The Pensions Regulator (TPR) has published its 2024 annual funding statement which is targeted at DB schemes undergoing valuations with effective dates between 22 September 2023 and 21 September 2024. It is also relevant to DB schemes that have seen a significant impact on their funding and investment allocations from the changes in market conditions over the last couple of years and who should therefore review their funding and investment strategies.
General considerations
Most schemes will have seen material improvements in funding levels, with half expected to have exceeded their estimated buy-out funding levels. As a result, trustees need to review their long-term objectives and their associated funding and investment strategies. Open schemes may also have seen a material reduction in the estimated cost of providing future service benefits. Trustees of these schemes are likely to be more focused on technical provisions compared to long-term targets.
Where trustees are considering employer requests to reduce or suspend contributions, or member calls for discretionary pension increases, they should look at the scheme's overall position, the resilience of their investment strategy to future market movements, and the level of covenant support. They should also consider which members would benefit from a discretionary increase and whether the scheme has a history of paying discretionary increases.
Trustees should recognise the economic uncertainty that will continue to impact investments and the employer covenant. This includes uncertainty over the future path of interest and inflation rates as well as a high level of geopolitical instability.
While overall reliance on the employer covenant will have reduced, the employer covenant remains an integral element to consider when assessing the level of risk that the scheme can support. If a scheme is still materially reliant on the employer covenant, trustees need to keep refinancing risks, covenant leakage and fair treatment at the forefront of their minds.
Climate change and wider sustainability issues have the potential to impact scheme investments and liabilities, the resilience of funding strategies, and the employer covenant. Trustees should allow for the potential impacts from climate change and wider sustainability issues when considering their future scheme horizons and their possible long-term covenant, investment and funding strategies.
TPR will publish the new DB funding code and a consultation on updated covenant guidance this summer. As a matter of good practice, trustees should consider what steps they can take now to align with the new code to avoid having to make significant changes at their next valuation.
Rethinking strategies
Where schemes are fully funded on a buy-out basis, they have the options of buy-out, run-on and (subject to gateway tests) consolidation. Trustees may need advice on the risks and benefits of the options available to them and their relevant duties. They should ensure they have sufficient understanding of the options they are contemplating. They should also be clear about the key risks within their chosen option and put in place suitable strategies to mitigate them. Whatever strategy trustees adopt, they should document it and explain why it is in the best interests of members.
Where the scheme is fully funded on a technical provisions basis, but has not reached buy-out funding, trustees should review their long-term objective, the timescale for reaching it and any plans they have to transition their investment strategy over time to align with it. Trustees can consider the relative merits of run-on and may consider emerging options such as commercial consolidators, capital-backed journey plans and the public sector consolidator that is to be launched via the Pension Protection Fund. TPR encourages trustees to consider all options and intends to publish guidance later this year on DB alternative arrangements.
Where the scheme has a deficit on a technical provisions basis, trustees should focus on bridging this gap first. They should revisit the technical provisions to ensure they are aligned with the long-term funding target. Risk-taking should be supported by the employer covenant and should reduce as funding improves or the scheme matures. Any deficit should be recovered as soon as the employer can reasonably afford.
How we can help
In addition to advising generally on the 2024 annual funding statement, Mayer Brown can advise trustees and employers on:
- The changes to the statutory funding regime that are coming into force this year and TPR's new DB funding code.
- Scheme funding packages, including contribution ratchet mechanisms and alternative funding solutions such as contingent assets, asset-backed contribution arrangements and escrow arrangements.
- Legal aspects of employer covenant assessment and monitoring processes, including information-sharing protocols.
- Investment governance processes.
- Scheme buy-out, including preparations for buy-out.
Originally Published 2 May 2024
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