Here are five tips for a successful discussion with your trustees on your DB funding valuation in 2023.

1. Focus on the long-term strategy

A focus on the long-term funding and investment strategy has never been more important, whether the strategy is driven by improved funding position or the new funding code (see our second tip). As many schemes have an improved funding position (particularly on insurance buy-out bases), the whole industry is talking about endgame strategies and the importance of knowing the ultimate plan for discharging a scheme’s liabilities. A triennial funding valuation is an opportune time to develop or refine that plan.

For sponsors, it’s critical to have a clearly articulated long-term strategy, for two reasons:

1. The company can only judge whether a funding plan is appropriate if it sees how the plan fits into a long-term strategy for managing the scheme’s liabilities.
2. It's far easier to get trustees on board with a short-term funding proposal when it makes sense relative to a long-term strategy.

So, when approaching a 2023 valuation, start with your preferred long-term strategy

2. Have the new funding code in mind

The Pensions Regulator’s (TPR) new funding code of practice is in its second consultation period at the time of writing (February 2023) and is expected to take effect for valuations from October 2023 onwards. It makes very little sense to agree a funding framework in 2023 without understanding how it will work with the new code This means you need to:

• Develop an appropriate long-term objective (at least for company purposes).
• Consider the level of investment risk being taken and the role of assumed asset outperformance in the recovery plan.
• Understand the covenant visibility that the pension scheme trustees have, and explore a role for legally enforceable security and the potential economic upside which this might deliver.

TPR is using Fast Track parameters to consider which funding plans to review further. The key aspects of Fast Track are plan to be fully funded on a long-term objective with a discount rate of gilts + 0.5% pa (or stronger) by the time duration falls to 12 years, and a technical provisions recovery plan of 6 years or less.

There is not a requirement to meet Fast Track thresholds and TPR’s own analysis shows many schemes may not do this. However, deviations from Fast Track need to be well thought through and justified.

3. Know the actuarial assumptions likely to require most discussion

We expect three actuarial assumptions to require the most attention for 2023 valuations:

• Inflation – with RPI trending down to CPI from 2030, market-implied RPI and CPI appear to be over[1]stated, with investors paying a premium for inflation protection. Both assumptions, including the level of the CPI wedge and any inflation risk premium, need careful thought for 2023 valuations.
• Life expectancy – the long-term impacts of Covid-19 on longevity are unclear, so this assumption needs particular care. However, there is a growing body of opinion that the pandemic will negatively affect future mortality improvements. Recently released ONS data shows significant “excess deaths” in 2022 relative to pre-pandemic levels, so mortality rates are unlikely to revert to pre-pandemic levels in the short term. In its 2022 Annual Funding Statement, TPR indicated it will accept liability reductions of up to 2% relative to pre-Covid expectations if trustees agree these are appropriate and justified.
• Expense reserves – as funding levels improve, it is worth reviewing the funding of expenses. Expenses might be funded out of scheme assets rather than from the company.

4. Be realistic about deficit contribution levels

Reducing deficit contributions can be difficult without a strong affordability argument. In its 2022 Annual Funding Statement TPR said that it views shareholder distributions as inconsistent with reducing contributions and that dividends should only exceed deficit recovery contributions if the pension scheme has a strong funding target and a relatively short recovery plan (less than five years is given as an example).

If deficit contributions remain at current levels in parallel with a strong improvement in funding, we recommend using triggers to cease contributions or divert them into escrow as full funding is reached, rather than waiting for the next triennial valuation to turn off contributions. A simple funding level monitoring mechanism can achieve this.

5. Understand the position for surplus refunds

Our 2022 FTSE350 analysis showed that the average FTSE350 scheme is less than six years from insurance buy-out. Use the valuation process to ensure you understand the position and powers in relation to eventual buy-out and surplus refunds. The position varies dramatically between schemes and depends on specific wording in scheme rules. Some employers have a unilateral right to trigger buy-out and access any remaining surplus. In other cases, trustees have a discretion or requirement to use surplus to augment benefits.

If a scheme has trustee-friendly powers, employers need to understand these well ahead of buy-out, and use the leverage they have in ongoing valuations for more influence over the buy-out and surplus refund

To discuss your 2023 funding valuation, please get in touch.