Articles - Five tips for success on 2022 funding valuations

 By Alistair Russell-Smith, Partner & Head of Corporate DB,  Andrew Udale-Smith, Partner,  Leonard Bowman, Partner & Head of Corporate DB Endgame Strategy and Sachin Patel, Actuary from Hymans Robertson

 The key emphasis for trustees is on understanding how their scheme’s sponsor is coping, noting some businesses and sectors will be impacted more significantly by recent events. It is therefore vital that companies are proactive in briefing the trustees on covenant considerations.

 The Pensions Regulator has renewed its drive for an equitable treatment of pension schemes relative to shareholders. In its 2022 AFS, shareholder distributions are viewed as inconsistent with reducing (or deferrals of) contributions and TPR indicates they should only exceed deficit recovery contributions if the pension scheme has a strong funding target and a relatively short recovery plan (under 5 years is given as an example). Where schemes have recently achieved full funding, or are close, then the focus should be on developing long-term plans and managing ongoing risks through contingent funding plans (e.g. to switch contributions back on if funding deteriorates).

 With that backdrop, here are 5 tips that could help achieve a smooth funding discussion with your trustees.

 3. Look at non-cash solutions carefully
 Some non-cash solutions have been around for a number of years, but this term now covers a whole range of options, including charges over company assets, inter-company guarantees, letters of credit, escrow accounts and more esoteric options like special purpose vehicles. They can be used to support longer recovery periods and the taking of higher levels of investment risk, whilst also helping to reduce the risk of the scheme generating a surplus that the company cannot get back.

 Some companies have rejected the concept of legally enforceable security in the past, for example not being willing to offer a parental guarantee because that is not consistent with corporate policies. However, it is worth investigating the full range of options, especially as some will not have been considered previously.

 And, as our recent modelling has shown, the economic value of offering alternative security can be compelling. For many companies this will become even more true as they focus on developing a long term strategy and thinking through the implications of the new funding code.

 4. Be clear on the actuarial assumptions that are likely to require most discussion

 The actuarial assumptions that we expect will typically require most attention for 2022 valuations are as follows:

 Inflation assumptions – with RPI and CPIH converging from 2030, market-implied RPI appears to be overstated, with investors paying a premium for inflation protection. The level of the CPI wedge and allowance for any inflation risk premium need careful thought for 2022 valuations.

 Life expectancy – the longer term impacts of Covid-19 on longevity remain unclear, meaning the life expectancy assumption needs particular care. However, there is a growing body of opinion that the pandemic will have a negative impact on future mortality improvements. The Regulator has softened its stance in this year’s AFS, by indicating it will accept liability reductions of up to 2% relative to pre-Covid expectations if trustees agree these are appropriate and justified

 Expense reserves – as funding levels improve, it is worth reviewing the funding of expenses. It may be possible to fund expenses out of scheme assets rather than having the company pay them.

 5. Get the company governance right
 The Pensions Act 2021 creates a raft of new governance challenges for companies, and new, more onerous ‘notifiable events’ reporting requirements are expected to apply to companies from April 2022. Companies should therefore review their pension governance framework. Setting a long-term strategy, considering the role of non-cash solutions, reflecting new notifiable events requirements, working through the use of member options and risk transfer……. these are conversations which are most easily taken forward within an effective governance structure. For more on this, please see our publication on effective corporate governance.

 As we emerge from the pandemic, companies with 2022 valuations face both significant challenges and opportunities. As always, the key is early planning and being on the front foot.