The Department for Work & Pensions (DWP) is currently consulting on draft regulations set to underpin the new long-term funding and investment requirements for UK defined benefit (DB) occupational pension schemes, as introduced by the Pension Schemes Act 2021 (for further discussion of various aspects of the Act, including changes to scheme funding requirements, see our previous blog). The new regulations will operate alongside the DB Funding Code of Practice (Code of Practice) currently being prepared by the Pensions Regulator (TPR).
The introduction of these changes represents the most significant alteration to the statutory funding regime for DB schemes in the UK since the current regime was established in 2005. The proposed changes will alter how schemes manage funding by ensuring that as many schemes as possible are fully funded on a "low dependency" basis and invested in low-risk assets by the time they reach significant maturity. To achieve this, schemes will be required to progressively de-risk in accordance with time limits set by TPR.
The new regime
Under the new requirements set out in the Pension Schemes Act 2021, trustees of DB schemes will be required to:
- establish a scheme funding and investment strategy to ensure that pensions and other benefits available under the scheme can be paid over the long term (funding & investment strategy);
- prepare a written statement of strategy detailing the long-term funding and investment targets for their scheme (statement of strategy).
Funding & investment strategy
According to the draft regulations, the funding and investment strategy must specify:
- the funding level that the trustees intend the scheme to have achieved as at the relevant date;
- the investments that the trustees intend to hold on that date.
The key principle permeating the new requirements is that of "low dependency on the sponsoring employer by the time the scheme is significantly mature". Low dependency means that the scheme will not, under reasonably foreseeable circumstances, require further contributions from the employer to make provision for pensions and other benefits under the scheme.
To achieve this, schemes would need to ensure they have sufficient assets invested to provide for accrued pension rights. In addition, the asset allocation must be structured in such a way that the risk rating of investments decreases as schemes move towards maturity.
The level of investment risk which can be taken by the trustees in accordance with the strategy will depend on the scheme's maturity status as well as the strength of the employer covenant. The stronger the covenant, and the further the scheme is from significant maturity, the more risk can be taken.
According to the draft regulations, a scheme reaches significant maturity on the date it reaches the "duration of liabilities" specified in the Code of Practice. The consultation has indicated that the Code of Practice is expected to specify a duration of 12 years, although TPR will consult on the exact contents of this later this year.
Statement of strategy
The trustees will be required to prepare a two-fold written statement of strategy as soon as reasonably practicable after the funding and investment strategy is determined or revised. The aim for this is "to facilitate better trustee and manager engagement, and better understanding and accountability between trustees and managers of schemes and the Pensions Regulator".
Part 1 of the statement should set out the long-term funding and investment targets for the scheme and must be agreed with the scheme employer.
Part 2 of the statement should include an assessment of the success of the funding and investment strategy, a breakdown of the implementation risks and mitigation strategies and a reflection on "important lessons learned" from past decisions. Trustees must consult with the scheme employer on Part 2 of the strategy and the employer can request that its comments are included in the statement.
The statement must be submitted to TPR in line with the scheme's statutory valuation process. There is also a requirement for the statement to be signed by the chair of a scheme's trustees meaning that a chair must be appointed for any scheme currently without one. Bringing the requirements for DB schemes into line with the current expectations for the appointment of a chair by defined contribution pension schemes.
The consultation will close on 17 October 2022 with the regulations expected to come into force in 2023. TPR has also indicated that it expects the new Funding Code to become operational in September 2023. It is therefore important that trustees and sponsoring employers familiarise themselves with the implications of the proposed regulations and look out for developments on the Funding Code. Employers should keep trustees informed of any issues that may impact covenant or scheme funding while trustees should take the time to discuss the impact of the new regime with their advisers and plan accordingly to ensure they are able to comply with the new scheme funding requirements.
If you have any questions about anything discussed in this blog, please contact a member of the pensions team.