The Pensions Regulator has today published updated covenant guidance for trustees of defined benefit (DB) pension schemes.
Today’s publication is the last piece of the jigsaw to help schemes carry out valuations under the new DB funding code, which came into effect on 22 September 2024.
TPR said the new guidance provides the market with greater certainty over how the regulator expects trustees to assess their employer covenant. It embeds good practice and encourages consistency across schemes.
All core sections of the revised guidance contain important new elements looking at cash flow, reasonable affordability, maximum affordable contributions, reliability period, covenant longevity, and contingent assets.
The areas of covenant assessment that require the highest level of judgement from trustees now include several worked examples. On contingent assets, there is a focus on how trustees can ensure the support needed for the scheme is provided when required.
There is also an increased focus on proportionality of covenant assessments to ensure trustees consider the right level of detail, based on the covenant support provided and the scheme’s position.
TPR said it expects trustees to use this guidance to review whether their existing covenant analysis is focused in the right areas and remains proportionate, especially if they have experienced a significant change in their scheme funding position in recent years.
“For the first time, employer covenant is defined in regulation”
Neil Bull, TPR’s executive director of market oversight
TPR’s executive director of market oversight, Neil Bull, said: “Today’s publication is the last piece of the jigsaw to help schemes carry out valuations under the new DB funding code. For the first time, employer covenant is defined in regulation.
“It’s vitally important that schemes understand that the risk taken on the journey plan to their low dependency target in their funding and investment strategy is supportable by the employer.”
Bull said that for many this will “bake in best practice” but the regulator expects all trustees to read applicable sections of the guidance in full and make sure their members are protected.
David Brooks, head of policy at Broadstone, welcomed the publication of the “missing link” to complete the funding code.
He said: “Trustees, schemes and their advisers now have full guidance on how the regulator will expect them to assess employer covenant with the aim of developing a consistent approach across the market.
“The latest guidance carries on in a similar vein to the wider funding code as good schemes will already have a handle on their covenant albeit may need to refine their metrics and monitoring.”
Brooks said that for others, the guidance should be the prompt they need to ensure good understanding of their covenant and the ability to support long-term strategy.
He said: “The sense of proportionality was noted along with the relevance of scheme size (in absolute and relative terms) together with the reliance on the sponsor.”
Balance needed
Katie Lightstone, pensions employer covenant and restructuring partner at PWC, said the trustees will need to find a balance between the application of over 100 pages of further guidance and the varying requirements for the Statement of Strategy, when in many cases schemes are “already well-funded with a sensible existing long-term strategy”.
She said: “An area of particular interest is how the guidance addresses various non-standard guarantees, many of which have been hard-won by trustees. The guidance requires trustees to have ‘reasonable certainty’ over the value of a guarantee, particularly when it is not a ‘look-through’/full solvency guarantee.”
She said this requirement is likely to increase the burden on schemes to carefully evaluate and justify the value attributed to such guarantees.
“Trustees grappling with ‘reasonable certainty’ over covenant reliability may find the case studies helpful, but must still weigh a broad range of factors—from market outlook to net-zero transition risks,” she continued.
“With all schemes legally required to assess and confirm that their covenant is ‘adequate’ for the scheme’s risk levels, the key will be to approach the exercise sensibly and in a practical way which is helpful on an ongoing basis,” she said.
Lightstone said PWC expects the new covenant approach to spark deeper conversations between sponsors and schemes.
She explained: “Sponsors will need clarity on key covenant metrics to inform their own position in funding discussions, and we anticipate more sponsors may set out their own conclusions for trustees to ‘diligence’.”
Alex Beecraft, head of covenant and security at Aon, said the new guidance confirms a regulatory shift in how the health of the sponsor is measured and its strategic implications.
“Change always brings unexpected consequences and stakeholders should engage early with the new requirements to understand their impact and set the agenda for future negotiations,” he noted.
Beecraft added that sponsors will have to “grapple” with increased information sharing requirements while trustees will need to clarify how undertakings such as guarantees support their scheme.
He continued: “As more schemes explore endgame choices, covenant advice will become central to these decisions. For the many sponsors that can demonstrate a sufficient expected lifespan, near-term insurance is not the only option for trustees to deliver financial security to their members. This has the potential to improve outcomes for members and sponsors alike.”
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