Funding statement: Not all employers were hit hard by Covid

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The Pensions Regulator’s latest annual funding statement shows funding levels have remained broadly unchanged and trustees should take into account their sponsor’s situation during the recovery – but not be overly accommodating where constraints are short-term and remain mindful of covenant leakage. On longevity assumptions, the regulator appears to prefer schemes using unchanged tables for now. 
The latest annual funding statement published on Wednesday shows that, at 31 December 2020, the aggregate funding levels for all schemes in the tranche was broadly unchanged compared with three years previously. 
TPR acknowledges the impact of Covid-19 on some employers in the statement but also highlights that others have benefitted: “We appreciate that events such as the Covid-19 pandemic and Brexit have presented challenges for some businesses and the pension schemes they sponsor. However, we also understand that others have not been as adversely affected and these events may have even created opportunities.” 
David Fairs, executive director of regulatory policy, said: “This has been a challenging period for many employers, and so trustees in carrying out actuarial valuations need to review how their covenant may have changed in the past year and then continue to monitor it. We expect them to remain engaged with employers, who in many cases are emerging from a difficult business period.” 
He said scheme funding in this tranche has remained “buoyant despite difficult market conditions for sponsoring employers, who have benefitted from extended government support”. It was too early to predict if there will be an increase in corporate insolvencies, he added, but reminded trustees to take covenant advice where employers are stressed or being restructured. 
TPR envisages that employers will fall into one of three broad categories: 

  1. Covid-19 has had limited impact on the business 
  2. The initial impact of Covid-19 was material but trading has, or is, recovering strongly; while the cessation of government support means many sponsors could experience short-term liquidity pressures, the medium-term prospects have not been impacted. 
  3. The impact of Covid-19 continues to be material, and the business may never fully recover; the medium term prospects are unclear. 
If Covid-19 continues to have a material impact on the employer, trustees should plan to recover deficits with a focus on the affordability of the employer, while maintaining fair treatment and balancing the sustainable growth of the employer, the statement suggests, with TPR expecting dividends and other covenant leakage to be minimised to protect creditors like pension funds. 
Where the impact from Covid-19 was material but trading is recovering, with potential short-term affordability constraints, trustees might find themselves torn. 
In such cases, “trustees should carefully consider any requests to accept a lower level of contributions. We expect any such request to be short term, with higher contributions in subsequent years limiting any extension to recovery plan end dates,” the funding statement reads. 
“Where the employer has recommenced, or continued to make shareholder distributions, we will view this as being inconsistent with the scheme having to agree lower contributions. We also expect any deferred DRCs to be repaid under such circumstances, ideally before any shareholder distributions recommence,” it adds. 
TPR also expects corporate activity to increase as the recovery progresses and warns trustees to be “prepared and ready to act” in such an event. 

Recognise mortality at future valuations 

The regulator notes that longevity assumptions will vary greatly depending on the view taken about the impact that Covid-19 on mortality, healthcare and hygiene habits will have on the population’s health.  
It suggests that “one way to capture the uncertainty from recent events may be to retain a mortality assumption similar to previous valuations and if evidence for different assumptions emerges, any savings from these can be recognised at future valuations” while “another reasonable approach would be to use the latest base mortality tables and projections available, suitably adjusted for scheme experience where appropriate". 
Liquidity also features prominently again, with the regulator telling trustees to consider liquidity risk in the same way they look at diversification, for example, and stress test this. 

Industry expects ‘challenging’ employer conversations 

Some in the industry feel the funding statement will be politely digested by the industry while it waits for the details of the DB funding code due later this year. 
For Mike Smedley, partner at consulting firm Isio, the big question is whether the UK economy can afford to keep tightening the rules on pensions funding or whether recovery from the pandemic requires a looser and more flexible approach.   
“Government may need to weigh up the benefit of protecting pension schemes against the risks to employers’ survival and job losses,” he argued. 
Others agreed that the tough line taken in the statement could be difficult for businesses at this time. 
“Given the challenging domestic and international economic environment created by the pandemic for UK businesses, the ambitious pace set out by TPR in the 2021 Annual Funding Statement to catch up on DB pension scheme payments will be unwelcome news to many companies with defined benefit schemes,” said Karina Brookes, covenant advisory leader at EY-Parthenon Pensions. 
“While there’s a clear acknowledgement in the AFS of the pressures faced by companies with DB pension schemes during the past 15 months, there is no let-up in TPR’s expectation that pension schemes are not left behind in the recovery. This could lead to some challenging conversations for scheme trustees, given that the expectation on them to catch up lost contributions may be at odds with the pandemic’s economic bounceback,” she observed. 
Matthew Harrison, managing director of covenant specialists Lincoln Pensions agreed that this year’s funding statement will not make for easy reading given the varied covenant challenges facing trustees. 
“Some will be back on track but must plan a route to their end game in a post-pandemic world, while others will be trying to balance supporting their still-stressed sponsor and protecting their members. All the while, the spectre of changing laws and regulation will force trustees to scrutinise corporate activity ever more carefully,” Harrison said. 

What is your view on the annual funding statement? 

Mike Smedley
Karina Brookes
Richard Farr