Regulator issues annual funding statement for DB schemes

News Alert 2024/02

At a glance

The Pensions Regulator has issued this year’s DB Annual Funding Statement.  As in previous years it sets out the Regulator’s key messages for trustees and sponsors of schemes who are undertaking valuations at the current time or are undergoing significant changes that require a review of their funding and investment strategies. This is expected to be the last such Statement under the current funding regime, with the new regime due to apply to valuation effective dates from 22 September 2024.

Key actions for trustees and scheme sponsors

• Given the significant improvements in DB funding that have taken place recently, reassess where the scheme has reached on its funding journey and take a fresh look at longer-term strategy, future risks and opportunities.  The Regulator is encouraging trustees to consider the full range of options for a scheme’s long-term future
• Through establishing which of the Regulator’s scheme types the scheme most closely resembles, assess whether its expectations for that scheme type affect the current approach being taken by the scheme in relation to covenant, investment and funding issues
• For imminent valuations, consider the steps that can be taken now to align, if only broadly, with the new approach to scheme funding that is to become operative for valuation effective dates from 22 September 2024
• Consider broader systemic risks, such as climate risk, geopolitical risk and sustainability, and the influence these might have on future scheme management and on the consideration of insurance options

The Detail

On 24 April 2024 the Pensions Regulator issued its 2024 Annual Funding Statement, aimed at trustees and sponsors of DB pension schemes.  The statement is focussed on “tranche 19” schemes – ie those with valuations with effective dates between 22 September 2023 and 21 September 2024 (the final tranche to be assessed on the current scheme funding approach), as well as schemes that have experienced significant changes that require a review of their funding and investment strategies.

This year’s statement is very much focussed on the material improvements in funding levels that many schemes have experienced, with the Regulator saying that half of all schemes are now expected to have exceeded their estimated buy-out funding level (up from a quarter last year).  The tone of the statement has also shifted with an increased mention of different end game options, including the possibility of running-on and seeking to generate additional surplus to benefit members and employers.  DB scheme consolidators are also mentioned, as well as of course buy-out with an insurer.

However, despite this good news a “sizeable minority” of schemes are expected to be in deficit on a technical provisions basis, and for these, a timely recovery of the deficit and paying close attention to the employer covenant remain key.

General considerations for schemes undertaking a valuation

Under this heading the Regulator gathers together a number of thoughts on topics that have arisen as funding levels have improved, such as calls from employers for contribution reductions or suspensions, and calls from members for discretionary pension increases.  

The Regulator also emphasises the need for trustees to consider the potential impacts from systemic risks such as climate change, geopolitical risks, and wider sustainability issues, including nature loss, when considering future scheme horizons, and the possible long-term covenant, investment and funding strategies.

Rethinking strategies

This section groups schemes into three categories according to the scheme’s funding level:

• For those above buy-out the Regulator’s focus is on end-game delivery, with some points being made about buying out with an insurer versus running on – including reference to the impact of buy-out on discretionary pension increases.  The Regulator is clear that trustees need to understand the risks and benefits of each option and their relevant duties
• For those above technical provisions but below buy-out, the Regulator asks trustees to review their long-term objective and a timescale for reaching it.  The Regulator also argues that such schemes may wish to explore other options “to achieve greater levels of governance and economies of scale”, and trails that it expects to publish guidance on DB alternative arrangements for consolidation later this year
• For those below technical provisions, the Regulator calls on such schemes to bridge this gap first, as quickly as the employer can reasonably afford

The Regulator also says that it expects its 2023 statement expectations under this heading to remain relevant.

Key risks and the Regulator’s expectations

At the end of the statement the Regulator notes that its guidance from previous years’ statements applies and links to the comprehensive set of tables provided in the 2023 statement in which the Regulator sets out its expectations across covenant, investment and funding, which differ according to the characteristics of the scheme.  There are five scheme types, with each further sub-divided according to whether the scheme is relatively immature or relatively mature.

Trustees are asked to find the scheme type closest to their circumstances, which should help them determine the direction and magnitude of change to their funding and investment strategies, the risks they need to focus on, and the actions expected.  They should then prepare any recovery plans to balance affordability with other reasonable uses of cashflow for the employer.