Member Article

The Government has published its response to the consultation on the new funding regime for occupational defined benefit (DB) pension schemes, as well as the draft Occupational Pension Schemes (Funding and Investment Strategy) Regulations 2024.

 

The new regime aims to balance the security of members' benefits with the sustainability of sponsoring employers' businesses, and to encourage long-term planning and collaboration between trustees and employers. The Funding Regulations are expected to come into force in April 2024 and apply to valuations from 22 September 2024 onwards, but schemes and employers should start preparing for the changes now.

The Funding Regulations will be supported by a revised Code of Practice on DB Funding (Code) from the Pensions Regulator (TPR), which was published for consultation back in December 2022. TPR confirmed to the Work and Pensions Committee last November that the final version would come into effect by the time the Funding Regulations become law. 

The new statutory funding regime

The Pension Schemes Act 2021 introduced a new requirement for defined benefit pension schemes to have a funding and investment strategy for the purpose of ensuring that pension and other benefits under the scheme can be paid over the long term. The detail of the new statutory funding regime is set out in the Funding Regulations.

The new regime introduces a legal definition of employer covenant for the first time. Regulation 7 of the Funding Regulations defines employer covenant strength as:

• the financial ability of the employer to support the scheme, in relation to its legal obligations; and
• the expected level of support for the scheme from any contingent assets to the extent that trustees could reasonably expect the contingent assets to be legally enforceable and sufficient to provide support when required.

The Funding Regulations outline the following as matters to be considered in assessing the employer’s financial ability to support the scheme:

• Cash flow and expected future cash flow of the employer.
• Other matters such as performance, future development and resilience of the employer’s business and likelihood of an insolvency event.
• How long trustees can be reasonably certain that they can rely on an assessment of the above two matters.
• How long trustees can reasonably be certain that the employer will be able to support the scheme.

The new statutory funding regime for occupational DB pension schemes was first considered and discussed at a time when schemes' financial circumstances were, in general, very different.  To put this into context, when the Government White Paper on Protecting Defined Benefit Pension Schemes was introduced, the aggregate deficit of 5,588 schemes in the PPF 7800 Index was around £73bn.  By December 2023, this had become an aggregate surplus (of around 5,000 schemes) of £425bn.     

Changes arising from the consultation

The new regime introduces the concept of "significant maturity", which is a measure of how close a scheme is to paying out most of its benefits. Schemes that are significantly mature will have to adopt a more prudent funding and investment strategy, while schemes that are less mature will have more flexibility to take appropriate investment risk. 

The Funding Regulations prescribe 31 March 2023 as the date to be used for basing economic assumptions to calculate significant maturity, but the Pensions Regulator will set out the duration threshold for significant maturity in the Code.

This does raise an interesting question regarding how the prevailing economic circumstances are to be determined.  Should they be determined through a subjective assessment by trustees, or will there be an objective standard laid down by, for example, TPR?

The new regime also allows for more scheme-specific flexibility in setting the funding and investment strategy, as the Government recognises that a one-size-fits-all approach may not be suitable for all schemes and employers. The Government has rolled back on some of the more risk-averse and prescriptive proposals in the consultation which preceded the publication of the Funding Regulations. Those proposals included the requirement to use low-risk discount rates and limits on recovery plan lengths. Instead, the Government has emphasised the importance of trustees and employers working together to agree on a strategy that reflects the scheme's circumstances and the employer's covenant.

For schemes that are still open to new members or future accrual (or both), the new regime will allow them to make a reasonable allowance for new entrants and future accrual in the scheme maturity calculations, subject to the trustee's view of the employer covenant. This will enable open schemes to maintain a more growth-oriented funding and investment strategy, as long as they can demonstrate that it is sustainable and does not compromise the security of members' benefits.

Statement of strategy

The statement of strategy is a document the trustees of schemes caught by the new regime must prepare and maintain under the Funding Regulations. The purpose of the statement of strategy is to assess whether the scheme's funding and investment strategy is being successfully implemented, and whether any adjustments are needed to get the scheme back on track. The statement of strategy must be reviewed at least every three years or whenever there is a significant change in the scheme's circumstances.

Consultation responses highlighted concerns over the administrative burden the statement of strategy might place on some schemes. In response, the Government has amended the Funding Regulations to reduce the associated practical and administrative burden. The main changes are as follows:

• TPR has discretion to take a scheme-specific approach in requesting information from scheme trustees, rather than applying a standard set of questions to all schemes.
• Trustees are no longer required to provide evidence of the discount rates they have used and explain why their funding and investment strategy remains appropriate. Instead, they only need to state the discount rates and the reasons for their choice.
• Trustees will now be required to provide a summary of their scheme’s valuation results in the statement of strategy, rather than with their recovery plan as is currently the case. This will allow TPR to remove some related questions from the scheme return and help avoid duplication of work for trustees. 

These changes are intended to make the statement of strategy more flexible and proportionate, while still ensuring that trustees have a clear and coherent framework for managing their scheme's funding and investment risks.

Next steps

The Funding Regulations will need to be approved by Parliament before they become law. Subject to that, the Government’s plan is for the Funding Regulations to come into force in April 2024, and for them to then apply to scheme valuations from 22 September 2024. However, the new regime will not be complete until TPR publishes the updated Code. TPR will also issue guidance on the proposed twin-track and bespoke valuations routes as well as updated guidance on assessing the employer covenant.  Schemes with valuations in or after September 2024 should consider engaging with their Scheme Actuary to start planning ahead.

 

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