The 2025 valuation cycle is here — and it’s unlike anything before it. First Actuarial’s Mark Frost identifies the key issues and argues that early, joined-up conversations will be essential – this is not business as usual.
For Defined Benefit schemes undertaking their first actuarial valuation under The Pensions Regulator’s (TPR’s) new funding code, the new regime brings a fundamental shift – covenant strength, investment risk and funding decisions are now hardwired together. Geopolitical and economic uncertainties affect each of these areas.
Trustees can defuse the potential shocks by starting conversations early in these areas:
⚡1 | Covenant – A deeper, earlier conversation
Covenant is no longer just a risk-rating, it is a fundamental driver of the valuation outcome. Trustees must assess:
- The reliability period – How long will the employer be expected to generate sufficient cash to support investment risk? This assessment needs to be documented. TPR expects it to be no longer than 6 years
- The covenant longevity period – A broader assessment of long-term financial support. TPR expects this to be no longer than 10 years
Together, the reliability period and the covenant longevity period will drive discussions on investment strategy and recovery plans. Trustees will need to decide whether they have the expertise and impartiality to look at this themselves or engage an independent professional, and start this work early.
In a volatile global environment, covenant strength may shift rapidly. Rising interest rates, supply chain disruptions, the potential hike in US tariffs, wars affecting oil and gas supplies and further potential for inflation, could all affect employer cashflows and business resilience. This is before even considering climate change impacts. Trustees should factor the macroeconomic and geopolitical risks into their covenant assessments – especially for employers with international exposure or sensitive import/export positions.
While independent covenant advice is not always required, it may be essential for more complex corporate structures.
⚡ 2 | Significant maturity
Discussions on investment strategy and recovery plans will also be driven by how mature the Scheme is (i.e. when a large proportion of the members are pensioners). TPR has defined a numerical measure of this, called significant maturity, by when the Scheme should be well funded and in a very low risk position. Your actuary will need to estimate when the Scheme is expected to reach significant maturity, at an early stage in the valuation process, and trustees will need to design their strategies around that date.
For open schemes, the time to get to significant maturity is further away and so there are some additional flexibilities, but TPR still encourages trustees to aim for that low risk position.
⚡ 3 | Long-term objective
Trustees and employers will also need to discuss their plan for providing benefits after significant maturity is reached. This is the long-term objective (LTO) which trustees and employers must agree.
The two principal LTO options currently available are:
- Run-on – Offering the possibility of better outcomes for both the employer and members
- Buy-out – Locking down members’ benefits for maximum security
Trustees need to consider any unintended consequences of committing to an eventual buy-out at this stage as it could limit strategic flexibility. It may be easier to raise ambitions later, rather than walk back from a publicly stated intention to buy-out, unless you are already committed to it.
Importantly, the Government has proposed new rules that would make it easier for employers to access surplus. This could shift the balance in favour of run-on, allowing schemes to deliver long-term security for members while offering a potential return for sponsors. Trustees and employers should factor this evolving policy landscape into their long-term planning.
⚡ 4 | Investment strategy under pressure
The Pensions Regulator (TPR) expects trustees to target a low-risk investment allocation, consistent with their LTO and covenant timeline. This needs to be considered once the LTO has been agreed.
Armed with details of the reliability period and the time to significant maturity, a scheme’s investment advisers will be able to advise on a suitable journey plan to get to the target low-dependency position before the shortest of those timeframes is exhausted. TPR expects stress testing of this strategy to be carried out and checked against the employer’s ability to support the investment risks.
Whether the trustees actually invest in accordance with this journey plan strategy is a different question and may be influenced by:
- any surplus assets
- affordability of the resulting recovery plan contributions
- supportability of investment risk (perhaps allowing for contingent assets)
⚡ 5 | Balancing prudence with flexibility
When it comes to actuarial assumptions, the key is to strike the right balance between prudence and flexibility. Too much prudence could lock in over-cautious funding and restrict investment strategy. But too little invites regulatory risk and may leave members unprotected.
There is a requirement for actuaries to advise on low-dependency assumptions as well as those needed for setting technical provisions (if different). Many schemes will have looked at this already, as TPR has been open about its intended approach in recent years.
One annoying possibility is that any changes to actuarial assumptions resulting from covenant and investment analyses could have a knock-on impact on the time to reach significant maturity. And that could mean having to revisit previous work! This is an electrical circuit that trustees will have to close.
⚡ 6 | Future expenses
Actuarial assumptions about expenses may be the next shock in store. TPR encourages trustees to consider adding all future expected expenses (at least after reaching significant maturity, if not before) to the balance sheet now.
This incurs the risk of creating a deficit, even in well-funded schemes, or making an existing deficit worse. Having to pre-fund long-term future expenses may have a material impact on short-term funding requirements.
This may not go down well with employers and is likely to be a major discussion point. Some employers – particularly in cost-sensitive settings – may want to revisit the precise wording of the scheme’s rules on payment of expenses, as this can have an impact on the approach taken.
⚡ 7 | Valuation
This valuation cycle demands a more integrated approach to funding decisions than in previous valuations, with earlier focus on:
- Investment stress testing
- Affordability of contributions
- Employer support for investment risk
All of this covenant and investment work provides the electrical currency that will drive the actuarial valuation and its outcomes. Compare and contrast with all the hours spent discussing actuarial assumptions in the past.
The funding code uses the phrase ‘proportionate approach’ at various points, but it remains to be seen how flexible TPR is willing to be when it comes to covenant analysis, investment risks and expense reserves.
⚡ 8 | Statement of strategy – a paperwork shock
The final shock to the system is the documentation (proportionality is in short supply here).
At a time when government is pushing regulators to cut red tape, we now have a material extra burden called the statement of strategy (SOS), which needs to be produced and signed off by the chair of trustees.
Do not underestimate the volume of work required to complete the SOS. We advise schemes to review the template early, otherwise, you may get to the end of the actuarial valuation exercise and realise that significant rework is required.
This requirement alone may leave trustees and employers shouting “SOS” in its original sense!
⚠️ Final thought
Current valuations will be unlike any previous cycle. With new regulatory expectations and market risks in play, preparation and early coordination between advisers and employers will be essential. Schemes that treat this as just another valuation may be in for a real shock.
Mark Frost
First Actuarial LLP
The Colmore Building
20 Colmore Circus, Queensway
Birmingham, B4 6AT
T: 0121 285 4090
E: mark.frost@firstactuarial.co.uk W: www.firstactuarial.co.uk