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Pensions Regulator sets out new DB funding code approach

Paul Brice Paul Brice

The Pensions Regulator has issued the first stage of its two-part consultation process on the new defined benefit (DB) funding code of practice.

This part of the consultation seeks to determine the approach set by the funding code of practice (the code) and the key principles which will shape it. The second stage will then consult on a draft version of the code, reflecting the feedback and outcome of the first consultation.

Eight principles of revised DB funding code

The consultation sets out the following eight principles – which The Pensions Regulator (TPR) will use to underpin the code – and requests feedback on how they should be applied.

1 Evidencing compliance

Trustees should be able to evidence how Scheme Specific Funding (SSF) and investment risks have been assessed and mitigated, and also demonstrate how these risks compare to what is defined as a tolerated risk position.

2 Long-term objectives (LTO)

All schemes should have an LTO, such that by the time a scheme becomes significantly mature, it will have a low level of dependency on the employer and be invested with a high level of resilience to risk.

3 Journey plans and technical provisions (TPs)

All schemes will be expected to have a journey plan to meet their long-term objectives. The journey plan should incorporate investment risk decreasing and technical provisions converging towards the LTO as the scheme matures.

4 Scheme investments

The investment strategy of the scheme should be broadly aligned with the scheme’s funding strategy, and offer sufficient security and quality, and be liquid enough to meet future cashflows. Significantly mature schemes should have a strategy which has high resilience to risk, good liquidity, and a high average credit quality.

5 Reliance on employer covenant

Schemes should assume a decreasing level of reliance on employer covenant over time which reflects the level of visibility of the covenant. Those schemes with stronger covenants should have the flexibility to take more risk and allow for higher investment returns within their funding calculations.

6 Reliance on additional support

Schemes should be able to account for additional support in their funding valuations provided it offers sufficient support for the risks being run, can be appropriately valued, and is legally enforceable and realisable at its expected value when required.

7 Appropriate recovery plans

TPR maintains its position that any deficit should be recovered as soon as affordability allows while minimising any adverse impact on the sustainable growth of the employer.

8 Open schemes

The accrued benefits of open schemes should be equally as secure as the accrued benefits of closed schemes.

Twin-track approach

The new code will include a twin-track compliance approach, providing schemes with the choice of fast-track or bespoke compliance, and the eight principles outlined above should apply to both options.

The fast-track option will provide quantitative compliance guidelines to ensure minimum regulatory involvement, and is expected to appeal to well-funded, well-managed schemes by allowing a more efficient valuation process.

The bespoke option will provide schemes with more flexibility to set their own parameters, and will therefore require more supporting evidence and potentially lead to more regulatory involvement. It is likely to be used by schemes which cannot or choose not to comply with the fast-track option, for example if additional risk is being taken which means they cannot comply with the fast-track criteria, or those with significant affordability issues.

Feedback requested on fast-track plan

It is intended that the funding code will provide quantitative guidelines and parameters for schemes that follow this approach, and the consultation is hoping for feedback to help shape these. Some of the key areas being considered are as follows:

  • How much allowance should be made for reliance on future employer covenant and how should it be integrated into the funding strategy, eg, should it be reflected in the discount rate as is currently the case?
  • Should the covenant continue to be assessed holistically or should a more formal calculation or metric be adopted? Do we need to increase the number of covenant ratings from the current system of bands 1 to 4?
  • How much visibility of the employer covenant should be allowed for within the funding basis?
  • What is an appropriate LTO for fast-track? Is a low dependency discount rate of between gilts + 0.5% and gilts + 0.25% over a timeframe of 15 to 20 years for a scheme of average maturity reasonable? Should any other assumptions be defined?
  • What shape should the fast-track journey plan take and how much covenant reliance should be embedded into the technical provisions?
  • How should investment risk be measured and what should the reference point be from which to measure it? How can schemes demonstrate that the level of investment risk is supported?
  • Should fast-track schemes aim for recovery plans of a standard length, or should it reflect covenant gradings and other flexibilities?

Next steps

The consultation had originally requested responses by 2 June 2020 but this deadline has been extended to 2 September 2020 due to COVID-19.

Our pensions advisory team provides expert covenant, actuarial and integrated risk management advice. If you would like to discuss the new funding code or any other DB pensions matter, please contact Paul Brice, head of our pensions advisory team.

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