Over the last few years, we have had to balance some difficult challenges. The pandemic, Brexit and the conflict in Ukraine mean a scheme’s funding position, investments and covenant could be more volatile – and liable to change quickly.
Defined benefit scheme funding levels so far have held up well, particularly where schemes have been well hedged. If you are a trustee of one of the fortunate schemes that are well funded, you are on track with your journey plan and have an employer that has not been impacted by the challenges of the last few years, then keep doing what you are doing, while remaining alert to risk.
If your position is more challenging and the economic situation has impacted your scheme funding levels, try to work with your employer to get back on track. While you should carefully consider any requests to accept a temporary reduction in deficit repair contributions if your employer is experiencing short-term affordability constraints, it remains the case that we expect any request to be short term.
Employers should make higher contributions in subsequent years and there should be a limit to any extension to recovery plan end dates. We will continue to view shareholder distributions as being inconsistent with the scheme receiving lower contributions.
It is unclear how the conflict in Ukraine will affect UK schemes. A significant risk is the impact the conflict may have on the global economy. It’s important to be alert to changes in liquidity demands and cyber risks; the longer-term impact on funding positions could be significant. In addition, employer covenants could be affected by indirect impacts on their customers, supply chain or financing costs.
For many businesses these factors will be coming on top of the ongoing challenges of Covid-19 and Brexit. The longer-term impact on future mortality trends as a result of Covid-19 also continues to be a further area of uncertainty.
These risks should be managed within an integrated risk framework and an open dialogue with employers when assessing a scheme’s covenant. An actuarial valuation is an opportunity to review your scheme’s funding plans and it may be a good time to seek future protections such as contingency plans and dividend-sharing mechanisms.
If your scheme is in deficit against its technical provisions (TPs), focus on recovering the deficit. If your scheme is in TP surplus and you have a journey plan, you should ensure your liquidity needs are covered and that you focus on managing risks through contingency planning.
The Pension Schemes Act 2021, once implemented, will make it a legal requirement for schemes to have a long-term strategy designed to deliver a long-term objective. Those that have a long-term target tend to fair better and schemes will need an Long-Term Funding Target (LTFT) to meet the requirements of the new DB funding code.
When setting your journey plan to the LTFT, you should consider the extent of the scheme’s reliance on the employer covenant. It may be years before the LTFT is reached, and there may then be a period before the scheme winds up.
You should therefore engage with the employer to understand the short and longer-term risks that could result in changes in covenant and affect the scheme’s journey plan to its LTFT and beyond. These could be employer-specific risks, such as over-reliance on a single, fixedterm contract, broader sector risks, for example, changes in consumer demand, or longer-term risks such as climate change.
An understanding of these longer-term risks should inform the development of appropriate journey plans, for example, whether accelerated de-risking is appropriate. You could also consider requesting downside protection from the employer to help manage these risks in the future.
Regardless of your position, challenges of the pandemic, Brexit and particularly the Ukraine conflict have shown us that no journey plan is fool-proof. So, you should think about liquidity, about impacts on the covenant and about cyber-attacks.
As a final word of warning, following a hiatus during the pandemic, more employers are returning cash to shareholders. You should work to ensure the scheme is being treated fairly.