The Pensions Regulator has targeted employers who pay large dividends while underfunding defined benefit pension schemes in its latest annual funding statement, increasing the pressure on trustees to secure as much funding as possible.
The regulator will begin to use its section 231 powers to pursue employers extending recovery plans unnecessarily or paying dividends that limit their ability to maintain the scheme.
Schemes with poor funding levels, long recovery plans and strong sponsors should seek increased funding to mitigate the risk of covenant deteriorating later, according to the report.
The regulator needs to consider additional methods of assessing the correct level of sponsor contributions to augment funding legislation
Stephen Soper, PwC
The affordability of accrued DB promises is a topic of intense debate in the industry. The regulator’s analysis showed that between 85 per cent and 90 per cent of schemes have employers that are able to manage their deficits and do not present any sustainability issues.
A tougher regulator
Clarifying its position on employer attitudes to funding, the statement warned: “We are likely to intervene where... the employer covenant is constrained and total payments to shareholders (including dividends and share buy-backs) are being prioritised and therefore are restricting or reducing the level of contributions being paid to the scheme.”
It also targeted unnecessarily lengthy recovery plans, and pointed to trustees’ responsibility to tackle employers who do not prioritise scheme funding.
“We’re seeing the more interventionist tone that’s been recently set by the regulator in their public documents reflected in this funding statement,” said Darren Redmayne, chief executive of covenant advisory Lincoln Pensions.
Redmayne said this could have been in response to a perception in the industry that the regulator had not yet made sufficiently wide use of its powers, and said it would be interesting to see if it also became more interventionist in its stance on corporate transactions, given recent political stances on the matter.
“All the political parties appear to be looking for a more interventionist, more protective approach to pensions, particularly where transactions are involved,” he said.
Is cash king?
While the funding statement referenced risk management and the fact that hedged schemes have tended to fare better during the downturn in yields, some experts felt it was too heavily focused on securing cash.
Jon Hatchett, head of corporate consulting at Hymans Robertson, said the stress on employer contributions as a release valve would likely create pressure to weaken technical provisions.
“Scheme choices on investment strategy affect funding volatility more than anything else,” he said, urging schemes to hedge exposure to rates and inflation, and avoid risking setbacks by “rushing to buyout”.
The regulator only identified 8 per cent of schemes with 2017 valuations that were taking too much risk, but Hatchett said he thinks “a materially higher proportion than that of schemes are taking more risk than they need”.
Weak schemes must aim for 'best possible' outcome
For those schemes that have weak employers who will not become insolvent in 12 months and so do not pass the test for a regulated apportionment arrangement, the regulator prioritised the continuing existence of the scheme, acknowledging that this implied a cost for both employers and the Pension Protection Fund. Continuing the scheme would pay members full benefits for as long as possible.
“In these instances, we expect trustees of stressed schemes, who are facing a challenging valuation and have limited ability or no ability left to use the flexibilities in the funding regime, to reach the best possible funding outcome taking into account members’ best interests and the scheme’s specific circumstances,” the statement said.
Industry finds no easy answers in dividends v deficits debate
Experts have called for more focus on the contrast between dividend payments and deficit repair contributions, though others say there is no one-size-fits-all solution.
Where the sponsor is part of a wider group, trustees were encouraged to seek legally enforceable support as part of their contingency planning.
Stephen Soper, senior pensions adviser at PwC, said the limited guidance provided for trustees in this situation seemed to rely on the government and its green paper response to tackle the large number of companies who cannot afford their pensions promises.
“TPR is accepting up to 15 per cent of schemes have sponsors who may not be able to pay; that equates to 1,000 schemes across the whole DB universe. Guidance for those schemes is very light,” he said.
Soper added that with increased contributions and limited increases in actual future payments to pensioners unable to offset decreases in discount rates, a change of approach might be needed.
“The regulator needs to consider additional methods of assessing the correct level of sponsor contributions to augment funding legislation,” he said.
