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This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Pension scheme fundingin the current environment
ACA Sessional Meeting
Tim Keogh FIA/Chinu Patel FIA13th June 2012
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Objectives
• Provide more insight into our thinking behind the Annual Funding statement
• Explain how the statement should help trustee and employers facing the challenge of current difficult conditions
• Clarify our expectations from trustees
• Clarify what trustees can expect from us
• Q & A
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Our regulatory model
• Balancing strategies for funding, risk and member security in a
risk-focussed and proportionate manner
Risk
Funding Covenant
• How much risk in funding and investment strategies?
• How is it financed?
• How is it supported?
Our expectation from trustees, based on the practical experience of the SSF regime over two full cycles is for a business plan which brings together these 3 strands in a coherent manner.
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
A re-statement of our earlier guidance
• Technical provisions– Primary measure of liability– Not to be compromised to make recovery plan affordable– Embedded risk should depend on available sponsor support
• Recovery plans– Determined by reasonable affordability to sponsor– Flexible in design and (within reason) length, to deal with individual circumstances.– Can be supported by non-cash elements
• Investment risk when used as a financing tool– Must take account of available sponsor support (which may be volatile over time)– Trustees should have realistic plans of how the sponsor will provide additional support if
expected returns are not realised whilst there is still time.
• Sponsor support– Numerous forms, some more accessible than others– Can be volatile and may erode quickly– Needs regular monitoring and clarity about actions that would be taken and in what
circumstances
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
"UK plc" funding development 2008 - date
-300
-250
-200
-150
-100
-50
0
50
100
Mar
-08
Jun
-08
Sep
-08
Dec
-08
Mar
-09
Jun
-09
Sep
-09
Dec
-09
Mar
-10
Jun
-10
Sep
-10
Dec
-10
Mar
-11
Jun
-11
Sep
-11
Dec
-11
Mar
-12
Month end
Su
rplu
s/(d
efic
it)
GB
Pb
n
T3 T4 T5 CPI T6 T7
PPF basis changes
Current context: difficult financial conditions
• Aggregate position of all schemes covered by April statement estimated to be as follows (blue) and compared with PPF7800 index for same schemes (green).
TPs (in blue line) defined as gilts plus same outperformance as at previous valuation
Limitations to our data makes this suitable for big picture analyses only.
• Expect most deficits to be worse than 3 years ago
• Volatile markets = Volatile deficits
• Scheme specific variations -depending on many individual factors
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Sources of deficit
31.3.12 update
• Some respite from CPI saving
• Contributions, despite being at record levels, neutralised by net investment and other misc losses
• But significant loss from having to mark to current market
• March 2012 deficits smaller than Dec 2011(and attribution to individual factors may be different)
Warning: This is aggregate analyses based on highly summarised data and may not be representative of individual schemes whose results will depend on many scheme specific factors.
-300 -200 -100 0 100 200 300
Initial deficit Mar10
CPI saving
3 years' DRCs
Equities underperform
Yields fall
Misc
Deficit Dec11
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Current financial conditions: the scale of the problem
Scenario projections - UK plc aggregate TP basis
-300
-200
-100
-
100
200
300M
ar-
07
Ma
r-0
8
Ma
r-0
9
Ma
r-1
0
Ma
r-1
1
DE
C-1
1
Ma
r-1
3
Ma
r-1
4
Ma
r-1
5
Ma
r-1
6
Ma
r-1
7
Ma
r-1
8
Ma
r-1
9
Ma
r-2
0
Ma
r-2
1
Ma
r-2
2
Year
TP
su
rplu
s/d
efic
it £
bn
no
min
al
Gilts flat
Gilts+50bps
Aggregate deficit
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Current financial conditions: a new norm or a temporary aberration?
Scenario projections - UK plc aggregate TP basisExisting contributions + RPI in future -
No change to return seeking asset proportion for 10 years
-300
-200
-100
-
100
200
300
Ma
r-0
7
Ma
r-0
8
Ma
r-0
9
Ma
r-1
0
Ma
r-1
1
DE
C-1
1
Ma
r-1
3
Ma
r-1
4
Ma
r-1
5
Ma
r-1
6
Ma
r-1
7
Ma
r-1
8
Ma
r-1
9
Ma
r-2
0
Ma
r-2
1
Ma
r-2
2
Year
TP
su
rplu
s/de
ficit
£ b
n n
om
ina
l
Gilts flat
Gilts+50bps
Yield reversion
No yield reversion
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Scenario projections - UK plc aggregate TP basisExisting contributions + RPI in future -
No change to return seeking asset proportion for 10 years
-300
-200
-100
-
100
200
300
Mar
-07
Mar
-08
Mar
-09
Mar
-10
Mar
-11
DE
C-1
1
Mar
-13
Mar
-14
Mar
-15
Mar
-16
Mar
-17
Mar
-18
Mar
-19
Mar
-20
Mar
-21
Mar
-22
Year
TP
su
rplu
s/d
efi
cit
GB
Pb
n
no
min
al
Gilts flat
Gilts+50bps
Optimistic
Yield reversion
No yield reversion
Pessimistic/de-risk now
Current financial conditions: other ways of getting there
31.3.12 update?
Which one will it be?
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Coping with current conditions: TPs
• A reminder that legislation requires trustees to take a prudent approach towards setting TPs, regardless of market conditions
• We therefore expect trustees to hold the strength of their TPs
• Smoothing TPs not consistent with asset valuations; volatility needs to be managed not hidden
• There is flexibility to cope with volatility and other aspects of the current financial landscape in the design of recovery plans
• If trustees have a strong view about what may be ‘normal’, and they want to factor it explicitly in their funding plan, then our preference is for this to be done in the recovery plan assumptions, together with a documented contingency plan
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
-300 -200 -100 0 100 200 300
Initial deficit Mar12
Discount rate unwind
Contributions current + RPI
Short term yield reversion
10 years' prudence unwound
TP Surplus Mar22
The power of recovery plans
31.3.12 update?
• Ultimately DRCs are the most important
• Views about future economic scenarios may or may not be realised, and could hamper return to solvency unless underpinned by suitable contingency plans
• That is why we are encouraging trustees to focus on the flexibility of recovery plans to cope with current conditions
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Future recovery plans: our expectations
• Guiding principle: reasonable affordability without compromising sponsor’s viability
• In general we expect contributions to be maintained in real terms or increased in line with business performance
• Higher increases if previous level of contributions was low relative to what the sponsor could have afforded
• Servicing debt and capex are essential elements of strong businesses – should be seen to be improving sponsor covenant
• When cash leaves the company the pension creditor should receive an equitable share
• Reassess dividend payments where there is a substantial risk of pension obligations not being met
• If affordability is reduced longer recovery plans may be acceptable but justification needed for material extension
• Trustees should document the justification for any reductions – good governance
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Impact vs affordability
Scenario 2
Scenario 1
Scenario 3
Worsened little change Improved
Impact on scheme(=need for contribution change or equivalent)
High
Covenant/Affordability
Low
Nil Polestar Uniq
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Managing T7 valuations
Scheme issues TPR process issues
Pro-active
Targeted Segmented
Risk
Cash Covenant
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
The Pensions Regulator: process
• Pro-active
– More interested in early engagement
• Targeted on key risks
– These are
• Covenant
• Investment
• Inadequacy of contributions
– TP/RP length is means to an end only
• Evolve triggers to better address key risks
• Segmented
– Increasingly discriminate between different situations in terms of our approach
Pro-active
Targeted Segmented
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Current recovery plans (T4): bird’s eye view
Range of contributions and funding levelTranche 4 (excluding outliers)
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
40% 50% 60% 70% 80% 90% 100%
Funding level as % reference liabilities
Co
ntr
ibu
tio
ns
as %
ref
eren
ce
liab
iliti
es
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Current recovery plans (T4): a closer lookRange of contributions by funding level decile
Showing 5th/25th/75th/95th percentile for each decile
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
3.2% 2.7%2.9%2.5% 2.1%2.2% 2.2% 1.6% 1.6% 0.9% 2.2%
43% 50% 53% 56% 59% 63% 66% 70% 75% 88% 61%
1 2 3 4 5 6 7 8 9 10 All
Median contribution Median funding level
Decile
Co
ntr
ibu
tio
ns
as
% r
efer
en
ce l
iab
ilit
ies
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Managing T7 valuationsTrigger developments we wish to explore
Scheme issues
Risk
Cash Covenant
Note: These are exploratory ideas only. The final approach may not adopt any of these ideas, and others may emerge
Funding
• Contributions vs TP/RP length
• Surplus declarations
Investment risk
• RBL
• VaR
• ABCs
• Flight paths
Covenant risk
• External advice
• Monitoring
• Directness of covenant
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Next Steps• Review of information submitted to us (work in progress). We may seek more
information on
– Contributions
– Levels of risk
– Investment risk mitigation (through swaps etc)
– Covenant
• A proactive engagement from us in some cases whilst valuations are in progress
– Where we have previously indicated substantial concerns
– In cases that we have not closed because of ongoing concerns
– Less than 100 schemes and all in excess of £500m.
• Updates to our triggers to reflect new priorities
• A much more focused review process
– We will still look at all schemes post-submission
– But expect a smaller number of more assertive interventions
This presentation remains the property of The Pensions Regulator and should not be reproduced without express permission
Sum up – our overall expectation
• Increasingly joined up funding/investment/covenant
• Business plan, including clarity about strength of sponsor support, where it resides and how accessible it will be if and when needed.
• Parental support / wider group support increasingly formalised
• Monitoring covenant and suitable actions that may be taken and in what circumstances
• Trustees to be flexible where covenant is weaker and tolerance needed, but with corresponding shareholder restraint
• There are many well managed schemes doing the right things. We are happy to work with them to identify models of best practice.
• We want to get ahead of issues for schemes where this is not the case, in part by pro-active engagement