The Pensions Regulator will undertake an in-depth review of its 2014 defined benefit funding code next year, as trustees struggle to exert power against employers armed with the watchdog’s new strategic objective.
Earlier this year the regulator endorsed an integrated approach to risk management in its first annual funding statement since the publication of the revised code of practice for DB scheme funding last year.
Aimed at scheme trustees undertaking 2015 triennial valuations, this year’s statement built on the messages of the revised DB funding code, advocating an integrated approach to risk management on a scheme-specific basis.
How trustees can input protections when sponsors request more flexibility
The Pensions Regulator’s Fiona Frobisher, head of DB policy, gave the following examples of how trustees can tackle tough funding negotiations with employers:
Scenario: The employer is trying to get into a new market and the sponsor needs trustees to release control of some of the scheme’s security.
Security for the scheme:Trustees released security back to the sponsor but reduced investment risk and guaranteed contributions for a five-year term to provide security against downside risks in lieu of lost coverage from the employer.
Scenario: The employer requested a two-year contribution holiday because they wanted to invest significant capital in the business.
Security for the scheme:Trustees were able to negotiate a guarantee from the wider group in addition – if the group is not willing to back the investment in that employer, why should the trustee be willing to give the employer money to do it?
Scenario: The employer wanted to pursue a very aggressive turnaround plan which was going to take most of the free cash flow for the next few years.
Security for the scheme: Trustees put in very clear monitoring with very clear covenant and trigger points and contingencies for what would happen if this went wrong, giving trustees visibility of the wider group, which gave them back a bit of power.
Speaking before delegates at the Pensions and Lifetime Savings Association conference last week, Fiona Frobisher, head of DB policy at the regulator, said in 2016 it will undertake an extensive review and report back to the industry on what has happened since the sustainable growth objective was introduced.
“That’s the time when people will have done their scheme funding valuations under the new regime, so they will actually have the hard figures,” she said.
No free pass for employers
Frobisher talked through key changes to three principles within the code, namely an increased emphasis on trustee and employer collaboration, a shift towards reaching funding targets in “an appropriate manner” and a focus on balancing the needs of the sponsoring employer with the needs of the scheme.
On the changes to reaching funding targets, Frobisher said the regulator had moved towards assessing risk across the scheme and sponsor in a holistic way.
“What is the risk that these members are not going to get these benefits? What is the risk this funding plan is so aggressive it's going to damage the employer? It needs to be something that is appropriate all round,” she said.
But Frobisher said the sustainable growth objective should not be viewed as a “free pass for employers”.
Steve Delo, chief executive at professional trustee company Pan Trustees, said in his work on behalf of trustees he came up against tough rebuttal from sponsors on the grounds of strategic growth.
Delo said sponsors either go “gung-ho” on a strong covenant or say they cannot afford anything because they have a weak covenant.
“That’s really difficult for trustees. Employers tend to have more muscle power than trustee boards,” said Delo.
“If you can join it all up and you can articulate it as a trustee board you have a more coherent message to be able to explain to your members and to the regulator if necessary – but it is a difficult job to get there and many trustees are fumbling along the way.”
Flexibility for strategic growth
Darren Redmayne, head of covenant specialist Lincoln Pensions, and delegate at the session, said the sustainable growth objective was the “right tool” to implement following the financial crisis, but raised concerns about how sponsors are using additional flexibilities permissible under the revised code.
“It should be of concern to people that the FTSE 100 deficits have gone up yet the overall level of contributions has gone down,” said Redmayne. “Fundamentally, we have an issue around contribution levels.”
