Bus and train operator FirstGroup is to engage in “strategic discussions” with its trustees, after the funding valuation for the First UK Bus Pension Scheme was finalised and improvements were made to its technical provisions.
According to FirstGroup’s 2021 annual results published on Tuesday, the scheme had a deficit of £271m at its 2019 valuation, which “is lower than that of the previous triennial valuation (£302m as at April 2016), but higher than the balance sheet position on an accounting basis at the relevant date”.
FirstGroup noted, however, that the shortfall on a targeted low dependency basis — with a discount rate of gilts +0.5 per cent a year — would be £170m higher than the reported figures.
Due to this, the sponsor was “actively engaging with the trustee on strategic discussions in relation to a long-term funding target for the scheme, including liability management options, covenant, derisking the investment strategy and securing member benefits”.
This type of change is likely to be well received by the Pensions Regulator and is in line with the long-term funding target that will become a requirement for schemes in the near future
Chris Mason, Quantum Advisory
The company is considering a discount rate for liabilities in the range of gilts to gilts +0.5 per cent.
It said: “Funding the scheme to such a level within a reasonably short time horizon, while taking actions to reduce exposure to investment risk, is both realistic and achievable — especially given the rate at which the scheme is now maturing following closure first to new entrants and then subsequently to ongoing accrual.”
Trustees to target lower return
The low-dependency method is used to mirror a situation where there is no further reliance on employer contributions and the scheme is able to sustain itself without support from the sponsor.
“Reducing the discount rate to the range of gilts to gilts +0.5% will lead to an increase in the scheme’s liabilities and hence an increased deficit,” said Chris Mason, consultant at Quantum Advisory.
“By reducing the discount rate, the trustees of the scheme will be able to target a lower return from their invested assets and so will be able to derisk the strategy, increasing the level of matching assets that they hold and removing large elements of the volatility within the funding level,” he added.
David Brooks, technical director at Broadstone, noted that opting for this approach now would put a great deal of strain on the employer to meet their obligations and so their aim is to gradually achieve this position over the next few years.
If the scheme was to target a low-dependency basis, it would involve moving to a lower discount rate and less risky investments to match the liability payments. However, a lower level of investment return may lead to an increase in employer contributions or a lengthening of the recovery plan.
Liabilities to increase by £100m
The statement concludes that the approach will increase liabilities by £100m compared with the funding basis, but Brooks suggests that this might be accounting for the rate of retirements and deaths as the scheme matures, and the time they expect to hit their low-dependency point, although it is unclear when that would be.
“What they’re discussing is a fairly common position for schemes these days as they look to nail down the risks and the reliance on the employer while improving security for members’ benefits,” Brooks said.
Mason added: “This type of change is likely to be well received by the Pensions Regulator and is in line with the long-term funding target that will become a requirement for schemes in the near future.”
In March 2020, TPR launched a consultation on the defined benefit funding code, where it announced its plans for a new split approach to DB schemes' funding, where schemes would have to opt between two choices. Pension funds that opt for a prescriptive fast-track funding arrangement would be subject to less regulatory scrutiny, while those opting for a bespoke arrangement would face stricter oversight.
New DB funding code could be delayed until 2022
The Pensions Regulator has issued an interim response that experts say could presage meaningful changes to the final version of the defined benefit funding code, which is likely to be delayed until 2022.
In April, FirstGroup’s UK Bus and Group pension schemes received £336m from the sale of First Student and First Transit assets to private equity company EQT Infrastructure for a combined £3.3bn.
The scheme had a calculated accounting deficit of £171m as of September 2020 and it was hoped that the contribution would “accelerate derisking” of the scheme.
