On 5 March 2019 TPR published its Annual Funding Statement. Previous statements have tended to be more clarifications of existing policy and adaptions of policies to current conditions. It is fair to say that this year’s statement is likely to be far more impactful and gives an insight into the Regulator’s future direction for regulating defined benefit schemes. We cover the key concepts below.
Long-term funding targets
Since the current scheme-specific funding regime came into being in 2005, the market has grown used to targeting Technical Provisions set according to the strength of the employer’s covenant.
The statement makes it clear the Regulator is now looking at scheme security beyond Technical Provisions and reveals it expects trustees and employers to agree a next stage target to reduce a scheme’s dependency on its employer. By the time a scheme has reached a level of maturity (undefined) TPR expects it to be fully funded on this target basis with the investment risk to have been largely managed out.
While many schemes are already targeting self-sufficiency or low-dependency (on the covenant) bases this is the first time TPR has publicly revealed LTFTs as an expectation across the sector.
Recovery plan length
Unlike LTFTs which have their own section in the statement, TPR’s expectations on recovery plan length are spread throughout the document. Nonetheless, this is the clearest declaration on recovery periods since TPR moved away from the 10 year trigger for regulatory intervention.
As part of “balancing risks” when managing schemes, TPR’s approach to recovery periods will be guided by covenant strength and maturity. The median recovery period is stated as 7 years and the Regulator expects “schemes with strong covenants should generally have recovery plan lengths which are significantly shorter than this”.
TPR clarifies later that for a relatively mature scheme with a strong a recovery plan in excess of 7 years will be too long.
In our view it is likely that the stated median recovery plan of 7 years will become the new yardstick for funding negotiations. For schemes with strong covenants recovery plans will need to be no longer, and most likely shorter, than this. The position is less clear for schemes with weaker covenants but this is not unexpected given funding plans will be driven by affordability and equitable treatment (see below).
Although this is very much not a new theme, in light of the stated recovery plan expectations further clarification has been provided.
- Where shareholder distributions (including dividends) exceed deficit payments TPR expects a strong funding target and “relatively short” recovery plans
- If the employer is tending to weak or weak, TPR expects deficit payments should be larger than shareholder distributions unless the recovery plan is short and the funding target is strong.
- If the employer is weak and unable to support the scheme, TPR expects the payment of shareholder distributions to have ceased.
The full statement can be found here.
Argyll comment: We have not seen firm guidance from TPR around deficit recovery periods since it abandoned the 10 year trigger for regulatory intervention. Funding discussions are very likely to focus on 7 years for stronger covenants with immediate effect. Beyond Technical Provisions however, much of the detail in terms of pace of achieving a LTFT is absent. It is likely therefore that TPR will need to set out its thoughts in greater detail in a new Defined Benefit Funding Code of Practice.