Consultation Response #3: Sailing into the sunset: LTOs and covenant reliability
At the heart of TPR’s recent consultation on the new funding code of practice is establishing a Long-Term Objective (“LTO”) to guide maturing DB schemes away from the ongoing sponsor reliance inherent in Technical Provisions (“TP”) targets. But where should schemes be guided towards as the sun begins to set on them?
TPR and the industry seem to agree – sponsor support becomes less reliable the further out you look. This may be due to changing demand preferences, technological innovation, or the risks posed by climate change.
Therefore, schemes should generally plan to gradually reduce scheme risk (and thereby covenant reliance) over time. Typically, that includes moving out of more volatile assets, investing in assets that protect against liability risks, and potentially including an allowance for future running expenses and demographic risks.
But even such a de-risked scheme is susceptible to tail (or not so tail) risks like the data issues which have never been investigated, or that sudden requirement to change historical benefits (looking at you, GMP equalisation). Clearly if a scheme is hit by one of these waves then it will need its sponsor to get it back on course.
But there is a further risk – sponsors themselves. Pension liabilities are measured in decades rather than years which is an uncomfortable thought when the average age of UK-registered companies is less than 10 years. Many schemes may be faced with the prospect of sponsor insolvency at some point over their remaining lives.
Even if buffers are held for all of the above scheme risks, schemes without a solvent sponsor are likely to require regulatory consent before being allowed to “run on”. Only a few have been able (and allowed) to do so thus far. Can trustees be certain the TPR / the PPF would let them run on, instead of pulling the plug to protect it from the risk of a PPF deficit emerging in future?
The fact that sponsors can’t be relied upon to always be there is increasingly acknowledged by trustees, with rising volumes of insurance buy-outs/ins and the emerging superfund consolidation sector demonstrating the desire to protect against this risk.
If the LTO isn’t equivalent to one of these options, then it is unlikely to be a suitable ultimate target for most schemes. Instead, the LTO becomes another marker buoy on the route between TPs and the end-game on the horizon.
Alex Beecraft, Director