Pensions managers and trustees should now be embarking on a review of their long-term strategies for maintaining their schemes after the Pensions Regulator (TPR) recently issued its Annual Funding Statement 2023 (AFS).

The statement carried a positive message about overall funding levels but also struck a cautious note about the variations between schemes and the need to review targets due to the uncertainty of future funding challenges.

The AFS is primarily for trustees and sponsoring employers of occupational defined benefit (DB) pension schemes and sets out specific guidance on valuations under current conditions, for schemes with valuation dates between 22 September 2022 and 21 September 2023.

It also applies to schemes undergoing significant changes that require a review of their funding and risk strategies and schemes that may be receiving requests for reduced contributions, amendments to contingent asset arrangements, and proposals for other uses of surplus.

In this latest AFS, TPR noted that most schemes had improved funding levels “through a combination of investment out-performance from return-seeking assets and a significant rise in gilt yields”, adding that around a quarter were expected to have exceeded buyout funding levels.

TPR said trustees would now need to consider if their long-term targets remained appropriate, whether buyout was viable, or to examine other end game options.

If funding levels have improved significantly, for example because of an unhedged position against interest rates, TPR said that trustees should consider whether continuing with the existing strategy and level of risk is in the best financial interests of their members and beneficiaries.

If not, TPR said trustees should seek to apply some of the funding gains towards a less risky funding and investment strategy designed for a smoother and more predictable transition to the long-term target.

Funding levels would have fallen for a small number of schemes, according to TPR, including some schemes invested in pooled funds and others unable to meet the necessary liability driven investment (LDI) collateral calls when gilt yields spiked in 2022 and they would need to reset their funding and investment strategies to reach long-term targets.

TPR also said that trustees should review their operational governance procedures and should not be complacent about covenant assessment and the support available from the employer covenant for the level of risk that trustees decide to build into their scheme’s funding and investment strategies.

Summarising the report, Louise Davey, TPR’s Director of Regulatory Policy, Analysis and Advice said:

“For the first time in many years, our AFS highlights how most DB pension schemes are ahead of their funding target.

“Long-term targets, and associated funding and investment strategies set in an era of low interest rates, should be reviewed. Despite improved funding levels, uncertainty remains, and economic challenges persist and so schemes should not be complacent about covenant assessments.

“The level of risk that trustees decide to build into their scheme’s funding and investment strategies should align with the level of support the employer can provide.”

MHM’s view

TPR has issued firm and clear advice in its 2023 AFS, with which we fully concur. We consistently advise our clients who are employers and trustees of company-sponsored pension schemes to review and reconsider their planned strategy as a matter of course. Carrying out such a review is a good opportunity to consider and prepare for the arrival of the new funding regime, which is now expected to apply from April 2024.

We would echo a small but we think significant point, in the AFS, that part of any strategic review should also ensure that “effective information sharing protocols are adhered to”. In other words, make sure that everybody who needs to know – especially members – is told about future plans and proposals.

To discuss your scheme funding and the implications from the regulator’s latest update, please contact Steve Button on 07952 035538 or by email to steve.button@mhmtrustees.co.uk

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