Back in September we discussed the upcoming changes to the existing scheme funding requirements for defined benefit ("DB") schemes. Whilst the publication of draft regulations provided some clarity, the industry has been awaiting further guidance from the Pensions Regulator ("TPR") in order to understand how the new regime will operate in practice. On 16 December 2022, TPR provided the final pieces of the puzzle by publishing a response to its first consultation and launching its long awaited second consultation on the funding framework.
Background
The new funding regime aims to reduce reliance on the sponsoring employer 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 facilitate this, trustees of DB schemes will be required to establish a long-term funding objective ("LTO") and to implement a funding and investment strategy that supports the LTO. In addition, trustees will be required to prepare a written statement of strategy for the purposes of facilitating better engagement, understanding and accountability with TPR. Trustees will need to monitor their strategy and revise accordingly in certain circumstances i.e. following each subsequent statutory valuation or to record a material change in the scheme’s circumstances.
The Funding Code
The draft code is designed to support trustees and sponsoring employers to manage their pension schemes in compliance with the relevant legislative requirements. It contains guidance for trustees establishing a journey plan detailing how they will achieve low dependency on the sponsoring employer. It also sets out expectations in relation to assessing the strength of the employer covenant on the journey to low dependency and assessing reasonable affordability when determining the appropriateness of recovery plans.
Significant maturity
According to the draft regulations, a scheme will reach significant maturity on the date it reaches the "duration of liabilities" in years specified by the Regulator in a Code of Practice. The draft code has indicated that the relevant duration may be set at 12 years. However, this is subject to change in recognition of the fact that the duration of liabilities for almost all DB schemes has significantly reduced as a result of recent gilt market volatility.
Employer covenant
The draft code highlights the importance of carrying out an employer covenant assessment in order for trustees to understand the extent to which the employer can support their scheme now and in the future. The draft code splits employer covenant support into two categories:
- the financial ability of the employer to support a scheme, including its cash flow, the likelihood of an employer insolvency event occurring and other factors that are likely to affect the performance and development of its business; and
- scheme support from any contingent assets to the extent these are legally enforceable and will be sufficient to provide that level of support when required.
TPR has indicated that it will be consulting on updated covenant guidance in the coming months.
Valuations: Fast-Track or Bespoke?
In addition to the draft code, TPR also published a consultation on its twin track regulatory approach to assessing valuations – Fast-Track and Bespoke.
Where a scheme's valuation meets all the Fast-Track parameters, TPR is unlikely to scrutinise the valuation submission further. TPR has however suggested that it may check compliance with Fast-Track through sampling submissions with a view to understanding "behaviours and risks across the landscape to inform setting parameters in the future".
Meanwhile the Bespoke route offers trustees a scheme specific approach with greater flexibility to adopt measures that are more suited to the circumstances of their scheme. For example, trustees may wish to take more risk than that available under Fast-Track. However, trustees adopting this approach will be required to justify their decision to deviate from the Fast-Track route and to demonstrate that the total risk run by their scheme is in line with the maturity of the scheme and supportable by the employer covenant.
Looking to the future
The consultation period will close on 24 March 2023 with the new regime expected to come into force for actuarial valuations with effective dates on or after 1 October 2023. To meet this implementation deadline, it is expected that the final code will be laid before Parliament in mid-June alongside the final regulations. This is a relatively ambitious timescale and TPR has acknowledged that the timetable is subject to change, not least because the final form of the regulations is not yet known and any changes that are made to the regulations when they are laid before Parliament will need to be reflected in the final code.
In the meantime, DB scheme trustees and employers should begin to consider the impact of the new requirements on their respective schemes and consult the relevant advisers as soon as possible in order to ensure they are adequately prepared for the entry into force of the new regime. If you would like to discuss anything raised in this blog, please get in touch with a member of the pensions team or your usual Brodies contact.
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