Scheme Funding - the focus may have changed but the principles remain the same

As a consequence of the Covid-19 pandemic, Britain’s economy will shrink by 14% this year. Currently, six million workers are on furlough and unemployment is predicted to rise to 9%. We are facing the worst recession since 1706 according to many reports I’ve read. Against this backdrop, the Annual Funding Statement (AFS) published by The Pensions Regulator on 30 April (together with previous guidance on easements) is very welcome to help trustees navigate this unprecedented situation.

However, the AFS isn’t a major overhaul of previous guidance. Clearly there is much greater emphasis on employer sustainability, but has it not always been in a scheme’s best interest to have the support of a healthy employer? Similarly, to say there is a renewed focus on affordability isn’t quite right. Employer affordability has underpinned the pace of scheme funding for many years.

What is different in the short term (and probably for longer based on the distress evident in many corporates) is that the level of affordability will be diminished for a large number of employers and there is limited visibility at present on when that situation will improve.

The Regulator is sympathetic to the situation trustees will face when negotiating a Tranche 15 valuation. It acknowledges that it is difficult to agree a recovery plan when affordability is hard to judge, and directs trustees to:

1. Take your time – delay valuation and recovery plan discussions until the situation becomes clearer. This does not, however, mean an extension to the 15-month process for T15 valuations.
2. Be more creative – consider contributions that step up over time, to reflect the short-term challenges facing the corporate, along with mechanisms to capture upsides, e.g. profit sharing agreements; and
3. Ensure the scheme is treated equitably – whilst funding to the scheme is constrained there should be no covenant leakage such as dividends, changes to security structures etc. that are detrimental to the scheme.

It is clear that expectations will have to change on recovery plan lengths as the “perfect storm” of higher deficits and constrained affordability collide. Similarly, it is hard to see how the now delayed Funding Consultation with its “fast track” or “bespoke” methodology will work as originally envisaged.

The Regulator is, however, demonstrating that its core scheme funding principles of employer covenant, affordability and equitability can be shaped to the economic circumstances of the day.