Pensions Arena

July 2020

Governance actions

Covid-19 “normal”

Operational

 

 

Corporate actions

Covenant funding

Investment

DC

Pension developments

Investment pathways

AE and Covid-19

Annual funding statement

GMP final data cuts

Corporate Insolvency/Governance Bill

DB superfunds interim guidance

Value for money consultation

PPF age discrimination

Pension Schemes Bill

Company news

De-risking

Funding

Plan design

Article

Emerging from lockdown

As we keep hearing, we are living in unprecedented times. However, as we turn our attention to the future, what does the “new normal” mean for defined benefit pension schemes?

Once the initial crisis management has passed, companies will have a myriad of different issues to address. Unfortunately, one of these is likely to involve the funding, investment and governance of their defined benefit (DB) scheme. It may be tempting to ignore the DB scheme, at least for 6 months, because of its long-term nature. But that risks exposing the company to some significant challenges in terms of both company pension costs and senior management time later in 2020.

In this article, which is a summary of our recent Pensions Perspective, we consider the most common pension issues that companies are facing and how best to ensure that the company approaches these on the front foot.

Covenant

Many companies will have been severely impacted by the lockdown. Even those businesses that have not will be facing significant uncertainty as a result of Covid-19’s longer term damage to the economy.

Some companies have requested and achieved a temporary deferral of deficit contributions, which they justified on the basis of short-term financial pressures due to the lockdown. On the face of it, this was an entirely sensible step to take and within acceptable regulatory guidance, if properly presented. However, we have seen evidence that, even though trustees have largely agreed to these deferrals, this has come at the cost of unsettling them about the strength of the sponsor, which could have unexpected longer term consequences.

For a number of companies there is no simple way to allay trustee concerns on covenant, other than to stick with best practice, specifically:

  • share as much detail as possible
  • be open about the challenges and the uncertainty in any projections
  • recognise the need to treat the scheme equitably with other stakeholders, i.e. lenders and shareholders.

In addition to the quality of the information provided, the frequency of updates and access to senior management are also key factors in maintaining trust with the trustees.

Investment strategy

The impact on investment markets has been volatile and complex since the start of the crisis, and that remains so. The impact on schemes’ funding largely falls into two camps:

  • well-funded schemes, with significant interest rate hedging, will not have seen a material worsening (and may have even seen a small improvement)
  • schemes with sizeable funding deficits, and lower levels of interest rate hedging, will in general have experienced a significant reduction in funding levels.

Whichever camp a scheme may be in, everyone is grappling to understand the medium and longer term economic consequences of Covid-19. This, of course, links directly back to the covenant discussion. Not only is there a big question mark over the future investment landscape, but also over whether the sponsor’s covenant still supports the pre-Covid level of investment risk taken by the scheme.

Funding

For companies facing a deterioration in their covenant or significant falls in their scheme’s funding levels, trustees will want to engage with the company to discuss some or all of the following:

  • an increase in cash contributions
  • a lower-risk funding target
  • other forms of security
  • negative pledges, for example restrictions on dividend policy and a block on additional security being granted to lenders.

Whilst pensions may be the last type of discussion the company wants to take part in, given everything else happening to the business, in our experience early and active engagement with the trustees will still be the best policy.

Pensions Regulator perspective

The Covid-19 crisis has created significant challenges for TPR. The Regulator is clearly trying to steer a course between its competing objectives to not impede the recovery of companies, whilst at the same time pushing sponsors to treat the funding of their schemes more equitably when compared with other key stakeholders. We would summarise this stance as giving trustees and sponsors some short-term latitude in managing down pension contributions, but not at the expense of long-term funding and risk management.

Insurer pricing

For schemes which had already hedged almost all of their interest rate and inflation risk relative to gilts and are already included within insurers’ pipelines, the terms which insurers may offer over the second-half of 2020 could prove even more attractive than those prior to the Covid-19 pandemic (at least for pensions in payment). What this means is that schemes which were targeting a significant insurer transaction over the next few years should be looking closely at current pricing and considering whether there is an opportunity to accelerate their plans.

Member options

Member exercises, such as encouraging individual member transfers or pension increase exchange, have proved to be a powerful tool in helping reduce a sponsor’s risks and liabilities. Logically, this should be even more the case following Covid-19. However, both the FCA and TPR are concerned about the options made available to members and whether their decision-making is based on sound advice and principles. This is particularly true for members choosing to transfer out of a DB scheme to a DC arrangement.

The last word

Many companies will be facing their most challenging time in living memory and the last thing senior management may want to do is focus on pensions. Unfortunately, not doing so could prove very costly. You need to approach pension funding on the front foot. Then, with some careful planning and meaningful dialogue with the trustees, it should be possible to navigate a route through the pension challenges that does not derail the company’s recovery plans. For more details about how bac can help you successfully tackle your DB pension issues as you emerge from lockdown, please contact us.

Dashboard

Investment returns by asset class

Investment yields

Annual rate of inflation (%)

30/06/2019 30/09/2019 31/12/2019 31/03/2020 30/06/2020
Expected RPI inflation over 20 years
3.55%
3.46%
3.36%
3.00%
3.23%
Index-linked gilts
-1.90%
-2.21%
-1.85%
-1.93%
-2.39%
Fixed interest gilts
1.44%
0.95%
1.30%
0.83%
0.64%
Corporate bonds
2.25%
1.81%
2.00%
2.31%
1.46%

Investment yields

30/06/19 30/09/19 31/12/19 31/03/20 30/06/20
Expected RPI inflation over 20 years
3.55%
3.46%
3.36%
3.00%
3.23%
Index-linked gilts
-1.90%
-2.21%
-1.85%
-1.93%
-2.39%
Fixed interest gilts
1.44%
0.95%
1.30%
0.83%
0.64%
Corporate bonds
2.25%
1.81%
2.00%
2.31%
1.46%
  • 30/06/19    ~    3.55%
  • 30/09/19    ~    3.46%
  • 31/12/19    ~    3.36%
  • 31/03/20    ~    3.00 %
  • 30/06/20    ~    3.23%
  • 30/06/19    ~    -1.90%
  • 30/09/19    ~    -2.21%
  • 31/12/19    ~    -1.85%
  • 31/03/20    ~    -1.93%
  • 30/06/20    ~    -2.39%
  • 30/06/19    ~    1.44%
  • 30/09/19    ~    0.95%
  • 31/12/19    ~    1.30%
  • 31/03/20    ~    0.83%
  • 30/06/20    ~    0.64%
  • 30/06/19    ~    2.25%
  • 30/09/19    ~    1.81%
  • 31/12/19    ~    2.00%
  • 31/03/20    ~    2.31%
  • 30/06/20    ~    1.46%

Annual rate of inflation (%)

Sources for market indices​

  • UK equities: FTSE Actuaries All-Share Index
  • Global equities: FTSE All-World Index (Large/Mid Cap) – in sterling
  • Index-linked gilts: FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
  • Fixed interest gilts: FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
  • Corporate bonds: iBoxx over 15 years AA corporate bond index
  • Expected RPI inflation over 20 years: Bank of England RPI implied inflation spot curve at 20 years (force of interest)
UK equities
FTSE Actuaries All-Share Index
Global equities
FTSE All-World Index (Large/Mid Cap) - in sterling
Index-linked gilts
FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
Fixed interest gilts
FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
Corporate bonds
iBoxx over 15 year AA corporate bond index
Expected RPI inflation over 20 years
Bank of England RPI implied inflation spot curve at 20 years (force of interest)

Almanac

Governance actions

Covid-19 “normal”

  • Are the trustees working effectively under the current stressed conditions?
  • Will the operational measures taken since mid-March continue to be effective over a longer timeframe, in particular the approach for meetings and for ensuring timely delivery of actions between meetings?
  • Do the trustees have a good understanding of how the company’s covenant is holding up following the end of lockdown and do they receive regular updates from senior management?
  • Over this period, has the scheme’s approach to IRM been effective and have your risk registers worked? Or does the scheme’s risk framework require a fundamental reset?
  • Have you identified any key person risks and taken appropriate action to mitigate them?

Operational

  • Have furlough and other corporate cost control measures meant a reduction in the scheme’s resources and, if so, has this affected delivery?
  • Trustees need to ensure their scheme is appropriately resourced and raise any concerns with the employer at an early stage.

Corporate actions

Covenant and funding

  • Make sure your trustees are not jumping to false conclusions about your covenant post-lockdown. Communicate, communicate and communicate!
  • Companies will need to balance the requirements of lenders, shareholders and trustees when developing their business recovery plans.
  • You will want to understand how Covid-19 has impacted your scheme’s funding strategy.

Investment

  • Depending on how the company has been affected by lockdown, you may need to review your risk appetite and what this means for your scheme’s investment strategy.
  • Specific investment classes, e.g. property and illiquid assets, should be carefully reviewed.
  • Well-funded schemes with high levels of hedging may have seen an improvement in their buy-out funding level. Make sure you are aware of current pricing and how this fits with your long term planning.

DC

  • Most employees will have seen a fall in the value of their DC fund. Companies need to consider whether/how to respond to this?
  • Is your default investment strategy still fit for purpose?

Pension developments / Company news

Pension developments

April

Investment pathways

  • in light of Covid-19, the FCA delayed until February 2021 the implementation of its final set of Retirement Outcome Review remedies, which include the introduction of four standard investment pathways for non-advised customers entering drawdown.

AE and Covid-19

  • the Regulator published guidance for employers about automatic enrolment and its interaction with the Coronavirus Job Retention Scheme. There was also more guidance on TPR’s approach to reporting duties and enforcement during the pandemic.

May

Annual funding statement

  • the Regulator recognised that March/April 2020 valuations will be challenging and warned trustees to be vigilant of employer covenant leakage.

DB transfers

  • TPR, FCA and MaPS provided a template letter for trustees to send to DB members considering a transfer out, warning the member that it is unlikely to be in their best interests to transfer.

GMP final data cuts

  • HMRC announced that final data cuts for GMPs are due to be issued by the end of July 2020 but warned the timeline could slip. It clarified that final data cuts reflect data at 5 April 2016, so HMRC’s online checker service should be used to obtain a revalued GMP amount.

June

Pension transfers

  • the FCA published a policy statement with new rules and guidance to improve the suitability of pension transfer advice. The rules focus on DB to DC transfers and ban contingent charging, except in very limited circumstances.

Corporate Insolvency and Governance Bill

  • in response to concerns that the Bill would weaken the position of DB trustees and the PPF, amendments were made to ensure that TPR and PPF are involved following an insolvency and a DB scheme’s interests are represented in any company restructuring plans.

DB superfunds interim guidance

  • TPR published standards that it expects to be met for these schemes in the period before a full legislative framework is in place. Superfunds can now be assessed by TPR and proceed with their first transactions.

Default fund charge cap

  • the DWP launched a call for evidence as it reviews the current default fund charge cap applying to schemes used for AE.

Value for money consultation

  • the FCA launched a consultation on proposals to make it easier for Independent Governance Committees and Governance Advisory Arrangements to compare the value for money of pension products and services.

PPF age discrimination

  • the High Court ruled that the cap on deferred members’ PPF compensation is unlawful on age discrimination grounds.

Pension Schemes Bill

  • four Opposition-sponsored amendments were made to the Bill at the report stage in the House of Lords, which suggests more changes are likely as it moves back to the Commons in July.

Company news

De-risking

  • The Co-operative Pension Scheme (known as PACE) agreed a £400 million buy-in with Pension Insurance Corporation covering the liabilities of 2,000 members of the Bank section and a £350 million deal with Aviva covering 2,300 members in the Co-op section.
  • Just Group agreed three pensioner buy-ins, the largest of which was for £160 million with the Leonardo Electronics Pension Scheme.
  • Legal & General agreed bulk annuity deals for the US and UK schemes of IHS Markit, worth £78 million and £38 million respectively, as well as a £650 million buy-in with the 3i Group Pension Plan.
  • The IPC Media Pension Scheme completed a £290 million pensioner buy-in with Rothesay Life.
  • The Willis Pension Scheme agreed a longevity swap with Munich Re which covered about £1 billion of its liabilities. The risk was transferred via a captive insurer, based in Guernsey and fully owned by the trustee.

Funding

  • As a result of Covid-19, Reach was reported to have asked the trustees of its DB schemes to defer some deficit recovery contributions.
  • Debenhams announced its intention to file for administration and reportedly missed paying its April 2020 deficit contribution.
  • ITV agreed with the trustees of its DB scheme to defer £15 million of deficit contributions from the first to the second half of 2020.

Plan design

  • Premier Foods announced a segregated scheme merger of three of its DB schemes – one is close to buy-out whilst another has a sizeable deficit.
  • The Nationwide Building Society DB scheme will close to future accrual on 31 March 2021, with employees then joining a group personal pension.
  • Nissan consulted on the closure of its DB scheme.
  • Both Deloitte and the Financial Times planned to temporarily reduce their DC matching contributions.