Amid high funding levels, the Pensions Regulator expects trustees of well funded schemes to reduce investment risk and remain vigilant given the uncertain economic outlook. Industry commentators say this message could be unpopular with a government that believes pensions money should flow into UK plc. 

 

The funding levels of most schemes have improved thanks to outperformance from return-seeking assets and a significant rise in gilt yields and many are expected to have exceeded buyout funding levels. Around a quarter of defined benefit schemes might now be able to buy out their liabilities, the Pensions Regulator said in its Annual Funding Statement 2023, published on Thursday. 

 

Where schemes have reached a high funding ratio, “trustees will need to consider if their long-term targets remain appropriate, whether buyout is viable or to examine other endgame options”, the scheme regulator notes. 

 

If funding levels have improved significantly because, for example, an unhedged position against interest rates, trustees should consider reducing some of the risk, it advised. If the level of risk is no longer right, it said trustees should use some of the funding gains for a less risky funding and investment strategy, “designed for a smoother and more predictable transition to the long-term target”. 

 

Schemes with a surplus will also have other issues to ponder – employers might want to reduce or suspend contributions, while scheme members could be calling for discretionary increases because at many schemes, increase caps of typically 2.5% or 5% have meant that benefits have not kept up with inflation, which is currently running at 10.1%. 

 

“When considering such pressures, trustees should be mindful of their overall position, the resilience of their investment strategy to future financial market movements and the level of covenant support,” TPR said. 

 

Most DB schemes are now in surplus, but the regulator noted that for a minority, funding levels have fallen – for example, if they were unable to meet collateral calls within liability-driven investments last autumn. 

 

“They will need to reset funding and investment strategies to reach their long-term targets and should review their operational governance processes to ensure future resilience,” the regulator said. 

 

 

Even though the overall picture is now better than it has been in many years, TPR reminds trustees that things can change given the current economic climate.  

 

Further interest rate rises would affect assets and liabilities but also push up borrowing costs for the employer, while high inflation impacts returns and employer costs. The Bank of England’s rate is currently at 4.25% - up from a record low 0.1% in less than 18 months because of high inflation. In the US, the Federal Reserve fund rate stands at 4.75% to 5%.  

 

Ongoing geopolitical instability could affect supply and distribution chains, or cost bases of employers, TPR also observed.  

 

The chair of the Association of Consulting Actuaries, Steven Taylor, said the regulator’s statement struck a very different tone to those of previous years – but TPR’s prudent stance might not be universally welcomed. 

  

“For sponsors, there are potentially mixed emotions here. With much of the hard work now seemingly done, many will have been hoping to negotiate some respite from onerous recent funding requirements,” he noted.  

 

“Today’s statement may encourage trustees to continue to drive hard bargains and so sets the stage for some potentially intense strategy discussions over the coming year,” he believes. 

 

 

“Despite the good funding news for most schemes, there is no respite for trustees as the regulator suggests this provides an opportunity to make changes to investment strategies to capture improved funding positions and revisit end game planning to ratchet up funding targets or start planning to buy out,” agreed Iain McLellan, who heads up research and development at consultancy Isio. 

 

McLellan noted that TPR highlights concerns about covenant weakness arising from the higher inflation and interest rate environment, particularly for companies due to refinance soon.  

 

“It is not clear how this messaging will go down with a government keen to see pension scheme assets supporting long-term growth,” he remarked. 

 

The Treasury is looking for ways to connect UK growth and UK pension fund investment, with the Financial Conduct Authority introducing a new Long Term Asset Fund aimed at defined contribution schemes, and the chancellor looking to further attract DC money into a new Long-term Investment for Technology and Science initiative. 

 

    

 In addition, City minister Andrew Griffith recently welcomed a report on regulatory reform by a group of MPs and peers that seemingly want more direct government intervention into regulation – something former prime minister Liz Truss had mooted but which was swiftly dropped by her successor, Rishi Sunak. 

   

    

Is TPR at risk of becoming a scapegoat for poor UK growth?