Pensions update: SHPS funding valuation and new Defined Benefit funding code

The NHF’s pensions advisors Isio provide an update on the Social Housing Pension Scheme funding valuation and the potential impact on employers, plus the Pensions Regulator’s new funding code for Defined Benefit schemes, and assess the steps employers can take to manage risks.

This information is relevant to organisations participating in trust-based arrangements, including the Social Housing Pension Scheme (SHPS), single employer trusts and where an employer has its own section within TPT Retirement Solutions.

SHPS funding valuation

As a reminder, the SHPS funding level at 30 September 2017 was 75%, with a deficit of £1.5bn (liabilities of £6.1bn less assets of £4.6bn). This led to an increase in contributions for employers (both deficit funding and future accrual) from April 2019 and a re-shaping of the previously tiered recovery plan. On average, employers saw a 60% increase in deficit contributions cost for the first year.

If experience over the three years to 30 September 2020 had been in line with 2017 expectations, it is estimated that the deficit at the 2020 valuation when measured on a 2017 consistent basis would have fallen to broadly around £1bn. At 2017, the deficit was projected to have been completely extinguished by the end of the current recovery period in March 2026.

However, due to market movements being worse than expected since 2017 (in part but not entirely from the impact of coronavirus), we are in a downside scenario at this valuation, and the funding level at 30 September 2020 when measured on a 2017 consistent basis is estimated to be broadly around 77%, with a deficit of broadly around £1.5bn. 

If this is paid off over a recovery period still ending in 2026, employer deficit contributions will increase by around 30-50%.  The average total cost of future accrual will increase by around 15%, but an actual employer’s rate is dependent on employer profile. These estimates reflect the collective views of a number of actuarial firms.

Of course, the actual outcomes will depend on the SHPS Scheme Actuary’s detailed actuarial calculations and the approach taken by the SHPS Trustee to this time’s valuation. This includes the level of prudence included in the discount rate and any changes in the investment strategy, changes to mortality and long-term inflation projections and the recovery period for making good the deficit. In turn these will depend on the trustee’s view of the employer covenant and the Pensions Regulator’s approach.

The Pensions Regulator’s new Defined Benefit funding code

The Pensions Regulator is consulting on a new Defined Benefit funding code for all trust-based schemes, including those in the housing sector. Note that this funding code will not directly impact the Local Government Pension Scheme as this is under separate regulations.

The code is intended to come in force for all valuations from the start of 2022, although trustees may look to introduce some of the principles before this date.

The proposed code includes requirements around a fast-track or bespoke process for submitting valuations, with fast-track guidelines prescribed by the Regulator and to include the following:

• A low risk long-term funding objective.
• Controls on actual investment strategy – via a prescribed stress test and possible liquidity and quality checks.
• Deficits to be met “as soon as affordability allows”.

The fast-track principles create a challenge for the housing sector around where housing associations’ resources are best placed.  In short, should cash be spent on new housing development and enhancing the quality of social housing or on the prudent funding of legacy pension promises?

The NHF is working with Isio to engage the Pensions Regulator during the consultation on behalf of the housing sector, citing in particular the strong long-term covenant of housing associations and the Regulator of Social Housing’s existing framework for stress testing. We will continue to represent members as the second phase of consultation progresses.

Given the shake-up of Defined Benefit funding, SHPS trustees may take the chance to step back and review the funding model as a whole. In particular, the design of a bespoke approach could enable a reappraisal of prudence. Analysis of the SHPS discount rate shows that it is already reasonably prudent when compared with the universe of trust-based schemes.

What steps can employers take to manage funding risk?

An organisation should be looking to understand and manage the risks associated with funding, if not already:

1. Incorporate estimated contributions into business projections.
2. Weigh up (or revisit) options for provision.
3. Embed funding risks into wider risk management and risk registers.
4. Consider the feasibility of member options exercises.
5. Review long-term funding strategy.
6. Consider timing.