For the first time, TPR explicitly sets out their expectation that trustees, and sponsors should set a Long Term Funding Target and, importantly, the need to evidence how shorter-term investment and funding strategies are aligned with the LTFT. Contributor Marian Elliott, Managing Director, Integrated Actuarial – Redington.
The rise of the Long-Term Funding Target (LTFT)
TPR also highlights the Government’s policy intent to make the LTFT a requirement. This underlines the need for joined up advice from covenant, investment and actuarial advisors, to ensure the targets selected are appropriate, and that all stakeholders understand and are comfortable with the impact on short-term funding and investment policies.
Key Takeaway: “For any schemes which don’t have a LTFT in place yet, discussions between the sponsor and trustees should start in good time to agree a target which takes into account scheme maturity and covenant strength. The approach to funding Technical Provisions (TP’s) should be consistent with this, and there should be a plan to move from full funding on a TP basis towards the LTFT once this interim target has been reached.
Clear rationale for strategy
“Trustees and sponsors should be careful not to fall foul of a ‘paint by numbers’ approach to funding. Whilst clarity around the expectations for each scheme ‘category’ is very helpful, it is important that trustees and sponsors consider their own scheme’s individual circumstances. For example, TPR suggests that schemes with a weaker covenant should consider reducing investment risk and taking a longer time to reach full funding, with a lower level of investment risk. However, this prolonged exposure to a weaker covenant may not always be the optimal approach, and trustees should not shy away from doing something different to what is set out in the statement, as long as they can evidence their risk analysis and justify the approach they have chosen.
Key Takeaway: “Be clear about why an investment strategy or funding plan has been adopted and evidence that risks have been considered adequately. A great way to do this is using a clear framework, kept front and centre, with scheme specific objectives and metrics.
Scheme maturity is important
As with previous funding statements, TPR explains that the strategy chosen should reflect scheme maturity and the ability of the assets to deliver returns over a reducing time period. Scheme maturity, alongside covenant strength, will be one of the key drivers behind whether TPR views a scheme’s strategy as being appropriate.
Key Takeaway: Don’t get too hung up on working out whether your scheme is ‘mature’ or ‘immature’. The important consideration is the proportion of assets your scheme pays out each year. In most cases, it makes sense to steer towards a low volatility strategy by the time a scheme is paying out 3-4 percent of its assets in cash each year. This is because it is much harder to recover from adverse events, when the pool of assets required to generate the return needed to ‘catch up’ is reducing.
Dividend Policy will attract attention
TPR expects trustees to negotiate robustly to ensure that the scheme is treated fairly relative to shareholders. A large part of last year’s statement was dedicated to the requirement for trustees to assess pension contributions against other distributions, and this statement again signposts TPR’s intention to take a strong stance where deficit recovery contributions are out of line with dividend payments.
Key Takeaway: “Assess the impact that the payment of dividends will have on the employer’s ability to fund the scheme and consider whether the scheme is being treated fairly. Any concerns in this area should be raised with TPR before agreeing a valuation.
Greater engagement for ‘higher risk’ schemes or those with ‘long’ recovery plans
During 2019, TPR plans to engage with schemes which they assess have long recovery plans, relative to the maturity profile and the strength of their employer covenant. TPR will also assess the valuation submissions it receives to consider whether the risk profile of the investment and funding strategy is consistent with the ability of the sponsor to support the scheme.
Key Takeaway: “Ensure that appropriate risk analysis has been carried out to justify the funding and investment approach taken. Keep records of engagement between the sponsor and trustees, including the reasons behind decisions on funding and investment policies. Comparison of long-term risk metrics such as ‘probability of paying pensions’ or ‘expected loss on sponsor insolvency’ under alternative scenarios can be very helpful when justifying an approach to TPR.”