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Scheme funding FAQs

Note: The Pensions Regulator cannot provide a definitive interpretation of the law, we can only express a view. The opinions expressed in our answers are based on general queries and care should be taken in interpreting them in the case of any particular scheme.

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The interaction of Part 3 with scheme rules

What are the regulator’s views in terms of how the requirement under a scheme’s trust deed and rules for triennial actuarial valuations interacts with the legislation under Part 3 of the Pensions Act 2004?

The scheme funding legislation of Part 3 of the Pensions Act 2004 does not explicitly replace the scheme rules requirements in respect of actuarial valuations and funding. And, in fact, section 306 of the Pensions Act 2004 provides that Part 3 is overriding wherever there is a conflict with a requirement of scheme rules.

Nevertheless, the regulator believes that in the great majority of cases, a Part 3 funding valuation is likely to satisfy the requirements of scheme rules.

Last reviewed March 2010

Newly established scheme - initial contribution rate

Would it be acceptable to the regulator for the first formal actuarial valuation of a newly established DB scheme to have an effective date the same as the commencement date of the new scheme?

Unless the scheme is unusual, assets and liabilities are both likely to be nil as at the commencement date of the scheme. Particularly if there is to be a transfer of past service liabilities, it may be better to choose an effective date somewhat later (but within the one year allowed) and after any transfer-in, if possible.

However, it is possible for the transfer to be taken into account where it takes place after the valuation effective date but before the schedule of contributions is certified, where the schedule is to be certified using the 'current date' form of certificate (see FAQ on Forms of certificate).

In any interim period up until completing the first scheme funding valuation and schedule of contributions, we would encourage trustees and employers to put in place a schedule of contributions, having agreed between themselves and the scheme actuary a contribution rate that will be broadly in line with the scheme funding schedule of contributions.

Last reviewed May 2010

Changing the valuation renewal date

Can the trustees choose a different effective date for their next actuarial valuation?

Yes, provided that the new effective date of the valuation is within three years of the effective date of the previous valuation and, before the valuation is obtained, the trustees update the statement of funding principles to reflect the new valuation cycle. The new effective date cannot be more than 3 years from the effective date of the previous valuation. This is a requirement under section 224 of the Pensions Act 2004 and we have no power to extend this period. We may address non-compliance through use of our powers under section 231 of the Pensions Act 2004.

The scheme's subsequent valuation must have an effective date within 3 years of the amended effective date.

Audited accounts will still be required as at the new effective date but there is some flexibility as to the period they can cover (between 6 and 18 months).

Schemes must still obtain actuarial reports for the years between valuations.

Example:

If a scheme's last valuation date was 6 April 2007 but the trustees wish to bring the valuation date into line with the accounting year end of 31 December, it would not be permissible to extend the next valuation date to 31 December 2010. However, it would be permissible to bring the valuation date forward to 31 December 2009.

Last reviewed February 2010

Valuation of insurance policies

Would you please clarify the valuation of insurance policies for Part 3 purposes?

In relation to insurance policies, we interpret regulations 3 and 4 of the scheme funding regulations as follows:

Regulation 3(1)(c) in combination with regulation 3(4) permits the actuary to omit insurance policies from the asset side of the balance sheet and the corresponding liabilities from the liability side if the actuary considers it appropriate.

We suggest that the likely circumstances where it would be appropriate to adopt this approach would be in relation to immediate annuity policies bought in the name of trustees to exactly match pensions in payment.

On the other hand, regulation 4(2) relates to insurance policies which are included in the assets (ie, specifically not excluded under 3(1)(c)). This regulation requires the actuary to place an appropriate value on such policies.

In the case of deferred annuity policies it would be possible to exclude them and the corresponding liabilities using 3(1)(c) and 3(4), but we think it is likely to be more appropriate to include them and invoke 4(2) given that deferred annuities are often allocated in a notional way to individuals and will not generally exactly match the scheme's accrued liabilities at any point in time.

Last reviewed March 2010

Describing assumptions in the statement of funding principles

Is it correct that the statement of funding principles should explain why the trustees have chosen the relevant assumptions, rather than simply stating the assumptions they have made, and that the actuary should be able to use the SFP to determine the assumptions to be used in the annual actuarial report?

Section 223 of the Pensions Act 2004 covers the statement of funding principles. However, the requirements of the section and of regulations made under it do not explicitly refer to principles but rather to decisions made.

Nevertheless, it seems to us that the fact that the statement of funding principles is so titled, does strongly suggest that the document should contain principles rather than simply the bare results of decisions made.

Accordingly, we believe that, in order to comply with the spirit of the legislation and best practice as far as the regulator is concerned, the statement should include an explanation of the trustees’ reasoning behind the assumptions chosen.

The assumptions to be used in the annual actuarial report are those set out in the scheme’s statement of funding principles (SFP) current at the date the actuary prepares the actuarial report, whilst, at the same time, being appropriate to the report’s effective date. In normal circumstances we would not expect the SFP to change between actuarial valuations.

Therefore, it will be more efficient for the valuation assumptions which are likely to be date sensitive (primarily the financial and economic assumptions including inflation and investment return) to be defined in the SFP in such a way that they can be readily interpreted at future dates. This could be achieved, for example, by referencing them to market indices.

Given that the trustees must obtain actuarial advice before preparing or revising the SFP, we would expect the actuary to explain the implications for the preparation of intervaluation actuarial reports if assumptions are defined in a way that would not enable them to deduce their values at future dates.

If the actuary is not able to deduce from the SFP the relevant assumptions for the actuarial report, the trustees will need to revise the SFP appropriately (which would require actuarial advice and usually employer agreement).

Last reviewed March 2010

Assumptions and method in relation to the future service contribution rate

Where a scheme remains open to future accrual, can the attained age funding method be used to calculate the technical provisions, as opposed to the projected unit method, given that the calculation of technical provisions under both methods are identical?

Regulation 5(2) of the Scheme Funding Regulations (SI 2005/3377) specifies that technical provisions must be calculated using an accrued benefits method. As the calculation of technical provisions under the attained age method is identical to the calculation under the projected unit method, the regulator takes the view that, for the purpose of calculating technical provisions, the trustees may select the attained age method.

As far as the contribution rate for ongoing accrual of benefits is concerned, the current funding regime does not explicitly address how it should be derived. In fact, it simply falls out as a consequence of the need for the actuary to be able to certify the adequacy of the schedule of contributions. We would usually expect the standard contribution rate calculated under the attained age method to satisfy the certification requirements.

Last reviewed March 2010

Is it permissible for trustees to select a higher investment return assumption than the discount rate used in setting the technical provisions, for the purpose of assessing the contribution rate for future benefit accrual only?

The trustees may, if appropriate, agree to different assumptions over the term of the schedule to those underlying the technical provisions. Naturally these assumptions would need to be compatible with the trustees' investment policy and would need to be consistent with normal trustee principles of prudence.

Last reviewed March 2010

Certification of a schedule of contributions: The form of the certificate

Please clarify the situations in which the various forms of certification may be appropriate.

The standard form of certification set out in schedule 1 of the scheme funding regulations (SI 2005/3377) is the 'current date' form or that which uses the phrase 'can be expected' (as at the certification date). However, the form which uses the phrase ‘could have been expected’ (as at the valuation date) can be used as an alternative.

For schedules drawn up as a consequence of a valuation (incorporating if necessary a recovery plan), trustees will normally be happy to use the alternative form of certification as at the valuation date. This will not involve the actuary updating calculations to estimate the funding position at the certification date.

However, where a schedule is revised at some other time and hence needs certifying, to base a certification solely on conditions at the valuation date which becomes increasingly historic requires a higher standard of justification. That is why the funding code of practice encourages a discussion between the trustees and their actuary.

Last reviewed May 2010

Effective valuation date around 31 March 2009 - taking account of improvements in the fund since the effective date

For many schemes with a valuation date around 31 March 2009, deficits have significantly reduced to date because the actual asset return has far outstripped the return built into the technical provisions. Can the recovery be taken into account in agreeing the valuation and recovery plan?

Whether trustees choose to take these returns into account or not, and how they do so, is an issue to be addressed in the context of ensuring that technical provisions are adequately prudent given the employer covenant available; and that any deficit is paid off as fast as can be reasonably afforded. These principles remain constant throughout the economic cycle and therefore help ensure that the scheme funding regime is balanced across the cycle.

Technical provisions need to be set prudently and therefore the discount rate or rates assumed must be based on the level of risk that trustees assess can be tolerated by the scheme. A higher discount rate may be used where a sponsoring employer or any contingent assets will easily and reliably be able to make up for any adverse consequences and a more conservative rate otherwise. We will be concerned if it appears that technical provisions have been set on a weaker basis to make a deficit appear smaller.

The legislation does permit allowance for post-valuation developments in recovery plans, but in normal market conditions trustees should be cautious about taking account of upward fluctuations as this may well not be in members' interests. However, given the extreme conditions in March/April 2009, we consider that for some schemes it may be reasonable to take into account some reduction of the deficit in the recovery plan.

This view has been formed in relation to these specific market events, and is not of automatic application to future situations which may develop, which we would consider on their merits. We note that it is also possible to conceive of extremely favourable conditions arising for a short period encompassing a valuation date where trustees would be expected to consider post-valuation changes reflecting a decline in the funding position of the scheme in a consistent manner. Any allowance for post-valuation developments, whether positive or negative, must be in accordance with the scheme's statement of funding principles and in the best interests of members.

Not all trustees will want to make any allowance for post-valuation changes at this time; where improvements in the position are not reflected in this triennial valuation, if the improvement is maintained it will be picked up at the next valuation. The overriding consideration should be that the recovery plan reflects what is reasonably affordable, which should be independent of whether the improvement is considered or not. We would therefore expect any changes to the recovery plan arising from factoring in favourable post-valuation events to affect the length of the plan rather than the level of annual payments.

In practical terms, favourable asset returns may be reflected in the recovery plan and the schedule of contributions by asking the scheme actuary to update figures from the effective date to reflect actual scheme experience. Any change in the value of liabilities must then also be reflected. It will not usually be necessary to revisit the entire valuation in order to do this.

Trustees should be aware that there is a choice over whether the schedule of contributions is certified as at the valuation date or the date of certification (see Form of certification). This arises independently of the question of updating. In some situations it can be acceptable to allow for post-valuation events by using the valuation date form of the certificate but choosing an asset return assumption for the recovery plan which reflects known post-valuation events that could have been reasonably expected at the time. We ask that this is done explicitly, rather than by choosing a higher long-term asset return than would otherwise be appropriate. For example, x+10% return for the first year after the valuation date followed by x% per year thereafter, where the +10% is justified by actual experience, allowing for changes in the value of both assets and liabilities. When submitting valuations and recovery plans to us, any excess out performance that has been assumed for a period should be shown explicitly.

Where parties do not believe that it is appropriate to rely on a certificate based only on figures at the effective date of valuation, then a certificate based on factors at the date of signing should be used. In order to produce this, the actuary will need to update the valuation. This will include the asset returns experienced, changes in the liabilities on account of changing market conditions and the impact of any divergence between the actual contributions paid and extra liabilities accrued since the valuation date. This may of course involve some extra cost.

Trustees and the employer must bear in mind that this is not an opportunity to simply pick the most favourable date for agreeing the recovery plan. Trustees should have a credible justification for the date and assumptions chosen, and be content that the plan is still appropriate and in members' interests in the light of conditions when the schedule of contributions is certified. If conditions deteriorate again it may be necessary to advance the next valuation or conduct an inter-valuation review.

Last reviewed March 2010

Scheme contribution rule and employer agreement

In what circumstances should the employer’s agreement be sought when setting the contribution rate?

The regulator’s code of practice on funding defined benefits confirms that trustees must normally reach agreement with the employer when setting the contribution rate but includes a table showing how the legislation regarding employer agreement is modified where the scheme rules give someone other than the employer power to set the contribution rate and other conditions are fulfilled. This table should be read in conjunction with the entire text relating to the 'spade' flag under paragraph 23 of the code of practice.

Where none of these modifications applies, trustees are required to obtain the employer’s agreement to the various funding matters as set out in section 229 of the Pensions Act 2004.

Last reviewed March 2010

Please can you clarify the factors and considerations that an actuary should take into account when assessing whether he or she is able to certify a schedule of contributions, where the contribution rate is determined by the actuary without the agreement of the employer?

In this scenario, we take the view that the actuary must put him or herself in the shoes of the trustees in assessing 'the rates he would have provided for' when deciding whether a schedule of contributions can be certified, proceeding independently as if he or she were the sole trustee (following the statutory requirements and taking into account the guidance provided by the code of practice on funding defined benefits).

A sensible way of ensuring that the actuary would be able to certify a schedule agreed between the trustees and employer where paragraph 9(5) applies would be to treat the process as tripartite from the outset, and be involved with and agree with all the Part 3 decisions as they are made.

Where information is needed to assess the employer’s covenant and ability to contribute the actuary would need to be comfortable that such information enabled him or her to form a view on the appropriate level of prudence to adopt in the assumptions and the appropriateness of any recovery plan. Any externally commissioned bespoke opinions on covenant should be addressed to both the trustees and the actuary, and it should be made clear to the trustees that if the information obtained by them was not sufficient for the actuary to decide on any matter, the actuary would need to obtain that information and pass on the cost to the trustees.

Last reviewed March 2010

Actuarial certification of the schedule of contributions and prudence

Please can the regulator confirm whether the actuary certifying the technical provisions is also certifying that the assumptions have been chosen prudently?

Paragraph 97 of the regulator's code of practice on funding defined benefits reflects the Government's policy intention that it is the trustees alone (with employer agreement where that is required) who are responsible for interpreting prudence in the circumstances of their scheme.

This would be undermined were the actuary to have a confirmatory role in this regard. We believe the final sentence of the text of the relevant certificate (see Schedule 1 to the scheme funding regulations) makes this clear, which reads:

'The calculation uses a method and assumptions determined by the [trustees] of the scheme and set out in the Statement of Funding Principles dated [date].'

Last reviewed March 2010

Payment of surplus to employer

Does the regulator consider that return of a scheme surplus to the employer can ever be in the interests of the scheme's members?

Legislation allows trustees to consider authorising a payment to the employer if the scheme is fully funded above a 'full buy-out' level, and trustees consider that such a payment is in the interests of the scheme members.

Trustees must have set out in the statement of funding principles the circumstances in which they would consider payment to employers and that payment should be consistent with those circumstances.

Doing so may be in the interest of the scheme members because employers may agree to higher scheme funding objectives, or more prudent assumptions in the knowledge that where investments perform better than expected and extra funds are generated, they may be accessed by the employer.

Trustees should consider carefully any request for a payment at the time it is made in the context of their scheme, particularly their investments and the investment strategy. They should weigh up the potential benefits and detriments of each option for their scheme members and seek to mitigate any potential risks. They should ensure that the legislative requirements (including member and regulator notification) are met and should seek relevant advice where they consider it necessary. In the scheme's next summary funding statement, trustees must also inform members if a payment has been made and, if so, how much.

Last reviewed February 2010

Schedule of Contributions cover period

What period must a Schedule of Contributions cover? Can the period be shorter than five years?

Section 227 of the Pensions Act 2004 and regulation 10 of the Occupational Pension Schemes (Scheme Funding) Regulations 2005 (the Regulations) require trustees to prepare schedules of contributions which show the rates and due dates of contributions payable towards a scheme during the 'relevant period'. The 'relevant period' begins on the date on which the scheme actuary certifies the schedule of contributions and runs for a minimum of five years or, if longer, the remaining period set out in the scheme's recovery plan.

The schedule of contributions cannot cover a period which is shorter than five years from the certification date, even where no contributions are to be paid for some or part of this period. Trustees must prepare the schedule of contributions for the full period and obtain the scheme actuary's certification. The form, content and certification requirements are set out in the regulations and the regulator has no power to vary them. We may address non-compliance through the use of our powers under the Act.

Last reviewed October 2012

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