DB funding and riding out the current storms

With the continuing challenges posed by the COVID-19 pandemic to commercial activity and profit-forecasting, as well as uncertainties to overcome as the Trade and Cooperation Agreement of 24 December 2020 beds in, trustees and sponsors of defined benefit (DB) schemes will also have to grapple with new funding requirements under the Pension Schemes Act 2021 and the Pensions Regulator (TPR)’s new code of practice on funding, both expected this year. Throw into the mix emerging issues in the global trade market regarding the US versus China, with Russia also in the frame, and the waters ahead do look choppy.

What does this all mean for DB schemes, their trustees and sponsors? This is perhaps hard to predict and will, of course, vary from scheme to scheme depending on factors like covenant, maturity and membership profiles. However, what we think is clear is that trustees and sponsors can start now to take a proactive approach to funding and their schemes’ next valuations.

Although the detail is yet to be finalised, TPR’s new funding framework, offering “bespoke” or “fast track” options, should prompt trustees to early engagement and to initiate important “journey-planning” discussions with sponsors when embarking on the next valuation process. It is expected that schemes will start to benchmark against the more conservative fast track approach and long-term objectives will become more important than before. However, that is not to say that TPR does not consider strain on the employer to be important: on the contrary, TPR has emphasised that affordability remains a key aspect of the covenant assessment.

For evaluating the employer covenant and likely short- to medium-term impact of shocks and external events, trustees should undertake risk planning for worst and best case scenarios in relation to global trade, the evolution of the UK/EU trade position post-Brexit and any upsurge of COVID-19. This would ensure a swift reaction to any material change in asset value, employer strength or investment returns. Trustees and sponsors can, nonetheless, take comfort in TPR recognising that it will take years for employers to become financially stable after the pandemic and parties should therefore be open to non-cash and/or contingent support as viable funding options.

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