The Regulator has followed-up its statements (issued in October 2008 and February 2009) on the impact of current market conditions on pension schemes with a new statement: "scheme funding and the employer covenant." This statement is intended to reinforce the messages contained in its previous statements and to provide a "consolidated summary" of its approach to scheme funding. It adopts a similarly pragmatic tone, with an underlying emphasis on trustees making use of the flexibility inherent in the scheme-specific funding regime (in particular, in relation to recovery plans) where the employer is experiencing financial difficulties.
- The statement repeats earlier acknowledgements that economic and financial conditions have resulted in short-term cash constraints and longer-term uncertainties for some employers, but that the legal and regulatory scheme-specific funding framework is sufficiently flexible to cope with these conditions.
Setting technical provisions and agreeing the recovery plan:
- The statement notes that a scheme's technical provisions (basically, the scheme's liabilities) must be prudent and that an unadjusted FRS17 basis is unlikely to represent an adequate level of prudence at present. Trustees should take account of the risks inherent in the scheme's investment strategy when setting technical provisions.
- Where an employer covenant is so weak as to be negligible, trustees should choose assumptions which allow the scheme to be self sufficient (that is, the technical provisions are set at a level at which they can be expected to meet full accrued liabilities and future expenses, on the basis that the scheme had been closed). However, where an employer covenant is strong relative to the scheme, a discount rate can take credit in advance for a prudent level for investment out-performance above a risk-free rate of return.
- Notwithstanding that there is flexibility in setting the recovery plan, a scheme's technical provisions should not be compromised in order to make that plan appear more affordable. However, the Regulator states that annual deficit repair contributions must be determined by reference to what is reasonably affordable for the employer; and that where the employer is "cash-constrained", trustees should consider the widest range of flexibility in recovery plans, including increasing their length, back-end loading and the use of contingent security. To underline its point, the Regulator states that it has considered recovery periods of between one and 20 years to be appropriate, depending on the individual circumstances of the scheme.
The employer covenant:
- The Regulator sets out a short, non-exhaustive list of questions which trustees should ask when assessing the strength of the employer covenant. These questions cover the employer's legal obligations to fund the scheme, the effect of the employer's group structure and the consequences for the scheme of sponsor insolvency.
- The statement also mentions the importance of mechanisms for regular monitoring and review, but does not go into further detail on this point.