U.K. regulator stresses DB risk management in annual funding statement

Defined benefit plan trustees should have "robust risk management" to prepare for volatility and change, The Pensions Regulator said in its annual funding statement Wednesday.

Factors including high inflation and energy prices, higher interest rates and slower economic growth could impact assets and liabilities and funding needs, the statement from the U.K. regulator said. The conflict in Ukraine could present further risks and "the longer-term impact on funding positions could be significant," it said.

Another uncertainty is how COVID-19 will change mortality trends. "These risks should be managed within an integrated risk framework and an open dialogue with employers when assessing a scheme's covenant," the statement said.

The covenant is the employer's legal obligation and financial ability to support the defined benefit plan going forward.

While pension funding levels have benefited from favorable investment conditions over the past three years, "now is not the time for complacency," David Fairs, executive director of regulatory policy for TPR, said in a news release.

The regulator has seen more employers returning cash to shareholders through dividends and share buybacks, and trustees should "consider whether their scheme is being treated fairly compared to other stakeholders," the release said. TPR recommends that trustees have employers provide financial projections and business plans, and that trustees "regularly monitor actual versus forecast performance."

The emphasis on strong governance and integrated risk management is important, said Charles Cowling, chief actuary at Mercer, in an emailed statement. "The crucial point is that even the best prepared schemes need to review arrangements and ensure they are still meeting these expectations given the current economic and geopolitical backdrop," he said.

Emily Goodridge, managing director with Cardano Advisory, said in a separate email that some pension funds have fared better than others through the recent integrated risk management shocks noted by TPR, and that has created "an expanding gap between well-funded schemes with a healthy covenant, and those in a weaker position."

The TPR annual funding statement "reminds trustees of the ongoing reliance on covenant up to the long-term funding target and beyond, to the point at which the scheme ultimately winds up. This is a shift of focus for many trustees, who still think of covenant only as a rating," Ms. Goodridge said.

Following changes made in the Pension Schemes Act 2021, DB plan trustees will soon be required to agree with the sponsor on legally binding long-term funding and investment targets, under rules expected to be finalized this fall. "Trustees should consider taking steps now, if they have not done so already," the TPR statement said.

Lynda Whitney, a partner at Aon, said in an interview that this year's statement continues risk management themes raised by TPR in recent years, although "this year the regulator has had to reflect on schemes in very different situations," she said. "We are really waiting for the new funding code (on long-term targets) to show the way forward."