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The Pensions Regulator has issued its first annual funding
statement today. The statement provides guidance on how
schemes should approach the valuation process in the context of the
current economic climate. It is aimed at schemes with
valuation dates between September 2011 and September
2012.
The Regulator says that "trustees and employers that
follow the guidance... are more likely to reach funding agreements
that the regulator finds acceptable without the need for regulatory
involvement".
What should schemes be doing?
In the Regulator's view, most schemes and employers should
be able to meet their pension promises to members with either no
change, or only small changes, to their present recovery
plans. However the statement considers some specific issues
which might arise because of the current economic position.
The Regulator expects valuations to be completed on time.
Trustees should not select an earlier effective valuation date to
make use of better economic circumstances.
The Regulator reiterates the requirements for prudence when
setting valuation assumptions. In particular
"investment outperformance should be measured relative to
the kind of near-risk free return that would be assumed were the
scheme to adopt a substantially hedged investment
strategy" and trustees should be sure that the employer
could pay any higher contributions required if actual performance
fell short of that assumed. In general, trustees should
undertake "contingency planning" in case practice does
not reflect the assumptions used.
The Regulator has received a number of requests to allow
schemes to incorporate allowances for anticipated improvements in
economic circumstances and gilt yields. However, it says
"it would not be prudent to try to second guess market
movements by assuming that gilt yields will inevitably improve in
the near-term. Such assessments may turn out to be inaccurate and
conceal important risks to the scheme's ability to meet its
liabilities. Any strongly held views about future financial market
conditions should therefore be accommodated in the recovery
plan". Where schemes exceptionally choose to rely
on anticipated changes, they must have viable contingency plans to
address the situation where this is not borne out and such plans
should be suitably documented.
Where schemes are close to funding targets and trustees and
employers consider that there could be surplus funding, the
Regulator says that "they may wish to consider mechanisms
such as an escrow agreement".
The Regulator expects the current level of deficit repair
contributions to be maintained in real terms "unless there
is a demonstrable change in the employer's ability to meet
them" and that there "should be documented
justification where deficit contributions are
reduced".
Where the employer's covenant has weakened and it cannot
afford either higher contributions or even to continue at existing
levels, trustees may need to agree to a longer recovery plan.
However, a "material extension to the recovery plan end
date will require sound justification".
Schemes should be "equitably treated among the
competing demands on an employer". Where cash is
being used within the business at the expense of pension
contributions, it should be used to improve the employer's
covenant. Where an employer cannot pay dividends without
prejudice to the funding of the pension scheme, dividend payments
need to be re-assessed in light of the obligations to the pension
scheme and other creditors.
What the Regulator intends to do next
The Regulator intends to identify schemes where approaches are
not in line with its statement and where its intervention may have
the greatest impact. It will consider these schemes in more depth
and look at "the extent to which trustees have brought the
funding, investment and covenant strands together to produce a
complete financial management plan, which includes contingency
mechanisms to address risk where appropriate". It
will also engage further with a "very small minority of
schemes" during the valuation process.
As ever, if you have any questions, please speak to your usual
contact at CMS Cameron McKenna.
This article was written for Law-Now, CMS Cameron
McKenna's free online information service. To register for
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Law-Now information is for general purposes and guidance
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give professional or legal advice. All Law-Now information relates
to circumstances prevailing at the date of its original publication
and may not have been updated to reflect subsequent
developments.
The original publication date for this article was
27/04/2012.
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