On 27^th April, The Pensions Regulator (TPR) published its Annual Funding Statement setting its expectations of trustees and sponsors for the year ahead.

The Annual Funding Statement appears to factor in some of the feedback on the draft Funding Code, providing more nuanced commentary on covenant and integrated risk management.

Please see our key takeaways below.

1. Warning against covenant complacency

TPR’s warning against covenant complacency is very valid. While many schemes have benefitted from recent improvements to scheme funding levels, this could change, and in many cases, macroeconomic factors are continuing to put sponsors under pressure.

2. Tailor your covenant advice to your circumstances

The Annual Funding Statement stresses the importance for trustees to tailor how they look at covenant to reflect their scheme’s circumstances. This reflects our long-held view that covenant analysis should evolve as a scheme progresses along its journey. For example, the shift of focus from recovery plan affordability to longevity of covenant for well-funded schemes is an important development in covenant thinking.

3. Think about the sponsors’ refinancing risk

The Annual Funding Statement specifically calls out the need to consider re-financing risk in covenant assessments, information sharing agreements and monitoring as it could impact future covenant support, restrict management actions and / or affect the scheme’s position as a creditor. We recently published our perspective on this topic.

4. Consider carefully before agreeing to reduce contributions or release contingent assets

The Annual Funding Statement recognises sponsors may ask trustees to reduce contributions or release contingent assets where schemes have become well-funded, or in cases of distress. TPR urges trustees to carefully consider any such request in light of scheme and covenant risks, noting improved funding levels could reverse if not locked in.

5. Having the right investment portfolio structure is crucial ahead of de-risking

The Annual Funding Statement recognises that many UK defined benefit pension schemes are ahead of plan, close to buy-out and maybe considering approaching the insurance market for settlement. Different approaches to de-risking and the suggestion to have an ‘insurance-ready’ portfolio are highlighted. We agree with this; as schemes seek access to the insurance market, having the right investment portfolio structure is crucial. But, ‘insurance-ready’ is only the broadest description of what can be done.

Having a segregated LDI portfolio that works alongside a scheme’s cash matching assets; is precisely rebalanced and is managed to an insurer’s price-lock will provide schemes with improved cost-efficiency, minimised basis risk and reduced execution risk. In contrast, the AFS noted the drawbacks of pooled LDI funds that came into focus during the gilts market crisis of 2022.

Please get in touch with us to discuss how we can help you.