DB pension trustees urged to develop 'sound understanding' of employer's obligations to scheme

Trustees that do not have the "objectivity or expertise" to perform their own assessment of that obligation, known as the 'employer covenant', should consider obtaining independent external advice, according to the guidance (66-page / 190KB PDF). It calls on trustees to assess and monitor the strength of the employer's covenant regularly, and to work "openly and collaboratively" with the employer and with other entities with a legal obligation to support the scheme.

The new guidance is the first of a number of publications planned by the regulator to assist trustees in their understanding of its new DB funding code of practice, published in June. It intends to publish similar practical guides on integrated risk management and investment strategy later this year.

"Our code highlights how trustees need a strong understanding of a scheme's covenant in order to take an integrated approach to risk management, and use the full flexibility of the funding regime," said Lesley Titcomb, chief executive of the Pensions Regulator. "I urge trustees to use this important guide to assess and monitor their employer covenant in a way that is proportionate to the circumstances of the scheme and the need for an employer to grow."

In a DB scheme, the pension scheme carries the risk of investment underperformance. Members are guaranteed a set level of benefits on retirement regardless of the performance of the underlying investment. For this reason, sponsoring employers are usually under certain legal responsibilities to meet the scheme's present and future liabilities. The employer covenant covers these obligations, as well as the employer's ability and willingness to support the scheme.

The regulator's code of practice on DB scheme funding makes it clear that trustees must fully understand the extent of the employer covenant, plus the employer's available financial resources, when assessing the funding position of their scheme, and establishing the level of contributions required from the employer. This understanding feeds into the integrated approach to risk management that is the central principle of the code.

The new guidance provides practical guidance for trustee boards that decide to assess the covenant themselves, as well as for those that commission covenant assessments from third parties. In particular, it sets out what trustees should consider when drawing up a brief for a third party adviser. According to the guidance, trustees should not perform the assessment themselves if they are not able to be objective - for example, if "an influential trustee holds an important role in the employer". Third party experts should also be commissioned if "the employer and trustees do not have a good relationship or the employer has been unwilling to provide requested information on a timely basis", the guidance said.

Trustees should perform formal covenant assessments at least once every three years, at the same time as the scheme's regular funding valuations. According to the guidance, trustees should take a flexible and proportionate approach to monitoring the employer covenant in between these assessments, bearing in mind that it can change materially over a short period of time depending on the business environment.

Helen Forrest of industry body the National Association of Pension Funds (NAPF) welcomed the "pragmatic" new guidance.

"In particular, the new guidance will make the whole process of covenant review significantly less arduous for trustees, and will hopefully also help them to save money on advice," she said. "It is essential that trustees and employers alike understand what will be required in practice from [the regulator's] new objective to minimise the impact of funding plans on the 'sustainable growth' of the employer and importantly what it doesn't require."

Trustees are advised by the guidance to monitor employers' plans to invest in sustainable growth in a way that restricts the funding available to the scheme. In many cases, the scheme would benefit from sustainable growth while other stakeholders, such as partner companies, could be required to step up their contributions to cover the shortfall.