Prudence in pension scheme funding can provide cover for downside scenarios and, in those situations, to not be reliant upon the sponsoring employer to make up any shortfall.

In that regard the introduction of the Scheme Specific Funding Regime in 2005, where trustees are required to calculate liabilities on a prudent basis and determine recovery plans against any shortfall, made sense.

However, move on to today and we see a lot of headlines around schemes being in significant deficits and some analysts suggesting schemes, and by natural extension their sponsoring employers, are unable to cope with these levels of deficit.

An alternative view

With the introduction of TAS 300 from 1 July 2017, the level of prudence within each assumption should be clearly set out and with the increased focus on defined benefit scheme funding, is it time to review how we view scheme funding results?

Whilst there are arguments for making fundamental changes to the way DB pension scheme stakeholders approach valuations and that there are a significant range of possible answers, at this point I am focusing not on how we re-frame the question, but how we look at the existing answers.

By shifting the focus away from a funding position against the prudent Technical Provisions and instead focusing on the funding position on a “best-estimate” basis along with a Prudence Reserve:

  • Discussions can start from a best-estimate point and then focus on the appropriate level of prudence given investment strategy and covenant strength, reflecting the Pensions Regulator’s Integrated Risk Management framework;
  • The actuarial valuation results can be better positioned with key stakeholders, including members; and
  • It paints a clearer picture on the level of prudence which allows trustees and companies to look at alternative approaches to funding the assessed Prudence Reserve, e.g. considering providing payment guarantees from banks and insurers for contributions the sponsoring employer(s) may, or may not, have to make at the end of a recovery plan

The aim here is not to present something that “sounds better” in that “100% funded plus 38% of assessed Prudence Reserve funded” may sound better than “82% funded”, but instead:

  • Bring attention back to the fact the scheme may be reasonably funded on a best estimate ongoing basis,
  • Help set recovery plans which support both the scheme and the sponsoring employer, and
  • Give members a better understanding of the funding of the scheme.

Which leads onto a question for another day…Does the prudence reserve need to be included within the scheme itself and what are the alternatives to cash funding it?