Home > News > 2006 > May 2006 > Are you ready for Scheme Specific Funding?
Are you ready for Scheme Specific Funding?
Actuarial valuations carried out with an effective date after 22 September 2005 will have to comply with the new Scheme Specific Funding regime. In most cases this will give trustees greater responsibility (and power) in setting the sponsoring employer's contribution rate. The Pensions Regulator (TPR) is pushing trustees to use prudent assumptions and seek additional contributions to clear any deficit quickly. All this will put upward pressure on the employer's contribution rate, at a time when the cost of pensions is already very high.
Employers will want to ensure that their views on scheme funding are adequately considered by the trustees. The valuation timetable may well be quite tight, so it is better for employers to speak to the trustees as early as possible in the process to make sure that their views are incorporated. Getting separate advice will not necessarily involve commissioning significant amounts of extra work as a lot of value can be added after simply reviewing the paperwork.
Some of the key areas that employers may wish to consider in relation to their first Scheme Specific Funding valuation include:
- Appropriateness of individual financial assumptions. As well as the individual assumptions for future returns on equities and bonds the employer will want to ensure that the overall investment return assumptions are reasonable, considering the scheme's long-term investment strategy.
- Appropriateness of individual demographic assumptions - particular attention should be paid to the mortality assumption.
- If the scheme is in deficit the trustees will often be looking to clear it quickly. However, the trustees may be willing to accept a longer period or negotiate on the pattern of contributions in certain circumstances.
- The FRS17 figures used in the company's accounts are being used as a benchmark by TPR in many instances, and these should therefore also be considered carefully.
These issues are considered in more detail below.
Investment Return Assumptions: The results of the valuation will be very sensitive to the financial assumptions; particularly the assumed future returns on equities and bonds. The equity return assumption is particularly subjective and may be up for discussion. It is also important the assumptions reflect the scheme's current and future investment strategy. The Scheme Actuary may suggest using different investment return assumptions before and after retirement. This is often a sensible approach but the post retirement investment return assumption should reflect the long-term reality of the scheme's investment strategy. For example, would the scheme invest 100% in bonds when there are only pensioners left? As life expectancies increase, a proportion of equity investment post retirement may well be sensible.
Longevity Assumption: Mortality studies continue to show that pensioners are living longer than actuaries had previously assumed. As a result many schemes' longevity assumptions are likely to be strengthened at the next valuation, although this may not always be appropriate. For example, separate studies have shown the wide variation in experience depending on the size of pension, industry and location. This is an important assumption and should be considered carefully. Larger schemes may wish to carry out an investigation into their own mortality experience.
Deficit Clearing Periods: Under the Scheme Specific Funding regime TPR wants trustees to carefully consider the periods over which deficits are paid off. It has indicated that the use of a period longer than ten years is likely to result in further questions. However, TPR has indicated that provided a longer period can be justified it should be acceptable. In such cases trustees may look for additional security from the employer. Trustees would normally look for cash contributions into the scheme so it is important the employer is aware of all the options.
TPR has also indicated that where a long deficit clearing period has been adopted the scheme's investment strategy will be examined. TPR is particularly keen to see that appropriate steps have been taken to minimise the risk of the funding position deteriorating. One way of achieving this would be to implement a Liability Driven Investment (LDI) strategy. This does not necessarily mean that the scheme has to invest solely in bonds and give up any prospect of seeing the higher returns it is currently anticipating that equity markets will provide. Although a scheme's investment strategy is ultimately the responsibility of the Trustees, in our experience, employers have often been the driving force behind the implementation of an LDI approach.
FRS17 Position: A scheme's FRS17 position has become more important now that it must be included in the main body of the sponsor's accounts. In addition, TPR has indicated that the FRS17 liabilities will be used as a benchmark in many situations.
Therefore, the trustees will now be looking at these figures as one indication of TPR's view. The FRS17 assumptions should therefore be chosen carefully. Despite the prescriptive nature of FRS17, the assumptions are not precisely defined and the employer may wish to get specific advice on this point. Auditors have been keen for the latest mortality projections to be used but, as discussed above, this may not always be appropriate. Other demographic assumptions such as the allowance for members taking lump sums at retirement can also influence the FRS17 funding level.
How can Barnett Waddingham LLP help?
Barnett Waddingham have built up significant experience of providing advice tailored specifically to employers that sponsor defined benefit schemes.
TPR has suggested that if the trustees and employer are unable to agree on a revised contribution rate then areas such as professional alternative dispute resolution should be used before it becomes involved. Our experience in providing advice to sponsoring employers and trustees of defined benefit schemes means we are well placed to act as a mediator in this situation.
In providing our advice to employers we are not looking to duplicate any calculation work carried out by the Trustees' advisors.
Therefore, we are able to add significant value whilst keeping costs to a minimum. Please speak to your usual Barnett Waddingham contact, the pensions team in your local office or email info@barnett-waddingham.co.uk, if you wish to discuss any of these issues further.
Barnett Waddingham LLP, May 2006.