of recovery plans, particularly where they are long and where there are concerns the scheme is being treated inequitably relative to other stakeholders.

If a scheme employer is in category 2, the Regulator says it expects any request for a temporary reduction in contributions to be short-term, with higher contributions in subsequent years limiting any extension to recovery plan end dates.  The Regulator views shareholder distributions as inconsistent with the scheme receiving lower contributions, and it expects any deferred DRCs to be repaid – ideally before shareholder distributions recommence.

Where an employer is in category 3 and requests DRC deferrals and/or lower ongoing DRCs as part of a revised recovery plan, the Regulator expects trustees to obtain suitable mitigations, referring them to its 2021 annual funding statement.

Actuarial assumptions

The Regulator flags the need to consider how to build recent and short-term inflation rates into the valuation calculations to ensure benefit increases are being modelled correctly.  It also flags that long-term inflation expectations have risen recently, increasing liabilities for many schemes.

The Regulator considers that the long-term impacts from Covid-19 on mortality rates have yet to become apparent.  Where trustees consider that changes to their mortality assumptions are appropriate at this stage, the Regulator expects any reduction in liabilities due to such changes to be no more than 2% unless accompanied by strong supporting evidence.

Future changes to funding regime

The statement flags that once the relevant parts of the Pension Schemes Act 2021 are implemented, it will be a legal requirement for schemes to have a specific long-term strategy designed to deliver an agreed long-term objective.  The Regulator says trustees should consider taking steps now to incorporate this into their thinking by agreeing a long-term funding target with the employer and setting their "journey plan" accordingly.  However, the statement confirms that the Regulator will regulate valuations covered by the statement in accordance with existing legislation and guidance currently in force.

Categorisation of schemes

As in previous years, the statement incorporates a table setting out the Regulator's expectations of schemes according to which category a scheme falls into, with category being determined by factors including employer strength and the scheme's funding level and maturity.  The one change is that references to the length of the recovery plan has been altered from seven to six years, reflecting that recovery plan lengths have decreased in recent years.