Valuation negotiations


A global manufacturer with a £1bn UK defined benefit (DB) scheme had, for a number of years, been following a long term investment de-risking plan. Like most schemes with a 2013 valuation, the past service deficit had increased substantially.

The Company was facing three issues in its valuation negotiations with the trustees:

  • whilst its covenant was strong enough for it to pay off the increased deficit over the remaining 4 years of the existing recovery plan (the trustees’ starting point), its priority was to make significant investment in new plant and machinery
  • it was genuinely concerned that the current deficit was artificially high, due to the historically low level of gilt yields at the valuation date. As can be seen from the second of the graphs below, if these yields were to revert by just 1% the scheme would move into substantial, and mainly trapped, surplus
  • the level of gilt yields was not conducive to pressing on with the existing de-risking plan. The trustees accepted that the plan should be put on hold but were keen to agree with the company when and how de-risking should proceed.

Meeting the challenge of 2013 market conditions

The company and trustees shared the same concern that the low level of gilt yields made it very difficult to make long term strategic decisions. However, the trustees wanted confidence that funding and de-risking would remain on track, even if yields did not revert in the future.

Neither trustees nor company liked the idea of weakening the technical provisions, simply to reduce the deficit at this valuation, and so the focus was on the recovery plan. However, the normal ways of re-shaping the recovery plan would only go so far, especially as a significant lengthening was not attractive. Whilst the company was open to the use of some contingent assets, it was clear that this could not be the solution by itself.

The Pensions Regulator has made it clear that he does not expect trustees to make any allowance for gilt yields to revert within the discount rates used to calculate the technical provisions but, in certain circumstances, yield reversion can be reflected within the recovery plan.

So, in addition to some re-shaping of the recovery plan, the trustees and company agreed to allow for a modest amount of yield reversion within the recovery plan, which reduced the required deficit contributions. However, this allowance was set at only one-half of the amount of reversion which the trustees and company believed to be likely. The company was happy to accept that any reversion above this allowance (which would generate a funding surplus) should trigger further investment de-risking. Separately, there was a further revision to the previous de-risking plan so that, instead of gilts, switches would be made into other forms of high quality debt.

The final agreement on the recovery plan resulted in annual deficit contributions about 40% lower than the original funding proposals would have required.