The UK’s pensions regulator has today launched the first part of a keenly awaited major consultation on its revised code of practice for defined benefit (DB) funding, which aims to set out more clearly what is expected from trustees and employers.
Spanning nearly 180 pages and posing 58 questions, the consultation document sets out The Pensions Regulator’s (TPR’s) thinking about the overarching principles that should underpin all scheme valuations and proposals for how these principles could be applied in practice.
A second consultation, planned for later this year, will focus on the draft funding code itself and what the final guidelines might look like. This will take into account industry feedback to the first consultation, the regulator’s impact assessment, and any changes to legislation and regulations.
It is expected that the revised code will come into force at the end of 2021.
Overall, the TPR is consulting on a new funding regime to address concerns highlighted in a 2018 government white paper on DB pension schemes and to implement new measures introduced in the Pensions Schemes Bill, which was laid in parliament in January and introduces new requirements for sponsors and trustees to agree long term funding and investment strategies.
David Fairs, executive director of regulatory policy at TPR, said: “The launch of the our consultation on a clearer framework for DB funding is a significant moment for DB schemes.”
Speaking to journalists yesterday, he said that at the heart of the consultation lay “a really simple concept: what is the balance between security of members’ benefits and affordability?”.
Noting the length of the consultation document, he added: “Funding of DB pensions is extremely complicated and therefore some of the trade-offs you have to think about are incredibly complex.
“We’ve tried to set out the thinking and challenges in arriving at what a suitable compromise would be.”
Twin tracks, key principles
As previously indicated, TPR is proposing a twin-track compliance approach to valuations.
If trustees can demonstrate their valuation meets certain quantitative compliance guidelines they will be able to choose a “fast-track” approach and expect minimum regulatory involvement on DB funding.
Alternatively, there is a “bespoke” valuation approach, relevant for trustees who either choose not to or cannot comply with fast-track guidelines.
This track offers greater flexibility, but requires trustees to submit more supporting evidence on their approach, including how they propose to manage any additional risk. This may also involve greater regulatory scrutiny.
TPR has been at pains to stress that bespoke and fast track approaches, if done correctly, are equally compliant with the legislation and that bespoke arrangements should not be seen as bad or a second-best option.
One example given for why a scheme might opt for the bespoke track was if the employer was very constrained and the scheme, therefore, needed a longer recovery plan.
According to TPR, most schemes are closed to new members and/or future accruals and can be expected to be “significantly mature” in 15 to 20 years’ time, with the majority of their members retired.
Fairs said: “These schemes will be more vulnerable to risks associated with poor funding levels and shorter investment horizons.”
A key principle being set out by TPR is that trustees should identify a scheme-specific long-term objective (LTO) so that by the time the scheme is significantly mature it is fully funded with a low dependency on the employer and invested with high resilience to risk.
For a fast-track approach, the regulatory is proposing that the low dependency funding basis be with a discount rate somewhere in the range of Gilts plus 50bp to Gilts plus 25bp.
TPR has also proposed key principles in relation to investments, such as that the asset allocation at significant maturity should have high resilience to risk, a high level of liquidity, and a high average credit quality.
In terms of recovery plans, TPR’s proposed principle is that these should remain based on affordability, but, as for other parameters for the fast track approach, it is consulting on options for standardised guidelines for recovery plan lengths.
Mouna Turnbull, policy lead at TPR, told journalists it was “too early to talk about a significant shortening of recovery plans”.
TPR is also consulting on the extent to which the employer covenant should remain a key aspect of scheme funding, including how it should be assessed and for how long reliance can be placed on it, and on alternative support and the reliance that can be placed on it.
In the consultation document TPR said it did not expect its proposals to be “too onerous for most schemes” but that there could be significant impacts for some schemes, in particular those that have been running excessive and unjustifiable levels of risk.
With regard to open schemes, it said its view was that the accrual of new benefits should not compromise the security of accrued benefits, but that this did not mean it was advocating the closure of open schemes.
The consultation closes on 2 June.