The Pensions Regulator (TPR) has published its draft funding code of practice for defined benefit (DB) pensions schemes and a consultation document.
The 14-week consultation sets out that schemes will be expected to set a long-term objective and a journey plan to get there. It is expected that schemes will reduce reliance on their sponsoring employer as they reach maturity. It will require trustees to improve risk management and raise the bar for evidencing supportable risk taking, the regulator said.
The code will support trustees, sponsoring employers and their advisers to manage their pension schemes and 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;
- 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 final regulations and code are currently planned to come into force in October 2023.
A new twin track regulatory approach will help TPR filter out schemes that require minimal engagement (estimated to be around half of schemes, as at March 2021), and identify and intervene when there are concerns schemes are not complying with regulations.
David Fairs, TPR’s executive director of regulatory policy, advice and analysis, said: “In line with [Department for Work and Pensions] DWP’s draft regulations, our draft code is clear that all DB schemes should have the necessary long-term funding approach to ensure savers have the best chance of receiving the benefits they expect.
“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.”
Fairs said the draft code’s principles reflects the 127 responses TPR received to its first consultation on the code – “the clarity we now have on the draft regulations, and our modelling and analysis”.
He said the code ”sets out our expectations in relation to how trustees should comply with legislative requirements,” urging trustees and their advisers “to read our consultation and respond.”
The new draft code is forward looking so only schemes with valuation dates on or after commencement will be affected. Trustees currently working on a valuation should continue using the code currently in force, the regulator noted.
Emily Goodridge, managing director at Cardano Advisory, said it was positive to see the regulator looking at covenant over a scheme’s journey plan, taking into account concepts such as visibility, reliability and longevity of covenant.
“However, we have reservations about a relatively prescriptive one-size-fits-all approach to assessing supportable risk,” she said.
“Trustees should focus on the expectations set by the draft regulations and draft Funding Code, and not just on whether TPR will check up on them. Fast Track is essentially just a way for TPR to proportionately filter valuations on a risk basis. It is not a gold standard, and is absolutely not an excuse for becoming complacent about covenant, particularly given the challenges many employers are facing at present and their role as the ultimate underpin for a defined benefit pension scheme.”
Along with the draft code, TPR is also publishing a consultation document on its Fast Track and a twin track regulatory approach, as well as a response to its first funding code consultation.
Fast Track is not mentioned in the legislation so is not included in the draft code itself. It is a regulatory approach set out by TPR to bring greater clarity to its approach to the scheme specific DB funding regime.
Trustees following Fast Track will be asked to evidence how their scheme meets three Fast Track criteria – surrounding technical provisions, an investment stress test and prescribed recovery period.
Bespoke is an equally valid approach and may be more appropriate for schemes following a more complex funding and investment path but also those unable to meet Fast Track criteria. Bespoke gives trustees the flexibility to select scheme specific funding solutions if the funding approach and actuarial valuation meet legislative requirements and key principles set out in the code.
Alex Beecraft, senior director and head of corporate solutions at Cardano Advisory, said: “The new funding code may be a double-edged sword for sponsoring companies. Fast Track risks increased funding demands to meet with TPR’s new yardstick, but sponsors with schemes funded beyond it could find that corporate activity actually becomes easier.”
He explained that while Fast Track may promise an easier ride, Bespoke will still offer the key benefits of the existing regime by allowing companies to balance protecting members against managing funding demands through appropriate reliance on their covenant.
“It should not be feared and should remain the default option for most schemes,” he said.
Both consultations will close on Friday, 24 March 2023.