2020 will definitely see progress being made towards a new funding code for defined benefit schemes. The Pensions Regulator has recently made clear that, despite numerous delays to date, consultation on the code will likely begin in January of next year.
Armed with new powers, the new code and its “clear, quicker, tougher” approach, the Regulator’s presence will loom large for many trustees. So, how then, will trustees keep the regulatory “wolf” from the door.
Here are some of my top tips and recent experiences.
1. Recognise and document your long-term objective
For all but the very largest of closed schemes, the end-point will be some form of insurance arrangement (consolidate or buyout). It is therefore important, as schemes mature, to put a greater focus on this end-point and estimate how long it will take to get there. This will likely mean contributions continuing even after the scheme has a surplus on the ongoing (technical provisions) basis.
So, trustees should get to know how long the path to buyout is and plan out their strategy to get there (including any investment de-risking along the way). Developing contingency plans with agreed actions for good and bad outcomes will also be very worthwhile.
2. Use an Integrated Risk Management approach to manage and monitor covenant, funding and investment.
Most schemes regularly review funding levels, investment performance and (perhaps less frequently) sponsor covenant. Often, however, these three strands are looked at in insolation and not part of a single “package”. To meet long-terms objectives, it is important to manage all of these risks together.
I have found it helpful to collate some key metrics for each area into a single one-page dashboard. This allows trustees to review overall progress and importantly review the need to take any action. Funding and investment metrics should be readily available, and it is worth engaging with the sponsor to get regular updates on key metrics in their business – they will be monitoring these so it should be easy to get hold of them to help trustees do the same.
3. Get-together more often
For me, the days of a “once a year” meeting and nothing much in between are gone. With volatile financial markets and the potential for fast-changing outlooks for sponsor covenants, schemes are “businesses” which need more regular attention.
In my experience, most scheme trustees would now expect to arrange some sort of meeting on at least a quarterly basis to review investment performance, funding progression and administration matters. These meetings need not be long and, with improving technology, need not be face-to-face either. Agendas can also be structured to allow advisers/providers to attend in part.
4. Make sure the basics are done
It sounds obvious, and maybe it is, but getting the basics right is important. Trustees should be making sure that:
- Data is clean, complete and up-to-date.
- Conflicts (and potential conflicts) are documented and discussed.
- Scheme documentation is complete and consolidated.
- Trustee Knowledge and Understanding is up to date, documented and future training is scheduled in.
- Investment compliance is up to date (ESG, Investment Objectives documented).
- Scheme business plans and risk registers are “live” documents, not just pages that gather dust between meetings.
- Future project work is factored in e.g. GMP equalisation.
- Be up-front if your scheme doesn’t fit with the ideal expectations of the Regulator
Back in the day, a recovery plan of over 10 years was a warning “flag” that often triggered some regulatory scrutiny. That was all washed away with the more employer friendly “sustainable growth objective”. The new funding code is likely to view 7 years as the benchmark recovery period. Indeed, I have already seen the Regulator gather information for schemes where the current recovery period is above that threshold.
However, it is also fair to say that many schemes, for many reasons, will have longer recovery plans that the Regulator will now view as appropriate e.g. charities, schemes with weaker sponsors.
Here, it is important for trustees to examine and clearly document the rationale for a longer recovery period. If affordability is shown to be constrained, it is likely that a longer recovery period should go hand in hand with a more cautious investment strategy. Taking risk on your sponsor (as demonstrated by a longer plan) should not be compounded by a higher risk investment strategy that the sponsor cannot afford to underwrite.
For me, a well set out and justifiable longer recovery plan with a cautious investment strategy is far better than over-optimistic actuarial basis and a “wing and a prayer” investment strategy which give the misleading impression of achievability.