Two-thirds of defined benefit schemes used a long-term funding target in their valuations, and 71% of these have a plan to achieve the target by the time the scheme is ‘significantly mature’ as stipulated by the new funding regime, a recent survey has found. 

 

Aon’s analysis of completed valuations found 67% of schemes used a long-term funding target, with 71% of those having a plan to achieve the target by the time the scheme is significantly mature.  

 

The new funding regime will apply for valuations with effective dates on or after 22 September 2024. It will require schemes schemes to have a journey plan towards a low dependency funding target, aiming to reduce reliance on the employer covenant and achieve low dependency as a scheme matures.  

 

“Ahead of this becoming a legislative requirement, the majority of schemes have already set such a target – and many have also produced a journey plan setting out how to get there,” Aon observed.  

The report added: “Though a revised Code is not yet in force, these statistics indicate that trustees and employers understood the importance of setting an LTO, and that they were anticipating some of the likely changes to the funding regime. However, they will need to consider whether and how they need to amend their long-term planning, when they determine their ‘funding and investment strategy’, to fully meet the requirements of the new legislation and the Regulator’s expectations set out in its finalised revised Code.” 

 

For half of schemes (49%), the basis for the long-term funding target was buyout. A fifth (21%) used gilts+0.5%, with rest using gilts and a lower margin. 

 

Average funding levels higher than ever 

 

The average technical provision funding level was up to 103% from 97%, and the proportion of schemes in surplus was 65%, up from less than half (44%). Both measures were higher than in any year since 2005, when the current funding regime started, the consultancy said. 

 

This will be related to higher gilt yields, but not just. The average assumed life expectancy among schemes was 0.3 years shorter than three years ago, when many schemes’ previous valuations were undertaken. 

 

High funding levels have perhaps led schemes to increase their hedging, as the vast majority (94% and 93% respectively) now hedged at least 70% of their interest rate risk and at least 70% of their inflation risk, compared with 78% and 79% three years ago. 

 

Are schemes still using contingent assets? 

 

Contingent assets continue to be a feature of the DB landscape, despite improved funding levels.  

 

“For the first time, the majority of schemes with such arrangements (71%) were in surplus,” according to Aon. 

 

Putting in place specified contingent assets can reduce a scheme’s Pension Protection Fund levy if they are certified annually, the consultancy noted, including guarantees from another group company. 

 

For this latest tranche of valuations, Aon said: “The primary reason for the provision of additional security was to add security in relation to the covenant.” 

 

It added that “for some schemes, the primary reason was that the employer wanted greater investment risk to be taken by the scheme”. 

 

Are DB schemes well prepared for the new funding regime?