Pensions Regulator sets out its expectations on long-term funding targets for Defined Benefit Schemes

The Pensions Regulator (TPR) has recently published its 2019 Annual Funding Statement, which applies to all trustees and sponsors of occupational defined benefit (DB) schemes. It contains details of TPR’s new expectation for all DB schemes to adopt a long-term funding target (LTFT). The Government’s White Paper of March 2018, ‘Protecting defined benefit pension schemes’, set out its intention to improve trustees’ focus on long-term strategic thinking by introducing a requirement for schemes to have a ‘specific long-term destination’, such as buy-out, consolidation or self-sufficiency, in line with the scheme’s maturity profile.

It is not yet clear whether or when the Government will legislate to introduce this requirement, but implementing TPR’s guidance on LTFTs now should ensure that schemes are ready. TPR has confirmed that it will consult on a new DB funding code later this year which will also focus on improving long-term planning. LTFTs also link in with TPR’s 21st Century Trusteeship programme which requires trustees to have a business plan setting out clear long-term goals and interim objectives, together with details of how these will be met and monitored.

TPR’s Annual Funding Statement notes that the key objective for all schemes is to pay the promised benefits, and that successfully run schemes often have a clear long-term strategy agreed by trustees and employers in order to achieve this goal. This will involve recognising how the balance between investment risk, contributions and covenant support may change over time as the scheme becomes better funded and more mature.

Following a similar approach, TPR now expects all schemes to consider their long-term strategy and to set an LTFT, in consultation with the employer. LTFTs will be specific to each scheme, but TPR gives by way of example an LTFT of reaching a level of funding at maturity which will enable the scheme to reduce its dependence on the employer and then be managed with a higher resilience to investment risks. Trustees and employers will need to be able to demonstrate that their shorter-term investment and funding strategies are aligned with their LTFT by means of journey plans which set out how they will achieve it.

The Funding Statement emphasises the need for trustees to follow a comprehensive approach to Integrated Risk Management, looking at employer covenant, investment risks and scheme funding in the round. For the first time, the Funding Statement covers TPR’s investment strategy expectations and how these should evolve over time. The strategy chosen should reflect scheme maturity and the need for assets to deliver returns over a reducing time period.

Some schemes may find the process of incorporating an LTFT challenging, and following TPR’s expectations will reduce flexibility. It will be essential to consult with sponsors and advisers in good time to ensure that the target is appropriate and specific to the scheme’s individual circumstances. TPR also stresses the need to ensure that trustees have proper evidence for their decisions. However, for many schemes, improving long-term strategy will be a natural progression which will undoubtedly help deliver benefits to members. Although the LTFT policy does not yet have legal force, TPR expects all employers and trustees to start focussing on long-term risks and the detailed requirements set out in this Funding Statement. It is particularly important that schemes which are engaging in Scheme Funding Valuations now, or in the near future, take expert advice on how to set an LTFT and ensure that their shorter-term investment strategy is aligned with it.