DRAFT
Our defined benefit
funding policy
December 2013
Contents
page
Introduction4
Our approach to DB funding
Understanding sustainable growth and our new objective
DB funding policies
5
5
6
Regulating across the three-year funding cycle
7
Assessing risk
Areas of risk focus
Covenant
Funding
Investment
Scheme governance
Segmenting the DB universe
Covenant segments and desired outcomes
Defining balanced outcomes in practice
10
10
11
11
11
12
12
12
14
Risk-based prioritisation
Risk indicators
Setting our risk bar for intervention
Small schemes
A flexible view of risks
Proactive engagement
Surplus schemes
15
15
16
16
17
17
18
Implementing our regulatory interventions
Educate
Enable
No investigation
Investigation
Investigation outcomes
Enforce 18
18
19
19
19
21
21
Measuring impact
21
continued...
Draft Our defined benefit funding policy
2
Contents
Appendix A – Assessing covenant strength
23
Appendix B – Segmentation
Covenant grade 1 (CG1) – Strong
Covenant grade 2 (CG2) – Tending to strong
Covenant grade 3 (CG3) – Tending to weak
Covenant grade 4 (CG4) – Weak
Outcomes and behaviours
25
25
25
25
26
26
Appendix C – Developing the balanced funding outcome (BFO) indicator
30
Appendix D – Our suite of risk indicators
32
Appendix E – Late valuations and failure to agree
34
Appendix F – Investigation outcomes
No further action
Inadequate response but no further action
Inadequate response and further action
35
35
35
35
Appendix G – Supporting analysis
Scheme significance and the impact of deficits on employers’ balance sheets
Member losses
Linkage between funding, covenant and investment
Segmenting the landscape
Illustrating our approach to the BFO indicator
36
36
38
40
42
44
Appendix H – Glossary 46
Appendix I – Data limitations
48
Draft Our defined benefit funding policy
3
Introduction
1.
The Pensions Regulator (‘the regulator’) is a non-departmental
public body which regulates work-based pensions1.
2.
This document sets out our approach to regulating the statutory
funding requirements2 for defined benefit (DB) occupational
pension schemes3 (DB funding).
3.
This document sits under our approach to regulating work-based
pensions4 and our DB regulatory strategy5.
1
Work-based pensions
are occupational pension
schemes, personal
pension schemes
where direct payment
arrangements are in
place or stakeholder
pension schemes.
2
As set out by, and under,
Part 3 of the Pensions
Act 2004 (‘the Act’).
3
References to schemes,
unless the context
indicates otherwise,
are to DB schemes
and include the trustees
and managers of
these schemes.
4
www.tpr.gov.uk/
regulate-and-enforce.
aspx
5
www.tpr.gov.uk/
dbstrategy
Draft Our defined benefit funding policy
4
Our approach to DB funding
Understanding sustainable growth and
our new objective
4.
Our DB regulatory strategy sets out how we balance all our
statutory objectives6 across our regulation of schemes. In addition
to our objectives to protect members’ benefits, reduce risks to
the Pension Protection Fund (PPF) and promote and improve
understanding of good administration we have a new additional
objective relating to our functions in respect of the DB funding
framework. This objective requires us:
‘in relation to the exercise of its functions under Part 3 only,
to minimise any adverse impact on the sustainable growth
of an employer.’7
5.
The new objective makes it explicit that we will consider the impact
on employers’ sustainable growth plans alongside members in
our approach to regulating DB funding. A strong and ongoing
employer provides vital support for a scheme. There should be no
presumption of conflict between the scheme’s needs and those
of the employer. However, we recognise that there are occasions
where conflict does arise.
6.
Striking the right balance between the needs of the employer with
those of the scheme is vital to allow employers to invest in the
growth of their business so that they can provide long-term support
to the scheme. This is why it is important that trustees should take
account of the employer’s plans for sustainable growth into their
assessment of the employer’s covenant strength (including the
employer’s current position and its prospects as well as what it can
reasonably afford)8.
7.
Employers’ investment can take differing forms, and we encourage
trustees in our funding code of practice to assess and understand
the nature of any proposed investment and how this fits with the
employer’s long-term business plans and the likely benefit to
the employer and the scheme. We ask trustees to bear in mind
the extent to which others with an interest in the employer share
or contribute to that employer investment. We also encourage
trustees to see whether additional support can be made available
to the scheme from this employer covenant growth.
6
See section 5(1)
of the Act.
7
Section 5(1)(CZA) of the
Act.
8
www.tpr.gov.uk/
draftcode3
Draft Our defined benefit funding policy
5
Our approach to DB funding
8.
Our approach will be to seek to ensure that the trustees have
carried out the appropriate due diligence and have balanced
the needs of the scheme with those of the employer to reach an
acceptable outcome.
9.
We apply the principles behind our approach consistently across
different employer types. However, we are mindful that growth can
be very dependent on circumstances and can, therefore, mean
different things to different employers. For some, growth is a real
prospect while for others it may be more about maintaining their
position or slowing a business decline. For employers in the notfor-profit sector, growth can also have a different meaning than for
employers in a purely commercial environment. We, therefore, seek
to understand the context of an employer’s circumstances, including
its investment aims and what will constitute success for its business
and interpret our statutory objective on sustainable growth broadly
to reflect this diverse range of circumstances.
DB funding policies
10. The significant shifts in the DB pension landscape in the last few
years as well as difficult economic conditions have posed particular
challenges for many DB schemes and their employers.
11. The significance of schemes and their deficits to their employers
varies. For some schemes, their deficits are easily manageable in
the context of the strength of the employer; however, for others the
level of employer support needed can be a material consideration
for both the scheme and the employer. Charts 1.1 and 1.2 in
Appendix G illustrate these differences.
12. The DB funding regime contains risk and our statutory objectives
do not require us to seek the elimination of all risks. This continues
to lead to claims on the PPF and, therefore, members receiving
less than the full benefits under the DB scheme (see Charts 2.1 and
2.2 in Appendix G). A greater number of claims on the PPF also
results in higher levy payments from schemes and so the effects of
insolvencies are wider than just for those schemes and members
with insolvent employers.
13. Despite these risks we believe that most DB schemes should be
capable of paying their benefits in full. We also believe that the DB
funding regime is designed, and is flexible enough, to encompass
both risk-taking and risk-mitigating strategies. However, it is
important that DB schemes are adequately funded and supported
and that any risk taken is understood and managed appropriately.
Draft Our defined benefit funding policy
6
Our approach to DB funding
14. Given this context our focus is currently on:
• encouraging trustees to give full consideration to their
employer’s affordability, growth and investment plans and
ensure that deficit repair contributions are reasonably affordable
and set in the context of the scheme’s needs
• ensuring that schemes are well governed and that they
understand and manage risks effectively through an
integrated approach to risk management to maximise their
chances of paying benefits in full
• ensuring that trustees focus on the importance of
understanding the employer’s covenant, its value
and enforceability
• encouraging trustees and employers to work collaboratively
to use the flexibilities in the system appropriately and to best
suit their circumstances and balance the employer’s needs with
the needs of the scheme.
Regulating across the
three-year funding cycle
15. Our DB regulatory strategy explains how we implement our
approach to regulating schemes through:
• assessing risk
• setting policies and defining what good outcomes look like
• deciding on appropriate interventions
• setting our risk bar to determine where we should intervene
• applying our regulatory tools, and
• measuring our impact and reviewing our approach.
Draft Our defined benefit funding policy
7
Regulating across the three-year funding cycle
16. We follow this process in our approach to regulating DB funding.
Our approach is grounded in the three-year funding cycle which
applies to most schemes (the total number of valuations is broadly
spread evenly in each year of the three-year cycle or ‘tranche’9),
so that we can direct our communications at schemes at their
important junctures. This process is illustrated below.
The three-year funding cycle process
Analysis of key
risks for schemes in
upcoming tranche
Reporting of
outcomes through
scheme funding
publications
Stakeholder
discussions
Annual funding
statement setting
out analysis and
policy messages
Recovery plan
submission
and review
Proactive
casework begins
Set risk bar for
intervention
9
We describe a set of
schemes with valuation
dates between 22
September and 21
September of the
following year as a
‘tranche’. Each three-year
valuation cycle therefore
covers three tranches.
Draft Our defined benefit funding policy
8
Regulating across the three-year funding cycle
17. The following table explains the three phases in the valuation
cycle that schemes will be at in any one year of the three-year funding
cycle together with the steps we typically take for each tranche.
Funding cycle approach (October to September)
Year 1:
Valuation process
• We undertake initial
modelling of the impact
of market conditions so
we can make tentative
conclusions on what the
key areas of concern
or challenge may be
for these schemes and
what balanced funding
outcomes might
look like
Year 2:
Finalise and submit plans
• We undertake modelling
to determine how we set
our risk bar for prioritising
interventions
• We take into account
any relevant information
from scheme proactive
work when these were
Year 1 schemes.
Year 3:
Prepare for next valuation
• All recovery plans should
have been submitted
and reviewed
• We will report the
outcomes in light of
our communications to
schemes when they were
in Year 1 and 2.
• This informs our
policy messages to these
schemes as they undertake
their valuations
• We begin proactive
engagement with
selected schemes.
18. We discuss the results of our modelling and policy messaging
with a variety of stakeholders (including actuarial firms, covenant
and investment advisers, trustees and employers) to ensure our
approach is reasonable and appropriate.
19. We use our annual funding statement to communicate these
messages and what balanced funding outcomes might look like.
This is normally published in the spring as around half of the
valuations in any year are completed with effective dates of 31
March and 5 April. We seek to reflect our understanding of the
actual market conditions at those dates.
Draft Our defined benefit funding policy
9
Assessing risk
20. A sound understanding of the risks across the DB landscape is
key to meeting our objectives for DB funding and underlies all our
activities from policy development to the design of our operational
processes. This section explains:
• the factors that we consider in developing an overall risk profile
for the DB landscape and for assessing risk associated with
individual schemes, and
• how and why we segment the DB landscape to enhance
our understanding of risks and focus our polices and
operational practices.
Areas of risk focus
21. Our approach to understanding risks to DB schemes focuses on
the key risk areas which influence the overall chance of schemes
paying benefits in full: employer covenant, investment and
funding. These are the three broad areas of risk we expect trustees
to manage as part of good governance and an integrated risk
management process.
22. Focusing on areas of risk in isolation is a poor indicator of overall
risk. Our modelling and casework suggests that covenant, funding
and investment risks are not always being properly linked up
(see Charts 3.1 and 3.2 of Appendix G). This is why an integrated
approach to risk management is a guiding principle and key
component of our code of practice on scheme funding and is at the
core of our risk assessment.
23. Our understanding of the overall risk profile is, therefore, informed
by following the same considerations as those we expect of
trustees. It involves making complex assessments when the future
is never certain. To address this, our approach combines both
quantitative and qualitative information and indicators. It is also
underpinned by expert judgement.
Draft Our defined benefit funding policy
10
Assessing risk
Covenant
24. Understanding the employer covenant strength and the impact of
long-term scenarios for the scheme demands is a central tenet in
understanding the scheme’s risk profile.
25. Our approach focuses on understanding the strength of the
covenant and the risks of this support reducing or being insufficient
when it may be needed by the scheme. We consider the employer’s
plans for sustainable growth and how this improves the covenant
to the scheme and how the scheme’s plans (for example, risk-taking
strategies) may impact on the employer in the future. We only
consider those employers with legal obligations to the scheme as
part of our risk assessment approach. We also take into account
contingent assets as part of this assessment.
Funding
26. An appropriate funding plan has two main elements: firstly the
objectives the plan seeks to achieve; and secondly the risks
to achieving them. Our approach aims to assess these two
features and ensure they are appropriate given the context of the
circumstances of the scheme and employer.
27. We are focused on the overall outcomes the funding plan is likely
to achieve, its impact on the employer and whether the level of
prudence embedded within the plan is appropriate given the
employer’s covenant.
Investment
28. The investment approach is a key part of a scheme’s strategy and
is a major factor in influencing the overall outcome and chances of
success of the funding plan. Our risk assessment focuses on judging
whether the approach to the investment strategy is appropriate
given the employer’s covenant.
29. We are focused on two key elements, whether:
• the downside risk being run in the investment strategy is
consistent with the ability of employer covenant to
realistically cover it over an acceptable period taking into
account the potential impact on the employer’s future plans
for sustainable growth
• the current and future investment strategy is appropriate for
the characteristics of the scheme’s membership both now
and in the future.
Draft Our defined benefit funding policy
11
Assessing risk
Scheme governance
30. Good governance is essential in managing the risks to the scheme.
Therefore, we consider indicators relating to the governance of the
scheme focussing on any areas where material poor governance
indicates improperly managed risks. When investigating cases
opened because of funding risks we consider whether improving
scheme governance mitigates those risks.
Segmenting the DB universe
31. In our regulatory strategy we explain that we may segment the
DB landscape by scheme and employer characteristics to help us
understand risks and to develop targeted policies and interventions.
32. In the funding context, we segment the DB funding universe on the
basis of the employer covenant. The covenant underwrites scheme
risks and underpins the trustees’ investment and funding strategies.
It should, therefore, be the key determinant in the behaviours of
trustees and employers and the funding outcomes they agree.
33. We use four employer covenant segments: strong, tending to
strong, tending to weak and weak. Appendix A explains how we
assess the strength of the covenant and Charts 4.1 and 4.2 of
Appendix G illustrate the distribution of pension liabilities and
number of schemes by covenant category.
Covenant segments and desired outcomes
34. Segmenting by covenant allows us to develop an initial, high-level
and consistent view of what an appropriate outcome for schemes
with certain characteristics might look like.
35. Our funding policies are informed by our understanding of the
risks with a focus on the behaviours and outcomes which we
expect for each segment. Our risk assessment is then tailored to
checking for the behaviours and the outcomes we expect to see,
with our risk bar (risk tolerance threshold for intervention) varying
for each segment.
36. We recognise that there are not ‘cliff edges’ or dramatic changes
in covenant strength or the types of behaviour appropriate to them
but rather a shift along the spectrum. We would expect schemes on
the borderline between two segments to include elements of good
practice from both10 in their approach, and this underpins our own
thinking and intervention.
10
See Appendix B.
Draft Our defined benefit funding policy
12
Assessing risk
37. The diagram below illustrates how our focus changes with covenant
strength and Appendix B explains the different covenant categories
in greater detail and outlines some of the implications for schemes
and our policy focus for each segment.
COVENANT STRENGTH
STRONG
TENDING TO
STRONG
TENDING TO
WEAK
WEAK
Sustainable growth plans
Payments that weaken
covenant a concern
Keeping covenant strong
Scheme viability
a concern
Managed
solutions
Likely to be in a position to handle risk
Funding plan to reflect covenant risks
Maximise
covenant value
Risk taking needs significant management
Strong contributions
or security in place
Strong target needed reflecting investment
strategy and weak support for risks
Draft Our defined benefit funding policy
13
Assessing risk
Defining balanced outcomes in practice
38. The level of contributions and amount of risk schemes take should
be consistent with the affordability and strength of the employer
covenant and its ability to support risks. We are encouraging
trustees to balance the needs of the scheme with those of the
employer, recognising that investing for sustainable growth can
help strengthen the employer’s ability to provide long-term support
to the scheme.
39. We express what a balanced funding outcome for individual
schemes might look like by applying a Balanced Funding Outcome
(BFO) indicator to each scheme within each covenant segment.
40. The BFO indicator does not set a minimum level of funding or
contributions but is a tool developed through our risk assessment
process to provide us with a model for the characteristics of what a
BFO for an individual scheme might look like. It takes into account
the strength of the covenant and the scheme’s needs, to enable us
to assess the level of risk associated with a scheme.
41. The BFO does not take into account constraints on affordability
and therefore, for some schemes and employers, the appropriate
balance may be different to that indicated by the BFO. This
may be, for example, due to affordability constraints and the
accommodation of employer’s investment for sustainable growth,
but still set in the context of the needs of the scheme.
42. Appendix C sets out in more detail our approach to determining the
BFO indicator and Chart 5.1 in Appendix G illustrates this approach.
43. Our approach to determining the BFO is evolving with our risk
assessment framework. We keep it under review to make sure it
remains flexible and capable of reflecting changing circumstances.
As part of our annual assessment we consider whether conditions
are such that we need to:
• alter the BFOs for all, or some, segments or
• make adjustments to reflect emerging issues or experience from
our casework.
We explain our considerations in our annual funding statement.
Draft Our defined benefit funding policy
14
Risk-based prioritisation
44. The most effective and proportionate way of regulating DB
funding is to provide a framework where we explain, based on our
understanding of the DB landscape, what we see as the key risks,
how they can be mitigated and what good outcomes look like. We
do this through our code of practice, annual funding statement and
other educational material.
45. It is for trustees and employers to ensure that schemes are
appropriately funded, in the light of this education, taking into
account the needs of both the scheme and employer, and we do
not seek to intervene in every valuation and recovery plan
submitted to us.
46. We aim to target our interventions on the subset of those schemes
which pose the greatest risks and where we believe we can have the
most impact.
47. This decision over whether further investigation is justified is made
by a panel of experts who review the recovery plan submissions.
Our overall decision as to whether further scrutiny and intervention
is proportionate and justified is informed by:
• our consideration of a suite of risk indicators, and
• our risk bar for intervention.
Risk indicators
48. Distance from the BFO is our primary indicator of risk but we consider
a broad range of other risk indicators to allow for a more rounded
view of scheme characteristics and risks. Appendix D outlines our
other risk indicators.
49. We constantly review risks across the landscape to inform and
develop our suite of risk indicators. Sources of information include
valuation submissions, reports (for example, on governance
breaches), horizon scanning and trends analysis.
Draft Our defined benefit funding policy
15
Risk-based prioritisation
Setting our risk bar for intervention
50. Not all schemes identified through our risk indicators are the
subject of our regulatory intervention. Scheme selection is
informed by our risk bar for intervention. The factors we take into
consideration when setting our risk bar include:
• the shortfall compared to the BFO indicator. We are more
likely to investigate those schemes with the greatest shortfall
compared to their BFO, all other things being equal
• the size of the scheme’s liabilities. We target our resources
to the areas we believe we can have the greatest impact. For
example, smaller schemes will have to fall short of their BFO
by a greater amount, or be further from our expectation of
behaviours underlying our other risk indicators, than larger
schemes before being investigated, all other things being
equal. This reflects resource and cost considerations given the
concentration of risk in a small number of large schemes (see
Charts 4.1 and 4.2 of Appendix G)
• the potential impact of our interventions and the value we can
add through intervention
• The overall resources we have available and the potential
complexity and resource intensity of our intervention.
51. Currently around two-thirds of our recovery plan interventions
relate to schemes where the funding outcome fell below our BFO
indicator (adjusted to take account of our intervention risk bar).
For many of these we also have concerns over other risks. The
remaining interventions relate to other concerns emerging from the
other risk indicators and relevant factors set out above, not all of
which are necessarily funding-related.
Small schemes
52. We recognise that in using the size of liabilities as a factor in
determining which schemes to engage further with, we are not
intervening directly with a large majority of smaller schemes. That
is not to say, however, that we do not expect the same standard of
behaviour from small schemes than we do of large schemes.
53. As well as direct engagement with individual schemes, we use
other approaches and communication channels (such as our annual
funding statements) to target our messages to reach trustees,
employers and advisers. We may also carry out specifically targeted
campaigns in order to ensure smaller schemes understand our
messages or engage with advisers who are best placed to reach out
to a larger number of smaller schemes. We use our experiences of
interacting with larger and smaller schemes to inform this.
Draft Our defined benefit funding policy
16
Risk-based prioritisation
A flexible view of risks
54. We recognise that the use of data and models has limitations. For
instance, the data that we have available is likely to be significantly
less detailed than that available to schemes. Our risk assessment
framework enables us to assess scheme risks, apply our risk bar and
decide on our interventions on an indicative basis.
55. Our direct engagement enables us to explore in greater depth
the issues identified and understand the scheme’s specific
circumstances, including those of the employer and their future
plans for sustainable growth. We may decide in the light of that
engagement that trustees and employers are doing all they can and
that the outcome is acceptable given the circumstances.
56. The behaviour and outcome changes we are seeking to achieve
through our interventions and policies are scheme specific in nature
and, therefore, vary. We recognise that there is more than one
funding outcome that may be appropriate for schemes in similar
circumstances. For example, appropriate outcomes may be an
increase in the contributions while for others it may be non-cash
solutions such as strengthening of the employer covenant through a
credible sustainable growth plan or use of contingent asset or wider
group support.
57. Our risk assessment and intervention approaches recognise and
encourage this flexibility.
Proactive engagement
58. We use our risk assessment framework to identify a group of
schemes to approach proactively before they have submitted their
valuation. For this assessment we will project their funding position
from the previous valuation to the current valuation date and
consider this against the outcome of their previous valuation. These
are normally larger schemes (greater than 2,000 members) to justify
the increased use of our resources.
59. Proactive engagement gives us an opportunity for discussion and
input early in the valuation process so that we are better able to
influence outcomes where appropriate.
60. The process also allows us to understand how schemes and
employers are incorporating our messages and guidance into their
funding plans and the specific issues and challenges faced by them,
particularly in the light of prevailing market conditions. This helps us
refine our guidance to the industry (for example, through our annual
funding statements) and make sure it is relevant and fit-for-purpose.
Draft Our defined benefit funding policy
17
Surplus schemes
61. We also assess schemes that have reported a surplus and have,
therefore, not submitted a recovery plan. In doing so, we use
the same principles for risk assessment. This recognises that
these schemes could be posing similar risks to those which have
submitted recovery plans.
Implementing our
regulatory interventions
62. We have a range of regulatory tools from education to enablement
and enforcement to mitigate the risks we have identified.
63. The following sections describe the standard steps we take when
using our regulatory tools. However, for those circumstances where
we believe it is appropriate, we may deviate from these standard
steps. Where we do so we generally aim (time permitting) to
explain the reasons to the parties involved. In certain circumstances
(for example, using powers under the special procedure11), this
explanation phase may not be appropriate.
Educate
64. We recognise the complexity of trustees’ roles and place great
emphasis on education including through:
• the code of practice12, which provides practical guidance
on DB funding, and supporting guidance
• the DB regulatory strategy13 and this funding policy, which
outline our key considerations in assessing risks and defining
good outcomes
• our annual funding statement14 where we provide up-to-date
messages and explain our approach in setting the BFO indicator
and risk bar for that year
• providing guidance on particular matters of importance to
funding and educating trustees through the provision of online
training in the Trustee toolkit.
11
See sections 97 and 98
of the Act.
12
www.tpr.gov.uk/
draftcode3
13
www.tpr.gov.uk/
dbstrategy
14
www.tpr.gov.uk/
funding2012 and www.
tpr.gov.uk/funding2013
Draft Our defined benefit funding policy
18
Enable
65. This section describes how we undertake our funding casework
following our risk assessment and prioritisation. We consider this
type of intervention to be educational and enabling.
66. Appendix E outlines in greater detail how we approach specifically
late valuation and failure to agree cases.
No investigation
67. We undertake a risk assessment of all the valuations that we
receive. For the vast majority, we decide not to open an individual
investigation. We send the trustees of these schemes a valuation
submission acknowledgement letter. This acknowledges that
we have received their valuation submission and we have no
further questions. This does not mean we consider the valuation
and recovery plan to be appropriate. We aim to issue this letter
within three months of the valuation submission or the statutory
timeframe, whichever is later.
Investigation
68. Where we decide that direct engagement with a DB scheme is
warranted following our risk assessment, we may open a case.
69. An opened case is allocated to a case team. The size of the
case team and its composition depends on the issues under
consideration but it generally includes a case manager, an actuary, a
business analyst and a lawyer. The degree of engagement with the
regulator depends on the nature and complexity of the issues.
70. We approach our engagement with schemes in a fair, open and
transparent manner. Our aim is for the process to be as constructive
as possible for all parties.
71. Selecting a scheme for further investigation does not imply that
the funding outcome agreed by the parties is not appropriate.
Instead, based on the information we have, we take the view
that the scheme’s circumstances present risks we consider worth
examining further.
Draft Our defined benefit funding policy
19
Implementing our regulatory interventions
72. We are clear from the outset as to why we wish to engage, what we
see as the key issues, the purpose of our actions and what parties
can expect from the process. The purpose of opening a case is to
understand the basis for key trustee decisions. Depending on the
circumstances of the scheme some of the things we are likely to
wish to discuss include:
• the trustees’ decisions in relation to any particular risk
we have identified
• the trustees’ decision-making process
• the trustees’ qualitative and quantitative analysis underpinning
their decision-making process including their assessment of
employer plans for sustainable growth.
73. We communicate in advance what issues we seek to discuss. It often
suffices to discuss these with the trustees alone. At other times
the employer may need to be involved based on our assessment
of the scheme’s circumstances. Where we determine that it will be
useful to involve the employer we will engage with them as early as
possible to prevent delays.
74. If we do not consider the explanations provided to be satisfactory,
we explain why and give the parties an opportunity to address
our concerns. In these instances the focus of further engagement
is to enable trustees and employers to agree what we consider
to be more acceptable funding solutions given the risks we have
identified. However, where there is a wider range of issues than
those associated with DB funding, these issues are also considered.
75. During our investigations we aim to highlight issues rather than
prescribe particular outcomes. We try to remain mindful of the
scheme’s specific circumstances, including those of the employer
and their future plans for sustainable growth, but need to also
consider where that scheme sits relative to the BFO and other
schemes to ensure consistent treatment. Our preference is to
indicate broad principles underpinning a range of acceptable
solutions given the scheme and employer’s circumstances.
76. To support their engagement with the scheme the case team
may gather further information through various means including
telephone calls, written requests, face-to-face meetings or, in rare
cases, by issuing a formal notice compelling production15.
77. We understand that schemes and employers are often working to
tight deadlines. We seek to understand any scheme and employer
timescales and try to meet those as far as it is reasonable to do so.
15
See section 72
of the Act.
Draft Our defined benefit funding policy
20
Implementing our regulatory interventions
Investigation outcomes
78. Once our initial investigation of the scheme’s funding is complete
we write to the relevant parties to let them know of the outcome
and potential next steps. These are broadly:
• If we have no outstanding concerns and are satisfied that
the DB funding requirements have been fulfilled we close
our investigation
• If we have identified concerns in the course of our engagement
but we do not consider that it is reasonable and proportionate
to use our funding powers, we may close our investigation,
outlining our expectations for the next valuation and explaining
how we consider those concerns should be taken into account
• In some cases where our concerns have not been adequately
addressed we may decide that it would be reasonable and
proportionate to take enforcement action.
These are outlined in greater detail in Appendix F.
Enforce
79. When we consider enforcement action, we not only consider
action under our funding powers16 but also whether use of other
powers is appropriate17.
80. We may consider that it is appropriate to seek a skilled persons
report18 to assist us in the exercise of our functions. The cost of that
report is likely to be at the expense of the scheme and/or employer.
81. Enforcement is, amongst other things, subject to the Case team
procedure and the Determinations Panel procedure19.
Measuring impact
82. We monitor the success of our approach to the regulation of
scheme funding by:
• using surveys to assess the understanding of our messaging
and the perception of our effectiveness
• engaging regularly with our stakeholders to sense-check
our understanding of the key risks against their experiences
and to assess how our messages are perceived, understood
and applied
• evaluating the outcome of valuations submitted to us against
the analysis and policies we set at the start of the funding cycle.
16
See section 231(2)
of the Act.
17
For example, appointing
a trustee under section
7(3) of the Pensions
Act 1995, issuing an
Improvement Notice
under section 13 of the
Act or Financial Support
Direction under section
43 of the Act.
18
See section 71
of the Act.
19
www.tpr.gov.uk/
procedures
Draft Our defined benefit funding policy
21
83. In particular we seek to measure:
• the impact of our policies and operational practices on
outcomes, including:
––
the level of scheme risk, and
––
the position of employers and how we have taken into
account their plans for sustainable growth
• the approach and level of consistency in our engagement with
schemes and employers
• understanding and awareness of our policy messages.
84. Our BFO indicator helps to inform our understanding of risk and
impact of our approach.
85. We keep our approach to regulating DB scheme funding under
review to ensure that it remains effective. This is informed by
our assessment of impact and our ongoing engagement with
the regulated community. We communicate how we adjust our
approach every year to take account of this evaluation and of
specific circumstances in our annual funding statements.
Draft Our defined benefit funding policy
22
Appendix A – Assessing
covenant strength
86. The strength of the employer covenant is an important element
in scheme funding and a key part of our risk assessment process
since it informs our risk indicators (for example investment
strategy prudence) but also allows us to look for specific events
or circumstances which put the scheme at risk – such as potential
avoidance of scheme liabilities.
87. We use a number of metrics relating to employers to look for
trends and risks. However, we recognise that this is highly complex
and that a one-size-fits-all approach to looking at the employer
covenant would miss the many complexities and nuances of
individual employers. We, therefore, combine the use of metrics
with expert judgment.
88. Most schemes have now submitted at least two valuations and
recovery plans to us. For each scheme an in-house expert at the
regulator has undertaken a high level assessment. The focus of this
exercise is to assess the likely ability of the employer to support the
scheme including its ability to afford contributions, support scheme
risks now and in the future, prospects for sustainable growth and
the risks of insolvency.
89. The main areas the regulator considers in relation to the ability of
the employer to support the scheme include:
• the outlook for the business and the plans for sustainable
growth as set out in any business plans provided to the trustees,
taking account of the factors below
• the strategic outlook for the sector and the position of the
employer within the industry
• the profitability of the employer, and the trends in that
profitability over time
• cash generation and the application of that cash
• the level of debt of or secured by the employer, and the
ability to service this comfortably from cash generation
within the business
• the strength of the balance sheet and its ability to withstand
trading shocks
• the size and value of the balance sheet in comparison with the
size of the pension liabilities and deficit, including, where the
business is considered weak, the likely asset cover in insolvency
Draft Our defined benefit funding policy
23
Appendix A – Assessing the covenant strength
• the level of reinvestment of profits/cash within the business to
ensure sustainability
• the level and sustainability of dividends (or other
analogous distributions, for example distributions to members
of limited partnerships), as a proportion of profitability and
cash generation.
90. We also check for materially detrimental events and how this may
change the overall balance of covenant, funding and investment risk.
Draft Our defined benefit funding policy
24
Appendix B –
Segmentation
91. As part of our risk assessment, we use four broad categories to rank
employers from ‘Strong’ to ‘Weak’ according to how well they are
able to support the scheme.
92. This is used as an initial assessment of the covenant for the purpose
of segmenting our universe, prioritising our resources and targeting
our policies and interventions. Where we engage with schemes,
our view is refined further and informed by scheme and employer
specific circumstances. This categorisation is not intended to define
our expectations for the exact nature of trustees’ own covenant
assessments. Our Code of practice gives guidance for trustees in
this respect.
93. We recognise that this approach differs from that of the PPF when
looking at employer strength for risk and levy purposes. The
following definitions of the categories are not designed to be
rigid descriptions.
Covenant grade 1 (CG1) – Strong
94. Very strong trading, cash generation and asset position relative to
the size of the scheme and the scheme’s deficits. The employer has
a strong market presence (or is a market leader) with good growth
prospects for the employer and the market. The scheme has good
access to trading and value if the employer is part of a wider group.
Overall low risk of the employer not being able to support the
scheme to the extent required in the short/medium-term.
Covenant grade 2 (CG2) –
Tending to strong
95. Good trading, cash generation and asset position relative to the size
of the scheme and deficits. Operates in a market with a reasonably
positive outlook and the employer has a stable market share.
Outlook is generally positive but medium-term risk of employer not
being able to support the scheme and manage its risks.
Covenant grade 3 (CG3) –
Tending to weak
96. Concerns over employer strength relative to the size of the scheme
and deficits and/or signs of significant decline, weak profitability
or balance sheet concerns and/or high vulnerability to economic
cycle. No immediate concerns over insolvency but potential risk of
further decline.
Draft Our defined benefit funding policy
25
Appendix B – Segmentation
Covenant grade 4 (CG4) – Weak
97. Employer is weak, to the degree that there are concerns over
potential insolvency, or where the scheme is so large that, without
fundamental change to the strength of the employer, it is unlikely
ever to be in a position to adequately support the scheme.
Outcomes and behaviours
98. The following table shows our initial focus when opening an
investigation into schemes depending on where we rate the
employer covenant: from CG1 to CG4. It highlights the likely key
issues we will be discussing with trustees, employers and third
parties and asking them to address by explaining the reasons
behind their funding decisions20.
99. Where we believe that the scheme’s position warrants our
involvement, we consider the range of options from education
through enablement to enforcement. In doing so, we do not only
consider action under our funding powers21 but also whether using
other powers is appropriate.
100.This is not an exhaustive list and should not be taken as the only
areas we consider that trustees, employers and third parties should
focus upon during funding negotiations.
20
See paragraph 72.
21
See section 231(2)
of the Act.
Draft Our defined benefit funding policy
26
Appendix B – Segmentation
Covenant grade 1 – Strong
Covenant grade 2 – Tending to strong
• Strong covenant means that the scheme is
likely to be in a position to take investment
risk. We check that the funding outcome is
balanced and that risk-taking is consistent
with the covenant.
• Tending to strong covenant means that
the scheme is likely to be in a position to
take investment risk. Risk-taking should
be commensurate with the medium-term
risk of the employers’ ability to manage
scheme risks. We check that the funding
outcome is balanced and that risk-taking is
consistent with the covenant.
• The level of affordability is such that
contributions should generally be at a
level to clear the deficit over a reasonably
short period of time. However, for schemes
looking to target a stronger outcome (for
example, through de-risking) a longer
period of time may be appropriate.
• Strong affordability means that scheme
contributions are unlikely to impact on the
employer’s plans for sustainable growth.
• Trustees understand and monitor the
covenant risks and are able to demonstrate
that if the situation deteriorated the
position could be recovered without
putting members’ benefits at risk (for
example, through contingent assets).
• High affordability generally means
employers are mainly able to afford
contributions to fund the scheme over a
short to medium period without impacting
on their plans for sustainable growth.
• Where contributions are constrained
through higher investment to support
business growth, we expect trustees to
have worked with employers to test that
the investment plans to strengthen the
covenant are credible and that appropriate
and robust mitigations and protections for
the scheme are in place.
• Trustees understand and monitor the
covenant risks and recognise that if the
covenant does deteriorate, the capacity
to support the scheme will increasingly be
stretched and trustees have appropriate
mitigations in place (for example, through
contingent assets).
Draft Our defined benefit funding policy
27
Appendix B – Segmentation
Covenant grade 3 – Tending to Weak
Covenant grade 4 – Weak
• Tending to weak covenant means that
risk-taking should be appropriately limited
given the limited ability of the covenant
to support this and the impact that
crystallising this support would have on the
employer’s business plans.
• Weak covenant means that the employer
is unlikely to be able to make good
significant reductions in funding level
due to investment losses and therefore
investment risk should be limited.
• Trustees and employers have sought
to maximise the support available to
the scheme including obtaining formal
group support.
• Trustees and employers understand and
monitor the covenant risks and are able to
demonstrate that they are aware of the lack
of capacity of the employer covenant to
recover investment losses.
• Trustees and employers have engaged
and discussed the employer’s plans
for sustainable growth to improve the
covenant and the interaction with the
scheme risks.
• Trustees and employers have engaged
and discussed the employer’s plans
for sustainable growth to improve the
covenant and the interaction with the
scheme risks.
• Trustees have discussed the appetite
for risk with the employer and have firm
contingency plans in place recognising that
if the covenant does deteriorate further
then the capacity to support the scheme
will increasingly be inadequate and that
poor scheme investment performance
compounds stress on the employer.
• Contributions are dictated by affordability.
• Affordability constraints likely to be
a concern and the need to balance
contributions with the employer’s plan
for sustainable growth and improving the
covenant to the scheme. Contributions
are at a level that reduces the deficit at an
acceptable rate.
• Trustees and employers have sought to
maximise the support available to the
scheme by:
–– limiting the flow of value away from
the employer (for example, through
dividend blocks)
–– preventing detriment to the scheme’s
claim on the covenant caused by the
employer’s debt financing
–– improving the scheme’s security (for
example through contingent assets
being provided to the scheme by
the employer), and
–– obtaining formal group support.
Draft Our defined benefit funding policy
28
Appendix B – Segmentation
Covenant grade 3 – Tending to Weak
Covenant grade 4 – Weak
• Where contributions are limited to
support investment in growth, the covenant
is strengthening and value protected for
the scheme. Trustees have considered
whether equity holders also support
investment in the employer by restricting
or postponing dividends.
• Trustees and employers have sought
to prevent the scheme’s position from
worsening by:
• Trustees understand and monitor the
covenant risks and are able to demonstrate
that they are aware that further
deterioration of the covenant is likely to put
members’ benefits at significant risk.
–– adopting an appropriate
investment strategy
–– focussing on the likelihood of accrued
benefits being paid in the context that
it is unlikely that future accrual would
be appropriate, and
–– considering whether it is appropriate to
crystallise the scheme’s position.
• Trustees have considered the sustainability
of future accrual in the context of difficulties
with supporting existing benefits.
Draft Our defined benefit funding policy
29
Appendix C – Developing
the BFO indicator
101.The BFO indicator reflects a number of factors and influences and
seeks to determine what a balanced outcome might look like. We
aim to set the BFO indicator consistently with our strategy and
policy aims and the messages we give to schemes.
102.The BFO for a scheme depends on the strength of its covenant. The
stronger the employer covenant, the more acceptable it may be
for trustees to seek higher returns through the investment strategy.
Assumed higher returns may reduce the contributions and/or assets
needed to meet the scheme’s liabilities. In comparison, the weaker
the employer covenant, the less acceptable it may be for trustees to
take significant investment risk. Assumed lower returns may increase
the need for the contributions and/or assets needed to meet the
scheme’s liabilities.
103.The more mature a scheme, the greater the proportion of the
scheme assets being paid out in benefits each year and the
less time the employer has to make good any crystallisation of
investment risks. Therefore, the BFO also depends on a scheme’s
maturity with, all else being equal, more mature schemes having a
lower level of acceptable risk within a prudent investment strategy.
104.The BFO for each scheme is set as follows:
• We calculate a notional level of assets, taking account of the
covenant strength and the scheme’s maturity, at which we would
deem it acceptable for no further deficit reduction contributions
to be paid into the scheme. This value is expressed relative to
the liabilities on a reference basis which is an objective liability
measure, independent of the scheme’s funding assumptions.
This allows us to assess all schemes consistently within a
common risk management framework
• We compare this notional level of assets to the actual
assets in the scheme and determine the annual rate of deficit
repair contributions (if any) required over the medium term
which constitutes a balanced funding outcome given the
scheme’s circumstances
• The resulting contributions are then compared with the deficit
reduction contributions committed in the scheme’s recovery
plan (with irregular contributions smoothed as necessary) to
indicate whether the funding plan under consideration meets
our expectations
Draft Our defined benefit funding policy
30
Appendix C – Developing the BFO indicator
• We limit the number of years’ contributions in this regard to
recognise both that there is scope to change deficit reduction
contributions at future valuations should the scheme’s
circumstances change and there is a limited horizon over which
the current strength of covenant can be prudently considered
likely to remain stable.
105.We recognise that scheme funding levels vary continuously with
economic and market conditions and, therefore, we adjust the BFO
indicator to reflect these conditions so that schemes with different
valuation dates within the same tranche are treated consistently. We
do this by:
• adjusting all valuations within each tranche to the same date so
as to remove short-term market fluctuations. This is done both in
our overall assessment and in the tools used to screen schemes
for potential intervention (see below)
• applying a time-specific adjustment to the BFO indicator
for each tranche to reflect economic and market conditions
at this common date and retain consistency between
successive tranches.
106.Defining the BFO in this way means that two schemes of similar
maturity, covenant, funding level (measured on a consistent basis)
with the same level of deficit repair contributions are perceived
to represent a similar level of risk and treated consistently. This
does not detract from the fact that in practice they may have quite
appropriately set their technical provisions and recovery plan
lengths and structures differently to reflect their scheme’s individual
circumstances and objectives.
Draft Our defined benefit funding policy
31
Appendix D – Our suite
of risk indicators
107.Our primary risk indicator is whether and by how much schemes fall
short of our BFO indicator.
108.Other risk indicators we consider when making our decision include:
• Investment strategy risk – we assess the level of investment
risk the scheme is running relative to the scheme’s maturity
based on the most recent information we have on the scheme’s
asset allocation. We then test whether this level of investment
risk can be supported by the employer covenant over an
appropriate period of time. In general, schemes which hold
a higher proportion of growth seeking assets, have a greater
proportion of pensioner members and are supported by weaker
covenants are more likely to flag under this indicator
• Mortality – we check if the scheme’s mortality assumptions
have been set prudently. For this assessment we look at
the two parts of the assumptions: the base table of current
mortality rates and the expectations for future improvements
in mortality. If significantly higher than average mortality rates
(and hence lower life expectancies) are being used in the base
table we consider whether such an adjustment is justified based
on the characteristics of the membership of the scheme, for
example industry sector and liability per member. For the future
improvements we check that the expected improvements in life
expectancies are not significantly lower than prevailing industry
practice
• Back end loading – an important indicator of short/mediumterm risk is the concentration of contributions in the later years
of the recovery plan. Of particular concern are those recovery
plans where the deficit reduction contributions over the period
until the next valuation are materially lower than subsequently
• Any reductions in contributions relative to existing
recovery plan – where contributions have reduced from the
current recovery plan, we check that this may be justified by a
reduced level of affordability or that employer resources are
being used to improve the strength of the employer covenant
whilst respecting the scheme’s needs and overall balance in
this context
• Avoidance issues – we review the recent transactions of
the employer(s) to check if they could indicate possible
avoidance activity
Draft Our defined benefit funding policy
32
Appendix D – Our suite of risk indicators
• Actions taken to weaken the covenant – we identify any
specific issues and/or concerns relating to a deterioration in
the strength of the employer’s covenant (for example excessive
dividends in the context of the contributions to the scheme)
• PPF funding risk – we combine the deficit on the ‘s179
valuation basis’22 (if any) with covenant strength to provide an
indicator of the risk to the PPF
• Reliance on investment outperformance in the recovery plan
– we assess how much reliance is being placed on investment
outperformance to make good the deficit in the recovery plan
and check if this appears excessive
• Governance – we consider reports of material poor governance
(for example, conflicts of interest, inadequate internal controls,
inadequate exchange of information between employers
and trustees, or failure to commission adequate professional
advice proportionate to the size of the scheme) which indicate
improperly managed risks
• Specific risks – such as the presence and underlying risks
such as late payments 23 or ‘section 75 double-counting’24
• Any issues raised at previous valuations – where we have
raised significant issues at previous valuations we are more likely
to investigate than otherwise
• Other interactions with us – to extent that we have engaged
with schemes or employers in relation to other matters we take
them into consideration.
22
Valuation of PPF
compensation benefits
under Section 179 of
the Pensions Act 2004,
for PPF levy purposes.
Liabilities are based on
the scheme benefits
taking into account key
features of the levels of
compensation paid by
the Board of the Pension
Protection Fund as set
out in Schedule 7 of the
Pensions Act.
23
See Appendix 4 of the
draft code of practice
on scheme funding
and statement at: www.
tpr.gov.uk/draftcode3
24
See paragraph 167
of code of practice
on scheme funding
and statement at:
www.tpr.gov.uk/
counting
Draft Our defined benefit funding policy
33
Appendix E – Late
valuations and failure
to agree
109.If we receive advance notification that the trustees are likely to
fail to complete their valuation within the statutory fifteen-month
timeframe, we generally do not engage at that point if work is
underway. In those instances we urge the parties to continue
to engage to try to complete the valuation process a quickly as
possible while reminding the parties that agreement should still be
appropriate and not ‘at any cost’.
110.Where schemes and employers have failed to agree to all of the
funding requirements25 within the statutory deadline, this must be
reported to us.26
111.Obtaining regular actuarial valuations is not just a legal
requirement27, it is a good discipline for schemes and their
employers to assess the financial health of the scheme, even
for schemes that may be in surplus. We have little tolerance for
outstanding actuarial valuations. Our key focus, therefore, is to
help a scheme in this situation find an appropriate agreement as
soon as possible.
112.We seek to understand the reasons for the delay and the likely date
of completion so as to determine the most appropriate course
of action. In our assessment we also consider any other relevant
factors such as whether there are any issues relating to funding,
investment or covenant support, concerns about governance or
evidence of avoidance.
113.This may involve meetings with the parties to try to explore whether
agreement is possible. In our discussions with the trustees and
the employer we seek to understand the reasons for the delay, the
nature of the parties’ position and the extent of the work done so
far. We also consider the extent to which the trustees and employer
have sought to put mitigating actions in place in view of their
failure to agree. Our objective is to facilitate discussions between
parties and encourage the trustees and the employer to engage in
a meaningful dialogue and to agree an achievable timetable within
which they can agree an appropriate outcome.
114.Where the delay is likely to be small or the deadline has just
passed or we are confident that good progress is being made, we
are unlikely to take action. However, in the absence of progress,
if delays are significant or we have identified other material risk
factors we consider the use of our powers.
25
Under Part 3 but
will generally be
completing the
actuarial valuation and
revising the schedule of
contributions as well as
updating (or putting in
place) a recovery plan.
26
See Appendix 2 of the
funding code for details
on these reporting
requirements under Part
3 of the Act.
27
See section 224(1)
of the Act.
Draft Our defined benefit funding policy
34
Appendix F –
Investigation outcomes
115.Once our initial investigation of the scheme’s funding is complete
we write to the relevant parties to let them know of the outcome
and any next steps.
116.Where we decide not to take action, we reserve the right to revisit
that decision where we receive information which is materially
different from that provided. A material change in circumstances
after that decision may lead to a new investigation.
No further action
117.If we have identified no concerns warranting further investigation,
we issue a valuation investigation closure letter (VIC letter).
118.This confirms that we do not intend to carry out further
investigations and do not propose to exercise any of our funding
powers28 in relation to the valuation in question. In the VIC letter we
may give some bespoke feedback to the scheme and the employer.
Inadequate response but no further action
119.Where we have identified concerns but we do not consider
that it would reasonable and proportionate to use our funding
powers (for example, due to the parties’ agreement to meaningful
improvements at the next valuation), we may issue a closure letter
communicating the issues outstanding, explaining why we are
closing the case down, outlining our expectations for the next
valuation and outlining what steps we could take should we still
have issues with the next valuation and the extent to which we
can take into account those issues with the current valuation when
doing so. The letter will also confirm any agreement reached by
parties for the next valuation in the light of our concerns.
120.Not using our funding powers in relation to the current valuation
does not preclude us from considering the use of our other powers
or taking other actions.
Inadequate response and further action
121.In some cases we may decide that the concerns we have outlined
to trustees have not be adequately addressed, or when agreement
remains outstanding, that it would be reasonable and proportionate
to take enforcement action.
122.In this case we explain to the parties our next steps and the reasons
for them.29
28
Under section 231(2)
of the Act.
29
Except in
circumstances as
detailed in
paragraph 63.
Draft Our defined benefit funding policy
35
Appendix G –
Supporting analysis
These charts are based on current data analysed at a point in time. The defined terms used in this
appendix are detailed in the glossary in Appendix H. The limitations to this analysis are set out in
Appendix I.
Scheme significance and the impact of deficits on
employers’ balance sheets (paragraph 11)
Chart 1.1: Estimated technical provisions (TP) shortfall as a percentage
of shareholder’s funds
100%
90%
Proportion of schemes (%)
80%
70%
60%
Negative SHF
50%
Greater than 100%
50% to 100%
40%
20% to 50%
30%
10% to 20%
5% to 10%
20%
Less than 5%
10%
Estimated TP surplus
0%
Estimated TP shortfall as (%) shareholder’s funds
Source: The Pensions Regulator and Financial Analysis Made Easy (FAME)
Note: Shareholder funds are calculated net of scheme surplus/deficits on an accounting basis. This has not been
accounted for in this analysis and would reduce the ratio of deficits to shareholder funds further for the majority of
schemes.
Draft Our defined benefit funding policy
36
Appendix G – Supporting analysis
• The implications of deficits for the employers’ balance sheets are widely variable
• Approximately 40% of employers could pay off their deficits from less than 20% of shareholder
funds. Schemes fully funded on a technical provision basis are likely to still be running
investment and funding risks and so will still be relying on employer’s to support these risks
• At the other extreme, around 30% of the schemes either have negative shareholder funds or
deficits in excess of 100% of their shareholder funds although this is particularly affected by the
factor outlined by the note at the bottom of the chart.
Chart 1.2 – Estimate of deficit recovery
contributions (DRCs) as a percentage of employer’s profit before tax
(PBT)
100%
90%
Proportion of schemes (%)
80%
70%
60%
Negative PBT
50%
Greater than 100%
50% to 100%
40%
20% to 50%
30%
10% to 20%
5% to 10%
20%
Less than 5%
10%
No DRCs
0%
DRCs as (%) PBT
Source: The Pensions Regulator and FAME
Note: PBT is calculated net of pension financing items on an accounting basis. This has not been accounted for in this
analysis and would reduce the ratio of DRCs to PBT for the majority of schemes. DRCs for this chart are the average over
the first six years of the current recovery plan.
• The impact of DRCs on employers’ income is also widely variable
• For around 50% of schemes, current DRCs absorb less than 10% of profit before tax
• At the other extreme, 25% of schemes either have negative PBT or deficit repair contributions
in excess of 100% of their PBT.
Draft Our defined benefit funding policy
37
Appendix G – Supporting analysis
Member losses
Chart 2.1 – Number of members transferred into the PPF and in PPF
assessment: historic and forecast as at March 2013
Number of members suffering benefit loss (thousands)
450
400
350
300
250
200
150
100
50
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
(Forecast) (Forecast) (Forecast)
Cumulative number of members accepted into PPF (pensioners and deferred pensioners)
Number of members in PPF assessment (pensioners and deferred pensioners)
Source: PPF and The Pensions Regulator data. The figures in this chart have been
sourced from successive editions of The Purple Book 2013 and the PPF’s Strategic
Plan 2013.
• As at March 2013 the PPF had agreed to provide compensation to
approximately 176,000 members (this does not include members of
schemes currently in assessment)30. The total amount of PPF claims is
estimated to have reached around £4bn31 at the same date
• In addition, our calculations suggest that further losses to members
not compensated by the PPF were estimated to be a further £7bn at
the same date – an average member loss (in capital value terms) of
about £25,000.
30
These figures are based
on the data underlying
Chart 2.1. The final
figures for 2013 as
reported in The Purple
Book 2013 are lower
than those quoted
above.
31
‘Claim value’ is defined
as the deficit against
the PPF liabilities at the
point at which a scheme
enters the PPF (see
Chart 2.2).
Draft Our defined benefit funding policy
38
Appendix G – Supporting analysis
Cumulative aggregate claims (£bn)
Chart 2.2 – Cumulative PPF claims: historic and forecast
25.0
20.0
15.0
10.0
5.0
0.0
2006
2010
10th/90th percentile
2014
(Forecast)
2018
(Forecast)
2022
2026
(Forecast)
25th/75th percentile
(Forecast)
2030
(Forecast)
Median
Source: Pension Protection Fund data
• The future claims experience of the PPF will depend on how a
number of interrelated factors32 develop over time, as well as in
relation to each other
• In the above chart we have shown the PPF’s historical claims
experience alongside a fan chart, taken from PPF’s base case,
showing the projected range of cumulative deficits over time of
schemes making a claim on the PPF, measured at the point at which
they enter the PPF33
• Whilst the actual outcome will be subject to many factors, it is clear
from the above projection that the PPF’s claims experience has not
yet fully matured and the cumulative claims should continue to grow
for a few years. Uncompensated member losses should also continue
to grow and a critical mitigation will be the strength of scheme
funding.
32
For a comprehensive
assessment see www.
pensionprotectionfund.
org.uk/Document
Library/Documents/
Funding_Strategy_
Review_2013.pdf
33
For this purpose ‘claims’
are measured as deficits
against the PPF liabilities
at the point at which
schemes enter the PPF.
Draft Our defined benefit funding policy
39
Appendix G – Supporting analysis
Linkage between funding, covenant and
investment (paragraph 22)
Chart 3.1 – Technical provisions as a percentage of
reference liabilities by covenant group
Technical Provisions as (%) reference liabilities
120%
115%
110%
105%
100%
95%
90%
85%
X
X
X X
CG1
CG2
CG3
X
80%
75%
70%
Source: The Pensions Regulator’s data
Note: For a definition of covenant categories see Appendix B.
Charts 4.1 and 4.2 below illustrate the distribution of schemes and
corresponding liabilities by covenant category.
• We would expect to see stronger technical provisions
for schemes with weaker covenants
• However, the range of technical provisions is broadly
similar between covenant ranges, with the average
CG4 technical provisions only about 4% stronger
than the average CG1 relative to a common
valuation basis.
CG4
5%
above
this line
75th percentile
median
50% of
valuations
25th percentile
5%
below
this line
Draft Our defined benefit funding policy
40
Appendix G – Supporting analysis
Chart 3.2 – Investment risk by covenant group
X MEAN Return seeking assets
100%
Return seeking assets (%)
90%
80%
70%
60%
X
50%
X
X X
X
40%
30%
20%
CG1
CG2
Source: The Pensions Regulator’s data
• We would not expect to see high
levels of investment risk associated with
weaker covenants
• In practice, investment behaviour does not
appear to be significantly different across the
covenant groups.
CG3
5%
above
this line
CG4
75th percentile
median
50% of
valuations
25th percentile
5%
below
this line
Draft Our defined benefit funding policy
41
Appendix G – Supporting analysis
Segmenting the landscape (paragraphs
33,50)
Chart 4.1 – Distribution of schemes reference
liabilities by covenant and scheme liability size
800
700
Reference liabilities (£bn)
600
500
400
300
200
100
0
CG1
CG2
CG3
CG4
Reference liability group
1 > £1.2bn
2 > £120m-£1.2bn
3 > £12m-£120m
4 <£12m
Source: The Pensions Regulator’s data
Draft Our defined benefit funding policy
42
Appendix G – Supporting analysis
Chart 4.2 – Distribution of number of schemes by
covenant and scheme reference liability size
2,500
Number of schemes (N)
2,000
1,500
1,000
500
0
CG1
CG2
CG3
CG4
Reference liability group
1 > £1.2bn
2 > £120m-£1.2bn
3 > £12m-£120m
4 <£12m
Source: The Pensions Regulator’s data
• Most of the members and liabilities are in the stronger covenant groups with a large
concentration of liabilities in a small number of very large schemes. Around £900bn of liabilities
– more than half of the total for all schemes – are accounted for by 182 schemes with reference
liabilities in excess of £1.2bn and in Covenant Groups (CG) 1 and 2. These schemes account for
approximately 55% of the aggregate deficit on a common valuation basis
• It does not, however, follow that the largest schemes and those that pose the biggest risks
necessarily have the strongest support. For example, 54 schemes with reference liabilities in
excess of £1.2bn are in the two weakest covenant groups which account for a further £172bn
of liabilities in aggregate (11% of the total for all schemes). These schemes account for
approximately 10% of the aggregate deficit on a common valuation basis.
Draft Our defined benefit funding policy
43
Appendix G – Supporting analysis
Illustrating our approach to
the balanced funding outcome (BFO)
indicator (paragraph 42)
The chart overleaf illustrates our approach to the BFO indicator for
an example group of Tranche 7 valuations (schemes undertaking
their valuations with effective dates in the period September 2011 to
September 2012).
Note: We used this general type of approach for Tranche 7 schemes for
the purpose of selecting cases and to communicate the reasons why we
selected schemes for further discussion. We are looking to consult on
the setting of the BFO and how we take this approach forward.
• Each dot on the chart below represents the scheme’s funding
position and the medium-term contribution commitment (with
smoothing of lumpy contributions). The line shown on the chart
below is drawn through the position of the average schemes and is
included for illustrative purposes only
• The BFO indicator depends on the strength of the covenant support,
the scheme’s maturity level and the financial conditions at the central
date of the tranche that the scheme’s valuation falls into (in this case
31 March 2012)
• For each scheme we can derive a ‘BFO line’ representing the level of
committed contributions required for different funding levels given
the scheme’s individual circumstances
• The chart shows that there is little, if any, correlation between
underfunding and contribution levels when assessed on a common
reference basis. Our data also suggests that there is also little
correlation across covenant strength categories.
Draft Our defined benefit funding policy
44
Appendix G – Supporting analysis
Chart 5.1 – Funding and contributions
across a sample of schemes
Annual DRCs as (%) of reference liabilities
6%
5%
4%
3%
2%
1%
0.0%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
Assets as (%) of reference liabilities
Source: The Pensions Regulator’s data
Draft Our defined benefit funding policy
45
Appendix H – Glossary
Tranches
’Tranche’ refers to the set of schemes which are required to carry out
a scheme specific funding valuation within a particular time period.
Schemes whose valuation dates fell between 22 September 2005 and 21
September 2006 were in tranche 1, between 22 September 2006 and 21
September 2007 were tranche 2, etc. Because scheme-specific funding
valuations are generally required every three years, schemes whose
valuations are in tranche 1 will also be likely to carry out valuations in
tranches 4, 7 and 10.
Technical
provisions (TPs)
The funding measure used for the purposes of Part 3 valuations. The
‘technical provisions’ are a calculation undertaken by the actuary of
the assets needed at any particular time to make provision for benefits
already considered accrued under the scheme using assumptions
prudently chosen by the trustees – in other words, what is required
for the scheme to meet the statutory funding objective. These include
pensions in payment (including those payable to survivors of former
members) and benefits accrued by other members and beneficiaries,
which will become payable in the future.
Reference
liabilities
An estimate of liabilities which enables a consistent comparison
between schemes by removing the impact of varying degrees of risk
between schemes.
Recovery plans
(RPs)
Under Part 3 of the Pensions Act 2004, where there is a funding shortfall
at the effective date of the actuarial valuation, the trustees must prepare
a plan to achieve full funding in relation to the technical provisions. The
plan to address this shortfall is known as a recovery plan.
Recovery plan
length
The recovery plan length is the time that it will take for a scheme to
recover any shortfall at the effective date of the actuarial valuation, so
that by the end of the recovery plan it will be fully funded in relation to
the technical provisions.
Deficit repair
contributions
(DRCs)
DRCs are contributions made by sponsors to the scheme in order to
address any asset to technical provisions deficit, in line with the schedule
of contributions and the recovery plan.
Draft Our defined benefit funding policy
46
Appendix H – Glossary
Return
seeking assets
The assets of a scheme that are invested in equities, property,
commodities, hedge funds, 50% of corporate bonds holdings and any
assets classified as ‘other’.
Shareholders’
funds and
profit before
tax
These are measures as reported in the corporate accounts before any
adjustment to remove the impact of pension accounting items. They
have been used here for illustration recognising that in practice other
measures may be more appropriate since trustees need to balance their
demands against other essential calls on the employer’s business.
Draft Our defined benefit funding policy
47
Appendix I –
Data limitations
Limitations of actuarial analysis
We have used the latest pension scheme data reported to us by each
scheme as at 31 March 2013, with earlier data rolled forward on an
approximate basis to 31 March 2013 allowing for contributions paid and
movements in the financial markets and other economic indicators.
Compared with the more accurate calculations carried out for formal
valuations and recovery plan reporting by scheme trustees, the roll-forward
techniques we have employed to estimate individual and aggregate
funding positions involve numerous assumptions and simplifications.
Many of these assumptions or simplifications have been driven by the
limitations of scheme data available to us. For example, we have used
index-tracking of major asset classes, made no allowance for hedging
instruments to mitigate risk and have made assumptions about scheme
liabilities in aggregate that may not accurately reflect the underlying
liabilities of individual schemes. The calculations are also highly sensitive
to the valuation date used and other scheme-specific characteristics.
This is not an exhaustive list of assumptions or simplifications, any of
which may be a significant source of error at the individual scheme level.
Limitations of employer analysis
We have used the latest published corporate financial data available as
at 1 September 2013 in respect of statutory employers (as reported to
us in a scheme’s annual return) – primarily relating to accounting years
ending in December 2012 to March 2013 but in some cases relating to
earlier years. Data for approximately 12% of schemes was not available
– we believe these to be concentrated in particular sectors (eg SMEs,
public/third sector or overseas companies) and therefore the analysis
may not be representative of these sectors.
Compared with the more detailed and contemporary information
available to trustees and their advisers, the techniques we have used
to estimate available covenant support involve various assumptions
and simplifications.
continued...
Draft Our defined benefit funding policy
48
Appendix I – Data limitations
Many of these assumptions or simplifications have been driven by:
data limitations or availability; the reconciliation of third party data
with our own; and, the methodological approaches necessitated by a
heterogeneous universe of employers with – in many cases – multiple
scheme associations both within and across corporate groups, the main
examples of which being:
• where an employer participates in more than one scheme or the
scheme is sponsored by more than one employer, we have made
assumptions about the division of an employer’s financial support
among the pension schemes in which it participates
• where corporate financial information for statutory employers was
not available individually, we have used consolidated accounts for
the relevant group, thus potentially overstating the covenant
support available
• where corporate financial information was not available for all
statutory employers to a scheme, we have used information
aggregated over only those employers for whom the relevant
data was available, thus potentially understating the available
sponsor support.
Any of these assumptions due to data limitations and interpretations
may be a significant source of error at the individual scheme/sponsor
level. Moreover, accounting based metrics may be poor indicators of
formally assessed covenant strength and accordingly this analysis should
not be seen as a substitute such bespoke assessments.
Draft Our defined benefit funding policy
49
How to contact us
Napier House
Trafalgar Place
Brighton
BN1 4DW
T 0845 600 0707
F 0870 241 1144
[email protected]
www.thepensionsregulator.gov.uk
www.trusteetoolkit.com
Draft Our defined benefit funding policy
© The Pensions Regulator December 2013
You can reproduce the text in this publication as long as
you quote The Pensions Regulator’s name and title of the
publication. Please contact us if you have any questions about
this publication. We can produce it in Braille, large print or on
audio tape. We can also produce it in other languages.