The Pensions Regulator has updated its guidance on monitoring and assessing the employer covenant. This update overhauls the Regulator’s previous guidance, issued in November 2010, and comes following a revision of the Regulator’s Code of Practice on funding defined benefits as revised in June 2014.
The employer covenant is the sponsoring employer’s legal obligation and financial ability to support its defined benefit (DB) scheme now and in the future. Regularly assessing and monitoring the covenant is a DB scheme requirement under Part 3 of the Pensions Act 2004. It is crucial in assisting trustees when deciding the appropriate level of risk in their investment strategy and considering their funding target and recovery plan. With this in mind, the Regulator’s guidance is aimed at providing trustees and their advisors with good practice guidelines in the following areas:
- assessing the covenant “as part of an integrated approach to managing risks”
- monitoring the covenant and taking action
- improving the security of the scheme.
The guidance sets out detailed points to consider when assessing the legal, scheme-related and financial aspects of the covenant, illustrated also by a number of practical examples. It goes on to provide considerations for trustees of schemes that are sponsored by not-for-profit organisations and for those managing non-associated multi-employer schemes. Throughout the guidance, there are a number of checklists and tables for trustees to use in the covenant assessment process.
The Regulator recommends that all trustees read the “At a glance” section which summarises the key points from the guidance. These include the following:
- Proportionality: a proportionate approach should be taken when assessing and monitoring the covenant and should be relative to the reliance of the scheme on the employer and the complexity of the employer’s operations.
- Independent advice: trustees should consider obtaining independent external advice where “they lack the objectivity or expertise required to perform an appropriate assessment”.
- Working collaboratively: trustees and employers are encouraged to work collaboratively and to promote good information-sharing practices.
- Forward looking: assessments carried out should be forward-looking and should focus on the employer’s ability to contribute cash to the scheme over an appropriate period to achieve and maintain full funding.
Further guidance focusing on investment strategy and integrated risk management is due from the Regulator later this year. For now, this guidance seems to be a clear indication that the Regulator is taking its statutory sustainable growth objective seriously.