COVID-19 – the impact on 2020 funding valuations
20th April, 2020
As trustees, we are now all settled into working at home, are confident that our pensioners will be paid on time and have our business continuity plan (and that of our advisers) well tested. We have also been keeping in regular contact with our sponsor as many businesses will be going through troubling times and even those that can continue functioning with everyone at home are likely to see a downturn over the next six months, with demand reducing as everyone tightens their belts.
Much of the work we do as trustees has to go on no matter, with the normal cycle of scheme events including trustee report and accounts, actuarial valuations or actuarial updates needing to be produced.
Like many other trustees I have schemes with valuation dates of 31 March and 5 April. These are very popular dates for scheme year-ends and normally this is when the corporate diary is less busy as the company year-end has been put to bed. Not this year!
The Pensions Regulator (TPR) has provided welcome guidance and some easements around valuations that are already in progress and approaching their statutory deadlines, and for the delay of deficit repair contributions. At the time of writing we are still waiting for the latest funding statement to be issued. However, TPR has noted that the current funding regime is flexible and so should be able to deal with the current volatility in investment markets, sponsor covenant and affordability.
Time on our side
So what does this mean for the many trustees who are embarking on valuations now? I think a key factor will be not to rush. We have fifteen months to complete the valuation and as we have seen over the last fifteen months a lot can change. Taking our time will also give the world and our sponsors an opportunity to get back to a more even keel.
Before starting a valuation, trustees need to have an understanding of their sponsor covenant as this is the foundation of the whole process. Covenant underpins the level of investment risk you should be taking, which in turn determines the maximum discount rate you can adopt adjusted for an appropriate level of prudence.
Now, more than ever, trustees will be relying on third party covenant advisers to help them assess sponsor covenant and I think it will be increasingly rare for trustees not to take external advice. Even where the trustees already believe that the sponsor covenant is weak, advice can help determine affordability and more importantly whether there is any further security that can be provided.
I will leave both covenant and investment matters for separate blogs as there is far too much to consider to be included here.
So back to the actuarial valuation. Assuming that we have covenant and investment matters sorted, much of the valuation process is routine. The administrators will need to provide a data cut to the Scheme Actuary and the Scheme Actuary will need to produce preliminary results. Because of the wonders of all the new and sophisticated models that actuaries use, we can see the impact changing assumptions has on the funding position and recovery plan contributions at the click of the button. No longer do we have to wait weeks for updated results. So when we are ready to make decisions on the final assumptions and recovery plans these can be made without delay.
For some schemes, particularly those that are well hedged, their funding position might not have been badly affected by the current volatility we have seen in investment markets. For those that are less well hedged and with large allocations to equities, their position at the end of March 2020 could look poor.
However, we can also take into account post-valuation date experience and this might be especially relevant for those less well hedged schemes. Particularly as the events surrounding Covid-19 and the impact on worldwide markets have been so unusual. This, of course, assumes that investment markets will normalise over the next year or so. If they don’t, then for some schemes we will need to have difficult conversations with our sponsors around how to fund the deficit.
We should also be thinking about the Long Term Objective (LTO) set out in TPR’s latest consultation on the new funding code. Although the new funding code will not impact current valuations we should be aware of the direction of travel. As the funding of our schemes should be approaching the LTO over time, we should be considering it now as we know this change is coming. It is worth discussing this with the sponsor as they may have strong views on the direction of travel of the scheme. We need to be realistic on where we are going and the time it is going to take to get there.
So, whilst the current situation with the coronavirus is affecting how we are doing things, it should not be impacting what we are doing at the current time. It is important to have an open dialogue with the sponsor so we understand the impact of Covid-19 on their business and its sustainability. However, we can work with them to find a path through the current challenging valuation process.