TPR warning on DB valuations and dividend payouts

DB schemes being valued this year will be more impacted by market conditions than schemes in earlier tranches, in part because sponsors are paying out more dividends and less deficit repair contributions (DRCs) says the regulator.

So-called Tranche 12 schemes, with valuations between September 2016 and September 2017, will have benefited from high valuations at their last valuation, but will be more significantly impacted by current market returns, putting stress on scheme affordability says The Pensions Regulator, in analysis published today.

Although asset returns have been better than expected, generally this has not been enough to offset the increase in liabilities due to the change in market conditions, meaning overall deficits have increased and funding levels have fallen.

TPR says that while over the periods December 2013 to December 2016 and March 2013 to March 2017, the FTSE All World (excluding UK sterling) returned 52.9 and 60.7 per cent respectively, wider concerns for global growth and reductions in the nominal and real yields are likely to have a significant impact on schemes’ expected returns across various asset classes over the medium and longer term.

Overall, our modelling suggests that, for the majority of schemes, the value of their liabilities is likely to have grown by more than their assets since their last valuation. The level of increase in deficits for individual schemes could vary greatly compared with our aggregate estimates depending on their valuation dates, their funding and investment strategies and in particular the extent to which they had hedged their interest rate risks.

TPR says that out 50 per cent of Tranche 12 schemes have the resilience to maintain the same pace of funding and many will be able to increase their contributions if the circumstances of the scheme require it. A further 37 per cent of schemes have an employer covenant which TPR considers adequate to support the scheme but their current contribution and/or risk strategies pose unnecessary longer term risks. This risk may be addressed by increased funding now combined, for some schemes, with a reduction in the level of risk says TPR.

It adds that for the group of FTSE350 companies who paid both deficit repair contributions (DRCs) and dividends in each of the previous six years, the ratio of DRCs to dividends declined from around 10 per cent to around 7 per cent. This is mainly driven by the significant increase in dividends over the period, without a similar increase in contributions.

TPR executive director for regulatory policy Andrew Warwick-Thompson says: “It is encouraging that 85 to 90% of schemes currently preparing their valuations have employers with sufficient financial resilience to be able to afford to manage their deficits, and don’t have a long term sustainability challenge. But it is clear that tough market conditions have led to a significant jump in deficits for this tranche of schemes despite their relatively stronger position three years ago.

“Ensuring DB schemes are properly funded is a key priority for us and so our annual funding statement this year takes a more directive approach than in previous years. We have been clear in what our expectations are; where we expect higher contributions into a scheme, and where we expect a scheme to reduce risk to an appropriate level and / or to seek legally enforceable support from its group or parent company. We also want more schemes and sponsors to make use of the flexibilities within the funding framework.

“It is disappointing to see that the ratio of DRCs to dividends has declined from around 10 per sent to around 7 per cent. We are not against companies paying out dividends but employers must strike the right balance between the interests of the scheme and that of its shareholders.

“Having made our expectations so clear in this year’s AFS, if we see a situation where we believe a scheme is not being treated fairly, we are likely to intervene. For example, if a company is paying out more in dividends than in deficit reduction contributions, we will expect to see a short recovery plan. And we will expect that recovery plan to be underpinned by an appropriate investment strategy.”