TPR's defined benefit funding code of practice and regulatory approach consultation - a holistic approach to funding, investment and risk
by Shoosmiths LLP
Pensions analysis: On 16 December 2022, the Pensions Regulator (TPR) published its consultation on the new defined benefit (DB) funding code of practice together with a response to its first consultation and a consultation on its proposed twin track regulatory approach to assessing valuations including its proposed Fast Track design. Suzanne Burrell, partner at Shoosmiths examines the consultation and its implications.
What is the background to TPR's consultations on the new DB funding code and its twin-track regulatory approach?
The new code (Code) originally stems from a 2018 White Paper which highlighted some grey areas in the existing DB funding framework relating to how trustees should set their scheme’s technical provisions and recovery plans. The Pension Schemes Act 2021 (PSA 2021) introduces a revised approach to scheme funding requiring scheme trustees to take a longer term approach to scheme funding.
Under the PSA 2021 and the draft funding and investment strategy regulations, trustees will be required to adopt a funding and investment strategy which deals with a pension scheme’s journey plan and how funding to that scheme’s endgame will be achieved. Trustees will be required to produce (and keep under review) a written statement of that strategy once the relevant parts of the PSA 2021 and new funding regulations come into force.
TPR says that the new Code is intended to strengthen TPR’s powers to enforce DB funding standards and to implement parts of the PSA 2021. The proposed twin track approach by TPR is not specifically mentioned in the new scheme funding legislation so it will not form part of the code of practice but will instead sit alongside it.
What was TPR's response to its first funding code consultation? Were any particular issues or themes raised in feedback?
TPR ran a consultation on the new Code back in March 2020. It published an interim response in January 2021 in which it confirmed there was general support for the proposals, but confirmed in its 2021 Annual Funding Statement that a second consultation (initially planned for mid-2021) had been deferred until after the Department for Work and Pensions (DWP) has consulted on new regulations under the PSA 2021. The DWP consultation is still underway.
TPR recognised some of the concerns raised during the first consultation and comments on some of these. Particular concerns were raised regarding the risk of unintended consequences as well as concerns regarding the twin track approach. These included the following:
- Potential loss of flexibility if Bespoke was benchmarked against Fast Track. TPR has confirmed that Bespoke will not be benchmarked in this way.
- Bespoke being second best and imposing an increased evidential burden.
- Risks around where the Fast Track lines are drawn resulting in levelling down and increasing costs. TPR has indicated that the new funding framework is not intended to change the landscape but to embed existing good practice.
- Reduced reliance on covenant support. TPR highlights that covenant considerations will now be embedded in legislation and that the draft code aims to set out how the three “fundamental pillars” of the covenant can support risk. Those fundamental pillars are employer cash, prospects, contingent asset support.
- How to reflect open schemes: the Code will reflect the differing characteristics of open schemes, particularly those where new active members are still being submitted.
What are the key aspects of the two new consultations?
A new twin track regulatory approach will help TPR filter out schemes that require minimal engagement (estimated to be around half of schemes, as of March 2021), and identify and intervene when there are concerns schemes are not complying with regulations.
TPR’s proposed twin track approach to valuations comprises the following:
- Fast track: TPR will set straightforward quantitative compliance guidelines for trustees to assess whether TPR would consider their valuation compliant with legislation. If all aspects are satisfied, trustees can expect minimal involvement by TPR.
- Bespoke track: Trustees and employers will have flexibility to account for scheme and employer-specific circumstances. Decisions will need to be fully articulated and evidenced and may involve greater involvement by TPR.
In either case, trustees will be required to submit evidence to TPR of their approach to managing their scheme’s funding and investment risks as part of the statement of strategy required by the PSA 2021.
The draft Code will replace the current code, introduced in 2014. It includes key expectations in relation to:
- trustees setting a plan for how they will achieve low dependency on the employer
- setting a journey plan to reach that point
- assessing the employer covenant as a key underpin for the level of risk that is supportable on that journey – considering cash, prospects and contingent assets. TPR’s covenant guidance will also be updated
- setting their funding assumptions consistently with those plans
- open schemes allowing for future accrual where they can justify their approach
- assessing reasonable affordability when determining the appropriateness of recovery plans
The draft Code reflects a holistic approach to funding, investment and risk which will form part of the regulatory landscape going forwards. Trustees will already be familiar with the concept of “integrated risk management” espoused by TPR. As well as looking at funding and covenant, the draft Code sets out approaches to investments which link to the Long Term Funding Objective (LTFO). In particular, the draft Code specifies that trustees should assume that scheme assets will be invested on a low dependency basis after the significant maturity date. Allowance for cash flow requirements (including unexpected cash flow demands) should be made together with a level of prudence such that no further contributions would be expected to be required from the employer.
What are the implications of the two consultations for pension schemes, trustees and providers?
Putting the LTFO on a statutory footing means that greater focus will be placed on a pension scheme’s “endgame”. TPR’s draft Code suggests that a scheme targeting buy-out may be looking to adopt a higher funding goal.
LTFO is itself not a new concept; it has been referenced in TPR’s annual funding statements at least since 2019. The change introduced by PSA 2021 and the draft Code reflects that a requirement to consider the long-term position is now to be placed on a statutory footing. The draft Code considers Schemes can provide benefits in a number of ways including:
- running off the scheme, paying the benefits from the scheme as they fall due
- buying out members’ benefits with an insurer
- transferring the scheme assets and liabilities to a DB superfund or another consolidation vehicle
Trustees and Employers should, if they have not already done so, start to think about longer term planning in terms of provision of benefits, cash flows into schemes and investment strategy. Scheme actuaries may already be starting to have conversations around the implications of Fast Track versus Bespoke.
What happens next?
The new draft Code is forward looking so only schemes with valuation dates on or after commencement, likely to be October 2023, will be affected. Trustees currently working on a valuation should continue using the code currently in force.
David Fairs, TPR’s executive director of Regulatory Policy, Advice and Analysis, said:
“We want to provide schemes with the continued flexibility around funding to suit their circumstances, while requiring trustees to think carefully about risk management to improve security for their members.
“I urge trustees and their advisers to read our consultation and respond”.
Trustees and sponsoring employers should keep a watchful eye on developments in this area and when appropriate, consider (with their advisers) the potential impact of the new funding requirements on their scheme.
This analysis was first published on Lexis®PSL on 9 January 2023 and can be found here (subscription required)