Deficit repair contributions may need to increase by 75 per cent if defined benefit schemes are to meet their recovery plan end dates, according to analysis published by the Pensions Regulator.
The regulator’s analysis of the most recent annual funding statement had to grapple with the emergence of Covid-19 between the months — December and March — where most scheme valuations take place, with valuations undertaken in December having been superseded by events.
In order to gauge the impact of the coronavirus crisis, the analysis looked at what the outcome would have been had all schemes undergone valuations in March, after the pandemic had struck.
It then looked at what would need to happen for schemes to retain their existing recovery plan end dates, and found that “the median required increase in DRCs... would be around 50-75 per cent”.
Lots of sponsors are not going to be doubling or tripling their DRCs, they’re going to be making them lower as that’s all they can afford
Mike Smedley, Isio
Furthermore, the analysis showed that “fewer than 15 per cent of schemes would be able to retain their DRCs at the same level or less, while around 20 per cent would need to increase DRCs to more than three times their current level”.
It added: “Some of this latter group of schemes would need to increase DRCs by much more than this.”
The regulator stressed, however, that these were average figures, and that the outcome for individual schemes could vary greatly depending “on scheme-specific, inter-valuation experience, valuation dates, funding assumptions and investment strategies”.
Coronavirus exacerbates pre-existing trends
Isio partner Mike Smedley told Pensions Expert that although the figures presented in the analysis were striking, TPR made no comment on the affordability of such dramatic rises in deficit payments.
In practice, “lots of those sponsors are not going to be doubling or tripling their DRCs, they’re going to be making them lower as that’s all they can afford”, he said.
He added that the impact of the crisis would depend largely on the health of the scheme when the pandemic struck, with those already in a poor position having been hit particularly hard owing to low funding levels, higher equity exposure and weaker sponsors.
“There’s a whole group of schemes where it probably looks OK. They were already derisked, with a reasonable funding level. They might have had a bit of a hit, but their deficit contributions probably weren’t that big to start with because they were well-funded,” Mr Smedley explained.
“For them things could have been a lot worse. But then there’s a different group that were already in a worse position, not as well-funded, probably had long recovery plans, probably were relying on equity markets to help bridge the deficit — everything’s gone against them.”
He said the result was a “vicious spiral”, with most of the impact being felt by schemes and sponsors that could least afford to bear it.
Trustees must ‘get to grips’ with their situation
While scope for flexibility in rearranging recovery plans and deficit repair schedules remains, trustees will be required to “get to grips” with their sponsors’ situations in more detail than ever before, according to Charles Cowling, chief actuary at Mercer.
“The regulator is encouraging trustees to get much more under the skin of how robust the business is, and how affordable the different scenarios of deficit contributions are,” he said.
“It is rightly very hot on the issue of treating stakeholders fairly and equitably. They don’t want to see the pension scheme at the bottom of the pile when it comes to who gets paid off and in what order.”
How easy it will be for trustees to properly scrutinise the business case for any new arrangement will depend partly on how open and transparent the sponsor is, but also on how much experience and technical knowledge the trustee can bring to bear, Mr Cowling said.
“Trustees who are not used to reading balance sheets and cash flow statements, and understanding banking covenants and debt refinancing and so on” are going to struggle, he explained.
“They in particular need support, help and advice. They need to make sure that they’ve got a handle on the business and what it can really afford.”
He added that while this task may understandably be tough for lay trustees, professional trustees will have an advantage, not least because they will be more familiar with what other trustees and sponsors in similar situations are doing.
DB employers mandated to justify further payment holidays
Trustees of defined benefit pension schemes will have to report decisions to allow sponsors to skip or delay deficit payments to the Pensions Regulator from July, as the watchdog drew fire for not insisting on this transparency from the start of its Covid-19 easements.
Vassos Vassou, accredited professional trustee at Dalriada, agreed, and added that trustees in general have been forced to get “much closer to the business, and to the finances of the businesses, than they ever were before”.
“That’s been a plus point, in a way, of Covid-19: trustees are much closer to the fundamental running of the business that supports their scheme, because the finance departments and the finance director have been much more open with them as part of their push to prove how difficult it is to carry on paying contributions,” Mr Vassou said.
“A lot of trustees have ended up with a much better understanding, but it’s an unfortunate scenario that’s driven us to this point.”
