How to prepare for a 2016 valuation

Slightly lower expectations of long-term inflation will have offset this increase in liabilities to some extent. In terms of investment, despite falls in early 2016, asset classes have in general seen positive returns over the three years to March 31, with bonds and overseas equities performing well.

Engage, understand, analyse

To facilitate a smoother valuation process, planning and preparation is important. Early engagement with the employer is critical and a valuation project plan is a very useful tool to keep the process on track and identify the responsibilities of the various parties involved.

The trustees should have a clear understanding of the employer covenant – the employer’s ability to contribute to the scheme now and in the future.

They also need to understand the cash flow requirements of the business, its current financial position as well as any future business plans, the likelihood of the employer’s failure and the assets of the business and the extent to which they would be available and sufficient to fund the liabilities of the scheme if it were to fail.

Since the last valuation of the scheme, a revised code of practice for scheme funding has been issued by the Pensions Regulator – which promotes an integrated approach to risk management and looks at the three key fundamental risk areas of funding, investment and covenant.

Trustees should use both qualitative and quantitative analysis to understand how these risks will impact on the scheme meeting its objectives and, as part of a risk management approach, understand the risks across all three strands and define acceptable parameters for each.

Trustees should strike an appropriate balance between these risk parameters and ensure an overall level of risk that is acceptable given the strength of the employer. 

Cash flow and liquidity

More recently, the regulator issued its annual funding statement, which highlighted the need for maturing schemes to consider cash flow/liquidity requirements, the need to meet the 15-month timescale for completion of the valuation and the importance of an integrated risk management approach.

In terms of scheme funding and investment, it is important to engage with the employer to establish their risk appetite and tolerance for adverse outcomes and increased contribution requirements.

The trustees should next set clear objectives in terms of the scheme’s long-term funding goal, to allow easier monitoring and ensure all parties concerned are aware of the flight plan for the scheme.

Advances in technology, including daily valuation tools, enable closer monitoring of funding and this valuable tool should help eliminate any unwanted surprises.

It will enable trustees and the employer to focus on the long-term objectives of the pension scheme and can allow trigger points to be more easily built into the investment strategy and schedule of contributions.

As valuation results can be available much faster, it also allows the valuation process to be completed more quickly. Time can instead be focused on strategic decision-making.

Effective IRM should be an ongoing process, and trustees should monitor funding plans to ensure they remain on track as material changes can occur between actuarial valuations.

Only as good as the data

Finally, it is important to remember that valuation results are very much dependent on the quality of the underlying pension scheme data. Historically, pension scheme data has been very poor, resulting in potential uncertainty as to the level of benefits that should be paid from the scheme.

It is therefore important and indeed a requirement from the regulator that trustees assess the quality of their scheme’s data. Rectification exercises may be required to improve the quality of the data, and schemes should have an improvement plan to address poor-quality data.

Helen Toner is an actuary at consultancy Spence & Partners