An employer perspective
Many employers will be in the process of consulting on 31 March 2020 actuarial valuations.
As part of the valuation process the Trustees must consult with the employer. The Trustees will engage with the employer in relation to the assumptions to use in the valuation, and on the contributions to be agreed as part of any Recovery Plan.
The current climate is likely to impact on these discussions in a number of areas:
- The funding position given market conditions as at 31 March 2020;
- The covenant of the Employer and short-term cashflow.
Funding positions as at 31 March 2020 are likely to be variable.
Interest rates have fallen by around 1% p.a. since 31 March 2017 which will increase liabilities by around 20% depending on the maturity of the scheme. Inflation has also fallen by around 0.6% p.a. which will reduce liabilities, all other things being equal. The impact will depend on the level of inflation linked benefits in the scheme. Considering both effects, schemes are likely to see increased liabilities, with schemes with fixed benefits impacted more.
The deficit position will also be impacted by how scheme assets have performed. The position will be highly dependent on the individual investments held. Growth assets may be broadly neutral – performing well until early 2020 then falling sharply due to Covid-19. Bonds will have performed well – any schemes with hedging in place will have seen the value of this in recent months.
Schemes may have also seen positive experience since the previous valuation. Inflation may well have been lower than assumed over the period. The impact of member events, such as taking a Pension Commencement Lump Sum on retirement, will have more of an impact due to the low interest rate environment.
Overall, on a like for like basis with the previous valuation, deficits are likely to have increased for schemes with fixed benefits and no hedging in place, and decreased for schemes with inflation linked benefits and high levels of hedging.
When considering assumption setting at 31 March 2020, we would expect to see updated mortality assumptions based on the most recently available information. We would also encourage consideration of future expected returns and how these may have changed given the current environment – for example has the equity risk premium increased and if so should a like-for-like ‘gilts plus’ basis have a higher outperformance assumption? It is important that prudence is not compounded. We would also look for recovery plans to allow for best-estimate returns on scheme assets where this is appropriate.
The Pensions Regulator generally expects to see a similar level of contributions agreed as in previous years, with good reasoning if contributions have to reduce. The best support for a pension scheme is a strong employer. Employers can negotiate on the level and timing of contributions payable and, as a result of Covid-19, can request a deferral of contributions to ensure the ongoing viability of the business.
Trustees are likely to request cashflow forecasts and management accounts to show the need for any reduction/deferral. Employers should be aware that less contributions now means more contributions later.
What should employers consider when agreeing valuations?
It is important that employers take their own professional advice, in particular in relation to setting the assumptions. There is a range of acceptable assumptions and ensuring these are set at the appropriate level should help with affordability.
It is important that as well as agreeing the valuation, employers consider a long-term view – what is the ultimate goal and what is the plan to get there? Advisers can help with strategy and journey plans and give employers some direction and control over the pension scheme.
There is 15 months to complete the valuation process. We would expect that the majority of valuations are completed well within this window.