The Pensions Regulator

Scheme funding – how the regulator intends to regulateArticles archive

Scheme funding - how the regulator intends to regulate

Executive summary

In May 2006, the Pensions Regulator published its statement on how it will regulate scheme funding for defined benefit (DB) schemes, following an extensive period of consultation. Charlie Massey, the regulator's Strategic Development Director, explains what this means for trustees.

Introduction

Under the 2004 Pensions Act, trustees of DB schemes are responsible for decisions on scheme funding and our code of practice on scheme funding, published in February 2006, provides guidance to trustees in this area. Our recent statement complements the code of practice, setting out how we intend to regulate the funding of defined benefits.

Our focus

Our intention is to focus our attention and resources on those schemes at greatest risk. To help us to identify these schemes, out of approximately 10,000 DB schemes under our supervision, we have devised triggers that relate to the scheme's technical provisions and recovery plan. During the consultation period, these triggers were discussed and suggestions for improvement were given to us; we have taken these on board and made a number of changes to our proposals as a result. We have, in particular, made it clear that trustees should not compromise technical provisions in the interests of achieving a shorter recovery plan.

Triggers are not targets

As our statement makes clear, triggers are not targets, and should not be viewed as such. They are simply one of the tools in our regulatory toolkit. We do believe, however, that they will enable us to prioritise and manage our work, and will help us to focus on those schemes genuinely at risk.

Triggers - technical provisions

Our first and most important trigger concerns the level at which trustees have set the technical provisions. Originally, we proposed to link this trigger to a percentage of the scheme's solvency measure (the 'buy-out' value). However, having listened to the level of concern expressed about the practicality or desirability of using such a trigger during the consultation process, we have amended our approach.

This trigger will, as we originally proposed, be based on a comparison of the technical provisions against a range between two liability values - section 179 liability and FRS17 liability (or IAS19 liability where available), irrespective of which of the two is higher. From summer 2006 we will be collecting information on the valuation results needed under FRS17 and IAS19 through scheme returns. We will apply a sense check to these figures, however, using other available information including buy-out valuations.

Triggers - recovery plans

The majority of DB schemes are likely to be in deficit against technical provisions calculated under the new framework and will have to prepare a recovery plan. We need, therefore, to be able to identify which of these schemes are likely to be most at risk, bearing in mind that deficits should be eliminated as quickly as is reasonably affordable for sponsoring employers. Although other suggestions for the appropriate length of time for a recovery plan were made during the consultation process, we still believe that ten years is an appropriate period. We will not focus attention on schemes where the recovery plan is less than ten years unless we feel that the assumptions on which the plan is based are inappropriate or we have concerns about the strength of the employer's covenant.

Where trustees have specified a prudent discount rate for technical provisions, they do not have to adopt the same assumptions for their investment strategy, providing that they are comfortable with the employer's covenant and have allowed for the risk that the employer may not be able to cope with any adverse circumstances. We have added a trigger to help us identify cases where the return assumed may be inappropriate.

Trustees must satisfy themselves of the willingness and ability of the employer to meet its financial responsibilities to the scheme. They will undoubtedly need to seek out information about the employer from a variety of sources, both internal and external. We expect trustees to negotiate assertively with the employer in the best interests of all the members of the scheme, and we will assist with these negotiations if trustees are unable to come to an agreement with the employer on the recovery plan. In such situations we will be sensitive to the issue of affordability for the employer. Our position is that a healthy ongoing business will be in the best position to ensure its pension obligations are met in the long term.

Help for trustees

We recognise that there may be trustees who are not used to engaging with the employer in this way. To help with this, and with other duties in respect of the trustee knowledge and understanding requirements introduced under the Pensions Act 2004, we are developing the Trustee Toolkit, a free e-learning programme for trustees. The introductory modules are already available at www. trusteetoolkit.com, with further material on scheme funding to follow at the end of July.

Additionally our website, http://www.thepensionsregulator.gov.uk/, contains a section dedicated to scheme funding, which not only includes the code of practice and the statement, but also has examples of funding documents designed to assist trustees and their advisers in meeting the challenges and responsibilities presented by the new scheme funding requirements.

Published: PMI News, May 2006