Trustees of defined benefit (DB) pension schemes must remain alert to the risk of weakening employer covenants as uncertainties remain following a challenging year for businesses.
This is just one of the expectations The Pensions Regulator (TPR) outlines in its Annual Funding Statement (AFS) 2021, published today.
Even though trading conditions have been difficult for many during the past year, many employers and trustees have worked together to maintain their funding commitments.
However, there is still uncertainty in the market due to factors including the COVID-19 pandemic and Brexit so trustees should remain vigilant and if necessary act quickly to protect savers.
David Fairs, TPR’s Executive Director of Regulatory Policy, said: “This has been a challenging period for many employers and so trustees in carrying out actuarial valuations need to review how their covenant may have changed in the past year and then continue to monitor it. We expect them to remain engaged with employers, who in many cases are emerging from a difficult business period.
“Encouragingly, scheme funding in this tranche has remained buoyant despite difficult market conditions for sponsoring employers, who have benefited from extended government support. It is too early to tell if we will see a rise in company insolvencies but uncertainty remains. If there is a prospect of insolvency or a restructure of scheme employers, trustees should probe the covenant even further and take professional advice to gain a fresh view on covenant strength to ensure their scheme is being treated fairly.
“The pandemic has thrown up short term challenges which heighten focus on areas such as sustainability and climate change and the impact that they can have on sponsors but also scheme assets and liabilities.”
As the UK economy emerges from the pandemic, the AFS envisages trustees having to deal with employers in one of three broad categories:
- COVID-19 has had limited impact on the business
There has likely been no balance sheet weakening and cash flow has remained strong.
- The initial impact of COVID-19 was material but trading has, or is, recovering strongly
Since the pandemic started, several measures were introduced to help support businesses. As they end, TPR anticipates many sponsors could experience additional short-term liquidity pressures. Any weakening of the balance sheet can be repaired over a short period, and the medium-term prospects have not been negatively impacted.
- The impact of COVID-19 continues to be material
The pace of recovery is uncertain and could take years, or the business may never fully recover. Short term affordability is stressed. The balance sheet has weakened due to measures taken to raise additional liquidity and to secure covenant waivers. Medium term prospects are unclear.
The AFS outlines how trustees should consider the long-term funding and investment of their scheme depending on the impact of COVID-19, Brexit, scheme maturity and the scheme’s funding position relative to its long-term target. The statement includes guidance on addressing these issues and sets out actions TPR expects trustees to take. A commitment to integrated risk management remains as important as ever and guidance on it is available on the TPR website.