Corporates should treat this valuation cycle as an opportunity to review their ultimate goals, understand the timescale to buyout, and plan for the new DB funding code.

With funding levels of most pension schemes set to improve in this year’s valuation cycle, corporates may be tempted to sit back and let the trustees take the reins.

In a survey during our recent webinar, more than 60% of employers said that their trustees led the last valuation process rather than the company.

However, 2022 is a great opportunity for corporates to take back some control to get the best valuation outcome, move closer to their endgame goals and manage increased regulatory risk.

Review endgame planning

Corporates should first look at their endgame planning and consider whether tweaks are needed to achieve their goals. Whilst buyout with an insurer is often the right end game, it is not always the case, with alternative options including run-off and superfunds.

If the scheme has a technical provision surplus, employers might assume it will be a smooth valuation process because there is no need for deficit contributions, and therefore they can let the trustees drive the agenda. However, we believe corporates in this situation should use the valuation to focus on endgame planning instead. Issues like the timescales to insurance buy-out and whether running costs are paid by the employer or out of scheme assets become more important.

We discussed these considerations in our webinar, Getting to grips with your 2022 valuation. My colleague, Andrew Udale-Smith, highlighted that a lot of companies and trustee boards are surprised when they discover how close their scheme is to a possible buyout.

“In fact, we expect that recent improvements in funding levels for many schemes, combined with the maturing of their liabilities, mean that buyout might be much sooner than corporates expect,” he added.

Traditionally, the endgame for DB schemes has been seen as either running the scheme on indefinitely or seeking an insurance buyout when it makes economic sense. It may be useful for trustees and corporates to discuss whether it is better to keep investment risk on, with a view to being able to buyout sooner, or to continue to de-risk the scheme and give a longer period to buyout.

It is also worth remembering there are other emerging ways to secure pensions liabilities than traditional insurance buyouts. For example, the first DB superfund, Clara, secured regulatory approval last year and other DB consolidator approvals are expected to follow. There are also emerging capital-backed investment products that offer an alternative to traditional bulk annuities.

Corporates should note that it is usually easier to persuade trustees to support a short-term funding proposal in the context of an agreed long-term strategy. That is another reason why being on the front foot and going to the trustees with a funding proposal will help employers reach optimal outcomes.

The new funding code

In the upcoming valuations, employers should also think about the likely impact of The Pensions Regulator’s new funding code, which will be introduced under the Pension Schemes Act 2021.

The code will not apply to 2022 scheme valuations. Indeed, the earliest it will come into force is for 2023 valuations. However, it is still relevant for this year’s valuations because employers will want to ensure they agree a funding framework that will work with the direction of travel of the new code. The code is expected to require all DB schemes to have a long-term objective (LTO) based on a discount rate in the range from gilts plus 0.25% to gilts plus 0.5%.

On the webinar Andrew said: “Many schemes already have a long-term objective, but we think it's important to review that to make sure you are aiming at the right place. And, critically, make sure you have a robust journey plan in place for getting to full funding on that LTO.”

Corporates also need to consider if they will adopt a Fast Track or Bespoke funding strategy when the new regime goes live in late 2022 or early 2023. We expect that 60% of FTSE 350 schemes are sufficiently well-funded that they will be able to comply with the Fast Track strategy under their existing funding plan.

For pension schemes to comply with Fast Track and avoid the scrutiny of the Bespoke approach, the technical provisions discount rate must trend to the LTO discount rate within around a 15-year period. Udale-Smith pointed out that a typical dual discount rate approach, which has a higher discount rate pre-retirement and a lower rate post-retirement, is unlikely to be Fast Track-compliant, even if the post-retirement discount rate itself complies with the LTO. This is because the dual discount rate only trends to the post-retirement discount rate when the last member retires (which is likely to be a lot longer than 15 years away).

“Therefore, corporates and schemes might want to consider reshaping the technical provisions discount rate at the 2022 valuation, so that it will be Fast Track compliant,” Andrew added.

Employers will, of course, want to avoid adding to their pension liabilities when revising the discount rate. That is why it is important to explore all possibilities for discount rates in advance of getting into valuation discussions with the trustees.

Be proactive

We think companies should treat DB pension valuations like a corporate transaction. This is especially the case this year given the upcoming tougher regulatory regime and funding code. Being proactive in the valuation process and developing a funding proposal to take to the trustees can generate better outcomes and help employers achieve their endgame goals.

To discuss any aspects of your own 2022 valuation please get in touch.