UK consultation shines light on new defined benefit funding rules

The Department for Work and Pensions is consulting on a set of draft regulations to sit alongside the new defined benefit (DB) funding code being prepared by the Pensions Regulator. 

The Pension Schemes Act 2021 contains  provisions which, when brought into force, will require trustees to set, and keep under review, a funding and investment strategy and written statement of strategy. The draft regulations provide more detail around these. They also make some changes to the existing DB scheme funding regulations.

The starting point

The Act will require trustees to set a funding and investment strategy for ensuring that pensions and other benefits under the scheme can be provided over the long term. The trustees will need to agree this strategy with the employer and, once it is agreed, prepare a statement of strategy. 

Part one of the statement of strategy will contain the funding and investment strategy. Part two will identify the main risks in implementing that strategy (and how the trustees intend to manage them). It will also record progress and identify any actions needed to get the strategy back on course. 

The trustees will need to consult the employer on part two of the statement of strategy and, when the statement is ready, arrange for it to be signed by the chair of trustees and sent to the Pensions Regulator. The scheme's technical provisions must be calculated in a way that is consistent with the funding and investment strategy.

Low dependency

The draft regulations set out what the funding and investment strategy and statement of strategy will need to include. They also explain that the funding and investment strategy should be set with a view to the scheme having a low dependency on the employer – including a "low dependency investment allocation" – by or before the date on which the scheme actuary estimates the scheme will reach "significant maturity".  

The consultation paper explains that a scheme "has low dependency on its employer when it has sufficient assets invested in a low dependency investment strategy to provide for accrued pension rights and is not" under reasonable, foreseeable, circumstances "expected to need further employer contributions. Such a scheme may still receive contributions from the employer for further accrual of future pension rights for any active members". 

At each actuarial valuation, the actuary will estimate the date at which the scheme will reach "significant maturity", the maturity of the scheme at any earlier target date for low dependency set by the trustees, and the maturity of the scheme as at the effective date of the valuation. The actuary will also estimate the scheme's current funding level, on a low dependency funding basis. 

It will be possible to change the target date for low dependency, and the consultation paper says that the policy aim is for trustees to consider whether the date they have set "remains appropriate, taking into account the actuary’s latest estimate of when the scheme is expected to reach significant maturity".

Low dependency is the minimum standard the scheme must meet by – and maintain after – the chosen target date. Schemes will be able to aim higher, for example by targeting buy out.

Risk and liquidity

The level of investment risk that the trustees can take as the scheme moves along its journey plan, and the level of risk they can take when deciding the actuarial assumptions used to calculate liabilities, will depend on the strength of the employer covenant and how near the scheme is to its target date for low dependency. More risk can be taken where the employer covenant is stronger and less where it is weaker. Subject to the strength of the employer covenant, more risk can be taken where a scheme is a long way from reaching its target low dependency date and less risk when it is near. There will be specific rules as to how the strength of the employer covenant must be assessed.

At all times, the "assets of the scheme must be in investments with sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements".

Timing

Trustees will have to finalise their first funding and investment strategy no later than 15 months after the effective date of the first actuarial valuation they obtain after the new regulations come into force. They will then need to review and, if necessary, revise their funding and investment strategy within 15 months of the effective date of each subsequent actuarial valuation.

It will also be necessary to do this "as soon as reasonably practicable after any material change in the circumstances of the pension scheme or of the employer" (for example, after a material change in funding levels or in the strength of the employer covenant).

Trustees must then review and, if necessary, revise part two of their statement of strategy and prepare an updated statement of strategy as soon as reasonably practicable after they have reviewed the scheme’s funding and investment strategy. They must do this even if they do not make any changes to the funding and investment strategy.

The signed statement of strategy must be submitted to the Pensions Regulator along with copy of the actuarial valuation.

Recovery plan and policy intention

There will be changes to what the scheme actuary needs to include in the valuation report, and the current scheme funding regulations will be amended to say that "in determining whether a recovery plan is appropriate having regard to the nature and circumstances of the scheme, the trustees or managers must follow the principle that funding deficits must be recovered as soon as the employer can reasonably afford.”

The consultation paper confirms that the intention is to "get the right balance between ensuring [DB] pensions are secure for members over the longer term and keeping them affordable for sponsoring employers… Those schemes that are maturing will be required to manage their risks carefully, taking proper account of the extent to which those risks remain supportable as they move towards run-off, or securing members’ benefits. 

"But these draft Regulations also take account of open schemes which are not maturing and have adequate ongoing sponsor support. It is not our intention that such schemes should have to undertake inappropriate de-risking of their investment approaches. The intention is to have better, and clearer, funding standards, but not to move away from the strengths of a flexible scheme specific approach".

What happens next? 

The consultation is open until 17 October 2022. The Pensions Regulator has been waiting for the DWP to issue this consultation before issuing its second DB funding code consultation. It is expected to open the second consultation (and so share the draft of its new DB funding code) this autumn. The draft DB funding code will provide more information about what is expected and around scheme maturity and employer covenant.

Trustees and employers should discuss this development with the scheme actuary or their actuarial advisers. They should also look out for the Pensions Regulator's second DB funding code consultation