Recovery plans

This code of practice applies to activities related to valuations with effective dates on and after 22 September 2024. For activities related to valuations with effective dates before 22 September 2024, refer to the 2014 DB funding code (PDF, 401kb, 51 pages).

1. When the scheme is in deficit on a technical provisions (TPs) basis as at the effective date of a valuation, trustees must put in place a recovery plan (or review or revise the existing plan) to restore the scheme to full funding on a TPs basis. They should set out the period over which this will be achieved.
2. In addition to complying with the matters set out below, a recovery plan must be appropriate, having regard to the nature and circumstances of the scheme. In determining whether a recovery plan is appropriate, trustees must follow the overriding principle that steps must be taken to recover deficits as soon as the employer can reasonably afford. Trustees should assess future reasonable affordability at least on a year by year basis, with steps taken to reduce the deficit set in line with this assessment. This is discussed in more detail in the section on reasonable affordability and the pace of funding below.
3. The matters that trustees must consider are:
   1. the impact of the recovery plan on the sustainable growth of the employer
   2. the asset and liability structure of the scheme
   3. its risk profile
   4. its liquidity requirements
   5. the age profile of the members
   6. in schemes where (a) the rates of contributions payable by the employer are determined under the scheme rules in accordance with the advice of a person other than the trustees (for example, the scheme actuary), and (b) the employer’s agreement is not required, the recommendations of that third-party must be taken into account
4. Trustees should follow our general principles and expectations below for determining the appropriateness of a recovery plan, which take the first five matters into account. Where appropriate, the trustees must also consider factor 3 (f) as they are determining the recovery plan.

General principles and expectations

5. When determining the appropriateness of their recovery plan, trustees should consider:
   1. the employer’s reasonable affordability
   2. whether to allow for investment outperformance
   3. whether to account for post-valuation experience
6. In practice, these factors are inter-related but can be considered in reverse order.
   1. If the trustees allow for post-valuation experience, this may change the deficit the recovery plan has to address.
   2. If the trustees allow for investment outperformance, this may reduce the deficit the trustees need to be made good via contributions from the employer.
   3. The deficit (or remaining deficit, if both or either of the above steps have been taken) that has to be recovered is subject to the overriding principle that steps must be taken to recover deficits as soon as the employer can reasonably afford.

Post-valuation experience

7. Post-valuation experience refers to the experience that has already happened between the valuation date and the date of finalising the recovery plan (which may be up to 15 months later under legislation). Actual changes in financial markets and their impacts on both investment returns and scheme liabilities will be known and measurable by the date the recovery plan is finalised, as well as other aspects of the scheme’s funding.
8. Trustees can take post-valuation experience into account in the recovery plan. If they choose to do so, they should:
   1. take account of favourable and unfavourable changes
   2. consider changes to scheme assets, scheme liabilities and covenant, including any changes to the assumptions that should be used to calculate the liabilities
   3. assess changes over the bulk of the period since the effective date of the valuation
   4. consider taking only a proportion of the post-valuation experience into account given that some of it could reverse before the next valuation due to the volatile nature of the underlying items
9. Trustees should consider whether it is appropriate to take a different approach to post- valuation experience than that adopted in the previous valuation.

Investment outperformance

10. Trustees may make allowance for investment outperformance in the recovery plan, meaning they may assume higher investment returns over the recovery period than has been assumed in the discount rates used to calculate TPs. This has the effect of reducing the part of the deficit that has to be made good via deficit repair contributions (DRCs).
11. If the scheme assets fail to achieve the higher return assumed, the deficit will not reduce as expected, and higher DRCs than planned for may be required in the future. Allowance for investment outperformance in the recovery plan could, therefore, remove some or all the prudence in the overall funding strategy, increase funding risk and reduce transparency around how much risk is being taken or assumed.
12. Before the relevant date, investment outperformance should only be allowed for to the extent it is supported by the employer covenant and is consistent with the principles of taking supportable risk over the journey plan, except where there is an ‘Inability to support risk’ as described in the investment and risk management considerations module of this code applies.
13. We would expect that the level of the investment outperformance and how long it is allowed for during the recovery plan should reflect no more than the best estimate return of the expected asset strategy over the period of the recovery plan. This would include allowing for any planned de-risking. However, we would generally not expect that any investment outperformance should be allowed for after the reliability period, unless the scheme has a sufficient employer covenant to support it.
14. The DRCs must be determined using the principle of reasonable affordability, as discussed below, and the timing and amount of those DRCs will determine how much of the deficit must be made good by DRCs when allowing for investment outperformance. Therefore, these factors are closely interrelated and we would expect trustees in many cases will need to consider the impact of investment outperformance in tandem with their assessment of reasonable affordability.
15. Once a scheme reaches its relevant date, we expect trustees to be running a prudent level of risk in their investment strategy, in line with a low dependency investment allocation. This will help limit any future reliance on the employer covenant. Given this, we would expect any investment outperformance in a recovery plan post significant maturity to be small.

Reasonable affordability and the pace of funding

16. The deficit shown in the valuation (subject to post-valuation experience and investment outperformance adjustments, where relevant) must be recovered as soon as the employer can reasonably afford.
17. Trustees should assess future reasonable affordability at least on a year by year basis, with steps taken to reduce the deficit set in line with this assessment.
18. There are three considerations to take into account when determining what contributions the employer can reasonably afford.
    1. Assessing the employer’s available cash.
    2. Assessing the reliability of the employer’s cash flows.
    3. Determining whether any of the available cash could reasonably be used by the employer other than to make contributions to the scheme (known as reasonable alternative uses).

Assessing available cash

19. Trustees should assess an employer’s available cash by aggregating:
    1. the employer’s cash flow (see assessing the employer’s current and future cash flow for more details on this), and
    2. its liquid assets
20. Liquid assets for these purposes are balance sheet assets after reasonable working capital requirements that can be readily converted into cash. For example, cash, intercompany debtor balances that relate to pooled or swept cash, proceeds of debt or equity raises to the extent that these are on the balance sheet and not already factored into cash.

Assessing the reliability of the employer’s cash flows

21. When determining an appropriate recovery plan, we expect trustees to consider the extent to which they have reasonable certainty over the employer’s cash flows to fund the scheme (the reliability period). The assessing the reliability period and covenant longevity section of the employer covenant module provides details on how we expect trustees to assess the reliability period.
22. Where a recovery plan extends beyond the reliability period, there is an increased risk that the employer may not have sufficient available cash to meet the funding needs of the scheme.
23. The reliability period is therefore key in determining the reasonableness of alternative uses of cash, as discussed below, which in turn will determine an appropriate pace of funding and recovery plan length.

Determining reasonable alternative uses of cash

24. The legislation does not necessarily require the entirety of an employer’s available cash to be used to pay down the deficit. The extent to which available cash may reasonably be used for purposes other than to pay down the scheme’s deficit depends on the circumstances of the scheme and the employer.
25. Trustees will typically have to consider three types of alternative uses for an employer’s available cash:
    1. Investment in sustainable growth
       1. This involves the employer using available cash to finance investment in its business.
       2. Sustainable growth refers to the growth a business could realistically achieve and maintain without creating a heightened risk of running into difficulty.
    2. Covenant leakage
       1. Covenant leakage occurs when available cash leaves the employer in situations where no clear return of monetary value is due.
       2. Examples of covenant leakage are distributions to shareholders or intercompany loans that are unlikely to be paid back.
    3. Discretionary payments to other creditors
       1. Discretionary payments are made when the employer elects to make payments to creditors other than the scheme at a time when those payments aren’t due. An example of a discretionary payment is the early repayment of a loan.
       2. Discretionary payments may be balance sheet neutral. However, they likely favour other creditors over the scheme (by exposing the scheme to the risk of available cash not being as reliable as expected) and will, therefore, only be a reasonable alternative use of cash in limited circumstances.
26. A fourth, less common type of alternative usage for available cash is making contributions to other defined benefit (DB) schemes sponsored by the employer. Although these payments may already be agreed under a schedule of contributions, if available cash is not allocated fairly between DB schemes, one scheme might be favoured over another.
27. Employers may identify other alternative uses of cash beyond what is set out above. We would expect employers to fully evidence and justify why the alternative uses are reasonable and should be preferred to repaying the scheme’s deficit. When assessing the reasonableness of these alternative uses, trustees should apply the same principles as discussed below and ensure that their approach is well documented.
28. When assessing the reasonableness of the employer’s alternative uses for available cash, trustees should pay particular attention to the:
    1. sustainable growth of the employer
    2. scheme’s funding level and level of funding risk
    3. reliability of available cash in the future
    4. maturity of the scheme
    5. fairness of treatment between the scheme, other creditors and shareholders
29. With this in mind, we would expect trustees to adopt the following reasonable affordability principles:
    
    

    In general, investment in the employer’s sustainable growth may be a reasonable use of available cash where the trustees are confident of the resulting benefit to the scheme and employer.

30. Where the employer is proposing to use some of its available cash to finance investment in sustainable growth, trustees should obtain from the employer clear and persuasive evidence around how the proposed investment will produce the anticipated sustainable growth and ensure they understand the risks and benefits to the employer’s business and the scheme.
31. The level of information provided by the employer and the complexity of the trustees’ assessment should be proportionate to the amount of available cash to be utilised in the investment. This is particularly important where this results in the recovery plan exceeding the reliability period, where there is a higher level of risk or underfunding in the scheme.
32. Where investment in sustainable growth results in the recovery plan exceeding the reliability period, this investment will generally be reasonable where the following apply:
    1. The benefits of doing so to the employer and scheme are reasonably certain; or
    2. A suitable contingent asset is obtained that:
       • meets the relevant criteria of a contingent asset as set out in the section on contingent asset support in the employer covenant module; and
       • is sufficient in value to cover at least the expected remaining deficit at the end of the reliability period generated by the investment in sustainable growth, and the trustees are reasonably certain that they will be able to access this value during the recovery plan period should the employer not be able to meet its obligations under the recovery plan
33. The use of available cash for sustainable growth will become less reasonable:
    1. the lower the scheme’s funding level
    2. the more mature the scheme
    3. the greater the level of risk being run
    4. the longer the extension to the recovery plan; and
    5. where no contingent asset is provided or where it does not meet the criteria of being a suitable contingent asset, as set out in the contingent asset support section of the employer covenant module
34. Once the scheme has reached significant maturity, DRCs should be prioritised over the use of available cash for investment in sustainable growth where the trustees are not confident that this investment will result in growth within a period consistent with the scheme’s liability profile.
    
    

    The lower the funding ratio and the more funding risk, the less reasonable it will be to use available cash for discretionary payments or to effect covenant leakage

35. Where a scheme has a lower funding level, the scheme is choosing to take more funding risk by adopting a less prudent funding basis, or both of these apply, the risks to the scheme are increased. We recognise these issues are interlinked and should be considered holistically.
36. For example, a scheme before the relevant date adopting its low dependency funding basis for TPs might be underfunded on that basis. However, if the scheme were to adopt a less prudent funding basis that was still supportable by the employer’s covenant, then it would be better funded (and possibly even fully funded) on that less prudent basis. Nonetheless, adopting the low dependency funding basis for its TPs, where the scheme would have a lower funding level, is likely to be the lower risk strategy overall.
37. Where the funding risks to the scheme are higher, we expect the scheme to receive more of the available cash by way of DRCs rather than for it to be made available for discretionary payments or to effect covenant leakage. If the scheme is running risks that are not supportable (according to the principles and approach set out in the journey planning module), then we would not expect any discretionary payments or covenant leakage. As the funding level improves or the level of funding risk declines, the use of available cash for those purposes is more likely to be reasonable (subject to the other applicable reasonable affordability principles).
    
    

    Available cash should not be used for discretionary payments or to effect covenant leakage where this would require DRCs to be paid after the reliability period

38. Trustees cannot be reasonably certain that cash will be available to pay DRCs beyond the reliability period. Covenant leakage and discretionary payments are unlikely to be reasonable alternative uses of available cash if that would result in DRCs being required outside the reliability period.
39. Trustees may consider the use of available cash to make such payments to be reasonable if a suitable contingent asset is provided. In addition to meeting the relevant criteria for a contingent asset as set out in the section on contingent asset support in the employer covenant module, the contingent asset should cover at least the expected deficit remaining at the end of the reliability period. The trustees should be reasonably certain that they will be able to access this value during the recovery plan period if the employer can’t meet its obligations under the recovery plan.
    
    

    The more mature the scheme, the greater the need for available cash to be paid to the scheme in the near term

40. As a scheme approaches significant maturity, the use of available cash to make discretionary payments or to enable covenant leakage is less reasonable. This is particularly the case if it could lead to DRCs being insufficient to enable the scheme to be fully funded on a low dependency basis by the time the scheme reaches significant maturity.
41. Once the scheme has reached significant maturity, DRCs should be prioritised over the use of available cash to make discretionary payments, enable covenant leakage or to invest in sustainable growth if the trustees are not confident that this investment will result in growth within a period consistent with the scheme’s liability profile.
    
    

    Allocation of available cash between DB schemes sponsored by the employer should be fair, considering the position of those schemes

42. Each scheme sponsored by the employer will have a particular need for cash contributions, considering the respective funding levels and proximity to the respective relevant date.
43. Trustees should request information in relation to the other schemes sponsored by the employer to understand the extent of other schemes’ reliance on the covenant and to assess fair treatment.

Dealing with short-term employer affordability constraints

44. Trustees should assess future reasonable affordability on at least a year by year basis, with DRCs set in line with this assessment, even if this leads to an unusual recovery plan structure.
45. Back-end loaded recovery plans are therefore only acceptable where trustees:
    1. can evidence that annual DRCs are set in line with the reasonable affordability principles; and
    2. consider with reasonable certainty that the higher level of DRCs factored into the recovery plan will be affordable in the later years and that no more is reasonably affordable in earlier years
46. Where available cash is limited in the short term, we would expect the trustees to take steps to manage this risk such as:
    1. requesting DRCs to be prioritised ahead of covenant leakage and discretionary payments
    2. seeking further protections where available, such as security or a guarantee, to mitigate the short-term risk of not receiving cash or receiving less cash into the scheme

Guarantors

47. Where a third party has provided a look-through guarantee, trustees should additionally assess the reasonable affordability of DRCs to the guarantor.

Employers’ obligations

48. We expect employers to provide trustees with the information they require to enable an assessment of reasonable affordability.
49. Where the employer wishes to use available cash to invest in sustainable growth, the employer should provide sufficient information to the trustees so they can make an informed assessment of the risks and potential benefits to the employer and the scheme.
50. This is particularly important where an appropriate contingent asset has not been provided and where:
    1. the investment in sustainable growth results in the recovery plan exceeding the reliability period; and/or
    2. the scheme’s funding level is low, and/or
    3. more funding risk is being taken

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