TPR's Annual Funding Statement highlights climate change risk and long-term targets

Defined benefit (DB) scheme trustees should develop integrated risk management frameworks that consider factors such as climate change and long-term funding targets, according to The Pensions Regulator’s (TPR) new Annual Funding Statement.

The funding statement stated that climate considerations may impact on the assumptions used in actuarial valuations, the investment strategy and the sponsor covenant, with the regulator arguing that assessing, mitigating and monitoring climate risk was key to successful saver outcomes.

Additionally, it stressed the importance of long-term funding targets, noting that it will soon be a legal requirement for schemes to have a specific long-term strategy designed to deliver an agreed long-term objective, adding that doing so before it becomes mandatory would make life easier for trustees.

The statement also outlined what the regulator expects from trustees and employers, providing a specific set of tables that group schemes depending on their circumstances and then offer specific risks and expectations.

After identifying their specific group, TPR said trustees should “set about preparing their recovery plans to balance affordability with contributions linked to well-defined triggers, contingency plans and other protections for member security”.

When it comes to valuations, TPR stated that, over the three-year period to March 2021, funding levels for Tranche 16 schemes on their technical provisions basis had improved, although it acknowledged that the position for individual schemes would vary greatly compared with our aggregate estimates.

The regulator noted that, at 31 December 2020, the aggregate funding levels for all Tranche 16 schemes was broadly unchanged compared with three years previously, with schemes that had hedged interest rate and inflation risks appearing to have slightly improved funding levels.

The statement said: “Where schemes are still behind target, trustees and employers will need to consider how far they may have strayed from their expected funding position and their longer-term target, and develop strategies to put them back on course.

“On the other hand, where schemes are now better funded on a technical provisions basis than was anticipated, or even in surplus, we encourage trustees to remain focused on their longer-term target and their journey towards it.”

In responding to the impact of the Covid-19 pandemic, TPR was cautious on big changes to long-term assumptions, saying that mortality changes should be "justified".

The statement cautioned that while short-term covenant visibility may have improved, trustees must continue to be alert to the risks of weakening employer covenants and remain engaged with employers as uncertainties continue.

The regulator said each scheme needed to consider its position individually depending on its own circumstances – with the statement being intended to equip trustees and employers with some tools to do so.

TPR stated: “We appreciate that events such as the Covid-19 pandemic and Brexit have presented challenges for some businesses and the pension schemes they sponsor. However, we also understand that others have not been as adversely affected and these events may have even created opportunities.

“Although it is important for trustees and employers to work together to manage unexpected events, they should also make sure they retain a focus on the long term - most specifically around planning and risk management. The best support for a pension scheme is a strong employer, and we are here to support and provide guidance, and to ensure savers are protected by having well-funded pension schemes.”

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