Pensions Essentials - January 2025

For the first time regulations define employer “covenant”.  It is the financial ability of the employer to support the scheme together with any legally enforceable contingent assets. When assessing covenant, trustees are required to consider “the cash flow, and expected future cash flow, of the employer” as well as “other matters which are likely to affect the employer's future ability to support the scheme including but not limited to the performance, future development and resilience of the employer's business, and the likelihood of an insolvency event occurring in relation to that employer”. The trustees will also need to consider how long they can be reasonably certain that they can rely on this assessment and how long they can be reasonably certain that the employer will be able to continue to support the scheme.

The level of risk that can be taken in relation to the calculation of liabilities along the scheme’s journey plan is dependent on covenant strength and the new strategy statement which must be submitted after each valuation must contain the assessment of covenant and how long it is reasonable to rely on the assessment. 

TPR’s covenant guidance sets out its expectations in relation to this covenant assessment. The guidance is intended to help trustees “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”. In addition, it expects “all trustees to read applicable sections… in full and make sure their members are protected”.

The guidance is broken down into 9 parts:

• General: The DB Funding Code says that TPR expects DB scheme trustees to “assess covenant support at each valuation. However, the required depth, and frequency thereafter, of an assessment should be proportionate to the circumstances of the scheme and employer.” The guidance considers the factors to take into account when determining the frequency and detail of covenant assessments, including size of scheme, funding level, maturity and size of employer. It also considers when a professional covenant assessment is likely to be required.
• Identifying the employers: The covenant review should focus on entities with a legal obligation to support the scheme. Where there are multiple employers, the guidance considers whether trustees need to assess the covenant of each employer, some of them or carry out an aggregate assessment. As part of the decision-making process, trustees will need to determine whether the scheme is a last man standing scheme or has partial winding-up provisions which will require legal advice. In a last man standing scheme, it may be appropriate to focus on the employers with the largest liability share. Where a scheme has partial wind-up provisions, reviewing covenant on an aggregated basis may risk overstating it.
• Assessing cashflow: The covenant assessment should consider the employer's cash flow available to meet any deficit repair contributions and support any investment risk. Cashflow for these purposes is the free cash after taking account of reasonable operational and committed finance costs (e.g., utility costs, maintenance and staff costs), but before deficit repair contributions or other reasonable alternative uses of cash (e.g. investment in sustainable growth; covenant leakage such as dividends; and discretionary payments to other creditors). Trustees need to understand management's forecasting assumptions and be able to understand and challenge the forecasts. 
• Employer prospects: Assessing the employer's prospects and insolvency risk will help trustees to understand the extent and duration of reliance that can be placed on covenant. The assessment should also highlight the risks of that support deteriorating. This involves looking at things like market outlook, market position, ESG issues and changing consumer demand. Where the employer has operational or financial links to the wider group, it may be necessary to extend the assessment of prospects beyond the employer. Trustees should also understand how an employer fits within its corporate group and how contagion from elsewhere in the group could affect it as well as the potential outcome for the scheme on insolvency.
• Covenant reliability and longevity periods: Trustees should assess the reliability period, which reflects how long they have reasonable certainty of the employer's cash flow to support the funding needs and investment risk of the scheme. The assessment of reliability should be proportionate. TPR expects that most employers will only have reliability in relation to cash flow for 3 to 6 years. They should also determine how long they expect the employer to continue to support the scheme. For most employers, reasonable certainty over covenant longevity will not exceed 10 years.
• Contingent assets: To factor contingent asset support into the covenant assessment, trustees must reasonably expect a contingent asset to be legally enforceable and provide the specified level of support when required. Legal enforceability is determined by the terms of the relevant agreement and the applicable law.
  
  The guidance considers how trustees should assess various forms of contingent asset. It differentiates between “look through” and other guarantees. A “look through” guarantee has a number of specific characteristics including a mechanism for trustees to look through to the guarantor's cashflows when setting contributions and allows the trustees to assess the guarantor as if it was a statutory employer. If the conditions for a look through guarantee are not satisfied, the trustees will need to assess the level of risk that the guarantee can support.
• Recovery plan: Where a scheme is in deficit on a technical provisions basis, a recovery plan must be put in place to recover the deficit as soon as the employer “can reasonably afford”. When determining reasonable affordability, trustees should consider the employer's available cash (cash flows and liquid assets) and the reasonableness of other alternative uses of cash (e.g. investment in sustainable growth, covenant leakage such as dividends and discretionary payments to other creditors). The guidance considers when using cash for these alternatives is likely to be reasonable. Covenant leakage and discretionary payments are less likely to be reasonable the closer the scheme is to reaching significant maturity and once a scheme has reached significant maturity, deficit repair contributions should generally be prioritised except in relation to investment in sustainable growth.
• Supportable risk: The funding and investment strategy should set out the scheme’s journey plan towards not being reliant on employer covenant. Funding and notional investment risk should be “supportable” and take into account available covenant support and the maturity of the scheme. When assessing supportable risk, trustees should consider maximum affordable contributions over the reliability period and the guidance provides factors to consider when assessing this.
• Monitoring: Trustees are expected to monitor the covenant throughout the lifetime of a scheme. The frequency and depth of monitoring should be proportionate to the circumstances of the employer and the scheme, but TPR expects updates to be at least annual. 

There is a lot in the covenant guidance and trustees should test existing processes against TPR’s expectations and identify where additional information and assessment may be required. They should also consider the degree of reliance that can be put on any contingent assets and the extent to which they can support additional risk taking. The concept of a “look through” guarantee is a new one and both trustees and guarantors will want to assess existing guarantees to determine if they satisfy the criteria and whether trustees are able to assess the availability of guarantor funds when determining scheme contribution rates. 

As we reported in our November 2023 edition, the Economic Crime and Corporate Transparency Act 2023 contains a number of provisions which are designed to stop the use of complex corporate structures to conceal economic crime and to improve corporate transparency. Once in force, this will include a requirement for all new and existing company directors and individuals who are “persons with significant control” to verify their identity. If this requirement is breached, both the individual and the company will have committed an offence. Identify verification can be carried out either directly by the registrar of companies, or an authorised corporate service provider.

More details of identity verification are set out in new regulations which set out the procedure that must be followed for identity verification. An application will need to contain an individual’s name and date of birth as well as additional information required in rules to be issued by the registrar. These rules have been issued in draft and envisage that individuals needing to register will provide documentation such as either a UK passport or driving licence – although alternatives are specified where an individual does not have such documentation. Once the registrar has verified an individual’s identity, they will be issued with a unique identifier. 

The key provisions of the regulations are not yet in force but the Government has said that from 25 March 2025, individuals can voluntarily verify their identity and that there will be a range of support and services to help them.

This process will apply to directors of pension scheme trustee companies and “persons with significant control” (“PSCs”). Details of who the PSCs are for a company will have been set out in the annual confirmation statement filed at Companies’ House. However, if you are unclear about who PSCs are, there is detailed Government guidance which can help. 

As there are potential criminal sanctions for non-compliance with required deadlines, companies, individual directors and PSCs need to keep an eye out for final deadlines or consider voluntary identification verification from March 2025.

Virgin Media update: By way of reminder, between 6 April 1997 and 6 April 2016, schemes could contract members out of the second tier of the state pension on a “reference scheme test” basis which meant that the scheme had to provide benefits at least broadly equivalent to a “reference scheme”. The actuary needed to certify that a scheme continued to meet the reference scheme test every three years and provide confirmation (in accordance with section 37 Pension Schemes Act 1993) when an amendment was made that it continued to be satisfied (although the nature of the confirmation changed over time).

In July 2024, the Court of Appeal confirmed that where actuarial confirmation was not obtained in relation to pre 6 April 2013 amendments, amendments in relation to both past and future service would be void, irrespective of whether they might have been in the members’ interests. 

This has resulted in schemes doing audits of historic amendments and, across the industry, it is clear that actuarial confirmations cannot now be found in all cases for such amendments. 

On 17 December 2024, the Association of Pension Lawyers, Association of Consulting Actuaries and Society of Pension Professionals published a joint statement saying they were continuing to work with and provide information to DWP in relation to the potential impact of the decision. In their view, the Government should make regulations that would "enable the validation retrospectively of any amendment that is held to be void solely because either a written actuarial confirmation was not received before the amendment was made, or where such a confirmation cannot now be located" and the statement indicated that the form of such regulations continues to be discussed with the DWP. There is however no indication as to what DWP’s views are or whether any regulations are likely to be forth coming or in what time frame.

In addition, a case (Verity Trustees v Wood) is due to be heard in February which may shed light on practical questions in relation to missing actuarial confirmations and the evidence that might demonstrate the existence of confirmation. 

GMPs: In a recent Ombudsman determination, a member who had transferred out of the scheme in 1991 asked the trustees on a number of occasions since 2020 to confirm the amount of his equalised GMP. The trustees replied that they were dealing with the matter but had limited data in relation to benefits that were transferred out 30 years ago. The member complained about delays in confirming whether his transfer payment would be uplifted and the lack of data.

The Ombudsman concluded that “This is a difficult and complicated project, and it is important to ensure it is carried out correctly. Therefore, although it should not be unnecessarily delayed, it is understandable that it will take a reasonable period of time to implement. I do not find that the project has, at this point, been unreasonably delayed.”

In relation to the lack of data about a 1991 transfer, the Ombudsman said: “While I acknowledge [the] concern that the Trustee records appear to be incomplete, on the other side of the coin I also acknowledge that [the member] transferred out of the Scheme some considerable time ago and that, in any event, the amount of data kept in respect of past transfers is limited”. In addition, the member could not show that he had suffered any loss as a result of the missing data.

The trustee had agreed to keep the member updated about the equalisation project and had failed to do so, so the Ombudsman award him £500 for distress and inconvenience. 

This decision will come as a relief to the many schemes that are still in the midst of their GMP equalisation projects.

Scheme return for DB and hybrid schemes: TPR has added new questions to the scheme return, which for most schemes will need to be submitted by 31 March 2025. The new questions are on:

• Data quality: Whether the scheme has measured common or scheme-specific data in the last 12 months, considered reviewing data quality, how often trustees review data and what their data score is. This additional data will help schemes ensure that they are dashboard ready and comply with TPR’s expectations in the General Code.
  
  It might be helpful to note that the Pensions Administration Standards Association (PASA) has released new guidance on Data Scoring. The guidance is designed to support trustees and providers “in achieving higher data standards while aligning with broader industry expectation”. It recommends annual testing of member data.
• Scheme membership: Details of the number of members with DC, DB and both DB and DC benefits to enable TPR to calculate the general levy for the year from 1 April 2025.
• Investment consultancy providers: Whether trustees have set strategic objectives for investment consultants, when performance was last reviewed against these objectives and when the objectives were last reviewed or if there has been no review, why not. 

TPR annual report and accounts: TPR’s annual report and accounts for 2023/24 show that 70% of members are now in schemes covered by relationship supervision and TPR has targeted a quarter of schemes for intervention (although the nature of that intervention is not specified). TPR suggests that this demonstrates its “dynamic market oversight to respond to a pensions landscape of fewer, larger schemes [which]… enabled it to address emerging risks, while supporting innovations in savers' interests”. The more collaborative ongoing engagement with schemes also seems to have resulted in a fall in the total amount of “frontline” penalties issued (other than for auto-enrolment non-compliance) from £107,600 to £70,800 and a fall in the use of its information powers. 

TPR on DB landscape in 2024: TPR has released its annual overview of the DB landscape in UK for 2024. Key findings reveal that the DB and hybrid landscape continues to shrink at a yearly rate of 3% on average. Schemes are still closing, with the percentage closed to future accrual (excluding those in wind-up) increasing from 72% to 73%. Total membership in private DB and hybrid schemes has decreased by 2% since 2023 to 9,424,000, with only 12% of members in open schemes. However, the funding level has remained fairly constant, increasing to 118% in 2024 from 117% in 2023.