1. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Dealing With tPR’sNew Scheme Funding Code22ndOctober 2014
2. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
An Evolving Pension Landscape
2
Time
2006
2014
3. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
1.“Schemes must minimise any adverse impact on the sustainable growth of an employer, with risks being understoodand managed appropriately.”
2.“Emphasis on collaborationbetween trustees and employers in regards to the scheme’s risks.”
tPR’sNew Scheme Funding Code
3
4. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Peter Ford, Partner Norton Rose Fulbright
Peter Ford is head of the pensions department at Norton Rose.
His experience includes pension scheme mergers and reorganisations, scheme winding-up, investment and custody and pensions litigation. Peter has previously been a director of two trustee companies and has recently been re-elected as a member of the Main Committee of the Association of Pension Lawyers. Peter was the lead legal adviser to the Government sponsored Pickering Review into the simplification of private pensions and is a member of a number of pensions organisations. Peter is recognised as an ‘excellent analyser and communicator’ and ‘a heavyweight in the field’ who ‘finds solutions rather than problems’ by Legal 500 UK 2013. He is noted“as a strong and dynamic performer” in Chambers UK 2010.
4
T:+44 20 7444 2711
F:+44 20 7283 6500
Email: peter.ford@nortonrosefulbright.com
5. The Pensions Regulator’s New DB
Funding Regime
Peter Ford
Partner
Norton Rose Fulbright LLP
Wednesday 22 October 2014
7. New DB Scheme Funding Code
• Issued with effect from 29 July 2014.
• Replaces previous (2006) Code.
• Reflects Regulator’s new statutory funding objective:
“to minimise any adverse impact on the sustainable growth of the
employer.”
7
8. Statutory Objectives
The Pension Regulator’s statutory objectives are:
• to protect the benefits of pension scheme members;
• to reduce the risk of calls on the PPF;
• in relation to scheme funding only, to minimise any adverse impact
on the sustainable growth of an employer;
• to promote and improve understanding of, and good
administration or work-based pensions; and
• to maximise compliance with the duties and safeguards in the
Pensions Act 2008 (i.e. Auto-enrolment).
8
9. Balanced Approach
TPR has stated that the same weight will be given to new statutory
funding objective as to other objectives including protection of
members benefits and reducing risk of call on the PPF.
Clear desire to promote a more balanced approach between
employers and trustees
“in particular, the Code recognises that a strong ongoing employer
alongside an appropriate funding plan is the best support for a well
governed scheme.”
9
10. Key Funding Principles
The Code sets out 9 key funding principles for DB schemes:
• working collaboratively;
• managing risks;
• taking risks;
• taking a long term view;
• proportionality;
• balance;
• good governance;
• fair treatment of the scheme by the employer; and
• reaching funding targets.
10
11. Key Themes
• Proportionality and balance.
• Collaborative approach.
• Integrated approach to risk management.
• Less prescriptive intervention.
11
12. Key Themes – Proportionality and Balance
Requirement for proportionality and balance permeate the Code.
Trustees should balance the need to pay the promised benefits
whilst minimising the adverse effect on the employer’s sustainable
growth – but paying the promised benefits remains the key
objective for scheme trustees.
12
13. Key Themes – Collaborative approach
Key emphasis on collaboration between trustees and employers to
achieve the appropriate funding outcome.
Balancing the need to pay promised benefits against potential
adverse effects on employer’s sustainable growth will require co-operation.
However, it is clear that sustainable growth will mean
different things to different employers:
“for some growth is a real prospect whilst for others it may be more
about maintaining their position or slowing a business decline.”
13
14. Key Themes – Integrated Approach to Risk (1)
• Clear focus on the interaction between employer covenant,
investment and funding risk.
• Recognition that a change in one of these three key risks will
affect the other two.
• Requirement for trustees to identify, assess, monitor and address
these risks appropriately and effectively – but not necessary to
eradicate risk completely.
• Importance of understanding covenant in establishing funding
targets and investment strategy is key.
14
15. Key Themes – Integrated Approach to Risk (2)
• Trustees should set an appropriate risk appetite.
• Need to recognise the importance of covenant over time and
undertake scenario testing.
• Agree appropriate management actions and contingency.
• It is clear that covenant will be a key factor in developing
investment strategy.
15
17. Key Themes – Less Prescriptive Intervention
• Removal of trigger based approach (e.g. length of recovery
period).
• Risk indicators:
– covenant strength (weak; tending to weak; tending to strong; strong);
– funding;
– investment risk; and
– governance.
• Target resources on schemes posing the greatest risk and where
can have greatest impact.
17
18. Comparison of Old and New Codes
2006 Code 2014 Code
Main focus on funding risk Integrated risk management
(covenant, funding and investment)
Prudent assumptions Balanced outcome
Mechanical approach to interventions Interventions based on assessed risks
Deficit eliminated as soon as the
employer can reasonably afford
Deficit eliminated over an appropriate
period
18
19. Practical Issues
• Valuations – still a requirement for assumptions to be prudent but
focus also on balanced outcomes. Issues still likely to exist for
schemes with weak covenants/poor funding.
• Integrated approach to risk – to some extent reflects existing best
practice. Regulator now asking to see VaR analysis.
• Covenant advisers will also start looking at VaR analysis.
• Helpful advice on dividends – recognition that dividend payments
can be consistent with sustainable growth and funding objective.
19
20.
21. Disclaimer
Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP, Norton Rose Fulbright South Africa (incorporated as Deneys Reitz Inc) and Fulbright & Jaworski LLP,
each of which is a separate legal entity, are members (‘the Norton Rose Fulbright members’) of Norton Rose Fulbright Verein, a Swiss Verein. Norton Rose Fulbright Verein helps coordinate the
activities of the Norton Rose Fulbright members but does not itself provide legal services to clients.
References to ‘Norton Rose Fulbright’, ‘the law firm’, and ‘legal practice’ are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together ‘Norton Rose
Fulbright entity/entities’). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is
described as a ‘partner’) accepts or assumes responsibility, or has any liability, to any person in respect of this communica tion. Any reference to a partner or director is to a member, employee or
consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity.
The purpose of this communication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose
Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your
usual contact at Norton Rose Fulbright.
21
22. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Dealing With tPR’sNew Scheme Funding CodeRobert Gardner
23. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Integrating Covenant, Funding And Investment
23
24. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
tPR’sApproach To Measuring Covenant Strength
24
Reducing Risk Budget for Investment & Demographic Risk
Strong
Tending to Strong
Tending to Weak
Weak
Sustainable growth plans
Keep covenant strong through security in place
Monitoring of covenant risks
Payments that weaken covenant a concern
Likely to be in a position to handle risk
Managed solutions
Maximise covenant value
Funding plan to reflect covenant risks
Risk taking needs significant management
Strong target needed reflecting investment strategy and weak support for risks
Scheme viability a concern
24
25. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
How Does Covenant Strength Impact AScheme’s Ability To Take Investment Risk?
25
0
20
40
60
80
100
120
140
160
CG1: Strong
CG2: Tending Towards Strong
CG3: Tending Towards Weak
CG4: Weak
Limiting the Risk Budget
Risk Budget
Maximum Covenant Load
26. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
What Levers Can We Pull?
26
£(m)
Time
Liabilities
Deficit
£10m
£15m
27. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
What Levers Can We Pull?
27
Investment return
Contributions
Time
3yrs
12yrs
6yrs
9yrs
2.0%
2.5%
1.5%
0.5%
1.0%
£10m
£15m
£5m
28. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014 28
How Do We Measure The Impact Of Investment Risk On The Sponsor Using Contributions at Risk?
29. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
How The Covenant Load Varies As You Move The Levers
29
£(m)
Contributions at Risk
£30m
£ Contributions
£15m
Investment Returns
£30m
Contributions at Risk
£20m
£ Contributions
£20m
Investment Returns
£20m
Contributions at Risk
£16m
£ Contributions
£17m
Investment Returns
£17m
75
60
40
Increase contributions
Extend Time Horizon
30. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Objective
Measurement
PerformanceIndicators
Performance(30 Jun 13)
Status
Primary Funding Objective
To reachfull funding by [2025] based on discount rate of Gilts + 1.00% (Technical Provisions basis)
Expected Returns (ER)>Required Returns (RR)
RR: Libor + 275bps
ER: Libor + 200bps
Difference: -75bps
SecondaryFunding Objective
To reach full funding ona buyout basis by [2035] based on a Gilts Flat discount rate
Expected Returns (ER) >Required Returns(RR)
RR: Libor + 250bps
ER: Libor + 200bps
Difference: -50bps
RiskBudget
The investmentstrategy should not risk the deficit worsening by [20%] of liabilities over a 1 year period
VaR95< [20%] of liabilities
VaR95:30.0%
Covenant Load
The sum of annual contributions and the 1 yearContribution at Risk
Contributionsat Risk < [£50 Million]
Contributions at Risk:[£100Million]
Hedging Strategy
Nominal/Inflation hedge ratio should be maintained within +/-5% of the funding ratio.
Funding Ratio (Gilts + 1.00%)
60%
NominalHedge Ratio (Gilts + 1.00%)
20%
Inflation Hedge Ratio (Gilts + 1.00%)
25%
Collateral
Maintain sufficient eligible for meeting collateral requirements that may arise from the Scheme’s current derivative positions over a 1 year period.
Total available eligible collateral
£300m
Remaining collateral after VaR95 event
£200m
Integrating Covenant Into Your Pension Risk Management Framework
30
Status
Metricis at or above target
Metric is within [10%] of target
Metric is more than[10%] away
31. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
What Does This Mean In Practice?
31
Covenant
Investment Strategy
Funding
Covenant strength
Downside protection and management of volatility
Deficit
Contributions
Benefit changes
Security arrangements
Asset backed funding
Cash flows needed to meet member benefits
32. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
How Do We Get The Right Balance Of Growth, Risk Control And Cash Flow Matching?
32
Meeting the Gap
Assets with Cash Flows
Smoothing Volatility
Gilts
Index Linked Gilts
Credit
Equities
Private equity
Risk Parity
VolControlled Equities
Multi-Asset
Illiquid credit
LDI hedging
Secured Leases
33. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
A Shift In Mind Set
33
34. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014
Conclusions
34
Integrate your approach
An integrated approach to managing risk means taking account of employer covenant, funding and investment risk when managing a pension scheme.
Categorised sponsor covenants
The pension regulator has classified sponsor covenants in four levels from Strong to Weak.
Constraints due to weak sponsors
Weak sponsors will lead to significant constraints on risk budgets.
Different levers are available
In order to reduce Contributions atRisk, contributions can be raised or the time horizon extended.
Contributionsat Risk
Contributions at Risk are a useful measure that enables a pension scheme to equate existing risk budgets with risk to the sponsorthrough the potential requirement for additional contributions.
The PRMF
The constraints can be built into an existing PRMF (Pension Risk Management Framework).
Gettingthe balance right
Finding the balance between assets for growth, risk management and cash flow matching.
Mind set
A collaborative approach i.e. a shift inmind set from win-lose to win-win.
36. Teach-In
Dealing with tPR’s New Scheme Funding Code
October 2014 36
The Endgame: What are the Illiquid Credit Opportunities?
ILS: Insurance linked securities
CRE: Commercial Real Estate Debt
