Scheme Funding Fraser Low & Vassos Vassou ACA - 25 May 2006

1. Scheme FundingFraser Low & Vassos Vassou ACA - 25 May 2006

2. This presentation • Not a comprehensive overview of the legislation or the code of practice • Aspects of particular interest to actuaries • The Regulator’s “Statement” • Contingent assets

3. The new regime • Part 3 of the Pensions Act 2004 • The scheme funding regulations (SI 2005/3377) • The Regulator’s code of practice • Other Regulator guidance • The Regulator’s Statement

4. Consultation document Underlying principles: • protecting members • scheme specific • risk based • proportionate • preventative • practicable • referee not player

5. What people said – trigger approach • Need for filters was widely accepted • Triggers may become targets • Lack of clarity around the triggers • Suggestion for triggers to be more directly related to prudent assumptions

6. What people said – trigger approach • Triggers should reflect scheme specific matters, particularly: • scheme maturity • sponsor strength • and allow for equity exposure • Triggers are there to manage workload; it’s the judgments that count

7. What people said – technical provisions triggers • Benchmarks received mixed reception • Some advocated having a single trigger of the section 179 valuation of PPF benefits • Others criticised s179 as valuing the wrong benefits and being purely gilt based • Some criticised FRS17 as being purely bond based and an employer accounting measure • Many criticised buy-out as an unreliable standard on which to base triggers • Some considered the 70% buy-out to be too high for immature schemes with strong employers • Some expressed concern over creating surplus which is difficult to recover

8. What people said – recovery plan triggers • Many thought 10 year trigger too short • Some considered it was reasonable as long as it is only a trigger • Views differed over whether strong employers should have shorter or longer time to pay off a deficit

9. Statement • How the Pensions Regulator will regulate the funding of defined benefits • Published 4 May • One clear message: • Any triggers we adopt are not to be seen as trustee targets

10. Regulator’s approach (1) • Promote understanding by trustees, employers and their advisers of the matters they should consider when deciding on a funding plan • Intervene “where the funding objective is imprudent or the recovery plan is inappropriate

11. Regulator’s approach (2) • Provide transparency about the ways resources will be focused on schemes likely to pose the greatest risks • Recognise that a healthy ongoing business is in the best position to support a DB scheme

12. Statement- changes made • Aligned text to final version of code • Removed ambiguities & made more succinct • Emphasised triggers are a first filter not targets • Reduced role of solvency to “sense check” • Removed reference to range of 70% - 80% • Stated strength of technical provisions is more important than a shorter recovery plan

13. Statement – changes made • Indicated that will not focus on recovery plans shorter than 10 years • Recognised investment return assumptions in recovery plan can allow equity out-performance • Added a trigger to identify inappropriate return assumptions • Provided more information on the process after triggering

14. Triggers • Technical provisions – set between s 179 and FRS 17 / IAS 19 according to maturity and employer’s strength with buy-out only a “sense check” • Recovery plan • 10 years • Back-end loading • Inappropriate assumptions

15. Contingent Assets

16. Contingent assets • Guidance to trustees on TPR website • There to help trustees considering using CAs • Help trustees ask right questions • If trustees rely on CA, it should satisfy guidance • General principle • Regulator does not wish to restrict trustees if they believe the inclusion of a CA will improve security of benefits

17. Contingent assets • Regulator’s guidance and PPF’s guidance • Consistent but not the same • PPF’s guidance • Insurance principles • Quantum of risk and probability of risk materialising • Reduction in risk leads to reduction in levy • Regulator’s guidance • Funding not a precise concept • Judgement is essential

18. Contingent assets • Regulator’s guidance and PPF’s guidance • Differences may arise because: • Definition of contingent event • Size of deficit the contingent asset is supporting • The term of the contingent asset • Should not assume that if contingent asset is suitable for scheme funding it is suitable for PPF levy (and vice-versa)

19. Examples of contingent events Technical provisions: • Assets under-perform assumptions used for technical provisions • Investment in return-seeking assets or assessment of excess returns • Funding level falls below pre-determined limit Recovery Plan • Employer fails to pay contributions due • Employer insolvency during term of recovery plan • Back-end loading or extended recovery plan

20. Types of contingent assets • Security over cash, property, securities • Group company guarantee • Letter of credit or third party guarantee • Not an exhaustive list

21. What trustees should consider (1) • Cash paid to scheme normally preferable • Employer’s reasoning for using a CA • Partnership between trustees and employer • Will this help keep the employer viable? • Is agreement legally binding? • Proposed pace of funding • Size of deficit vs value of contingent asset • Effect on technical provisions and/or recovery plan

22. What trustees should consider (2) • Documentation and legal enforceability • Independence and qualification of legal advice • Financial strength of counterparty • At least AA- • Quantum of contingent asset • Not to double count • Effect on cash flows • Employer related investment

23. What trustees should consider (3) • Contract subject to law of an OECD country • Contingent asset is appropriate and fit for purpose • Flexible and realisable • Regular review of role of CAs in funding strategy • Interaction with triggers.

24. Response/questions