The UK's new DB funding framework will apply to scheme valuations from September

The Department for Work and Pensions has published the response to its 2022 consultation on the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations, together with the final draft of the regulations, which have been laid in Parliament.

The new regulations will be a key part of the new funding framework for UK defined benefit (DB) pension schemes. They will sit alongside a new DB funding code and fast-track parameters to be issued by The Pensions Regulator (TPR).

What is the new DB funding framework?

Under the new framework trustees will need to set a "funding and investment strategy" (FIS) with a view to the scheme having:

• a "low dependency on the employer" by or before the date on which the scheme actuary estimates the scheme will reach "significant maturity"; and
• a "minimum funding level" of at least 1:1 (assets liabilities) calculated on the new "low dependency funding basis" by that date.

Low dependency on the employer means the scheme is not reasonably expected to need further employer contributions to fund its liabilities (calculated on the new "low dependency funding basis"). It will be possible to aim for a higher funding level; for example, by targeting buy out.

Under the new framework, actuarial valuations will need to include the actuary's estimate of the maturity of the scheme and when it is expected to – or when it did – reach significant maturity and the funding level of the scheme on the new "low dependency funding basis".

The FIS must be set out in a "statement of strategy" prepared by the trustees or managers of the scheme and signed by the chair of trustees. The statement of strategy must be in two parts. Part 1 is the FIS. Part 2 will set out supplementary matters. These include the level of investment risk as the scheme moves along its "journey plan" (that is, the scheme's path to significant maturity), the main risks faced by the scheme in implementing the FIS and how the trustees or managers intend to manage them, and an assessment of the employer covenant.

When will schemes need to comply?

The draft regulations – the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024" – still need to be debated in Parliament but it is very unlikely that they will not get parliamentary approval. They are expected to come into force on 6 April 2024 and will apply to valuations with effective dates on and after 22 September 2024.

To support this, TPR will need to issue the final version of its new DB funding code and its fast track parameters. A recent press report suggests that TPR expects the new code to be laid before Parliament in the summer.  TPR is also expected to consult on updated covenant guidance.

Have any changes been made to the regulations?

One of the main concerns with the initial draft regulations was the potential impact on open schemes.  There was also concern about the potential for constraint on investments. The government in its consultation response says it has sought to address these concerns by:

• Making it explicit that in determining the future maturity of a scheme, trustees can take into account new entrants and future accrual of benefits, provided such assumptions are "reasonable" and based on an assessment of the strength of the employer covenant.
• Making clearer the flexibility relating to investments – in particular, some of the proposed requirements relating to investments at maturity are no longer in the regulations.

Another issue was the extent to which the underlying assumptions were impacted by events following the September 2022 budget, in particular the rise in gilt yields. The government has responded to this by prescribing a fixed date – 31 March 2023 – on which economic assumptions used to calculate maturity must be based.

The measure of when a scheme reaches significant maturity will be set out in TPR's code, and the revised draft makes clear that TPR can set different dates for different types of schemes, with the intention that TPR will set a different duration for cash balance schemes.

The initial draft regulations have also been revised to be clear that although it will be an objective for scheme assets to be invested in accordance with a low-dependency investment allocation once the scheme has reached significant maturity, this only applies to assets to which the minimum funding level relates, not to any surplus funding.

The definition of the "strength of the employer covenant" and the matters to be considered in determining this have been revised to deal with some of the concerns raised in the consultation. The regulations still provide that, when deciding whether a recovery plan is appropriate having regard to the nature and circumstances of the scheme, the statutory funding objective should be met "as soon as the employer can reasonably afford.” However, the factors that trustees must consider when preparing or revising a recovery plan will now include the "impact of the recovery plan on the sustainable growth of the employer”.

Some of the detail of what is to be included in the FIS and in part 2 of the statement of strategy has been revised.

What do trustees and employers need to do?

Trustees and employers, especially the trustees and employers of schemes whose next valuation will have an effective date of on or shortly after 22 September 2024, should discuss the regulations with the scheme actuary or their actuarial advisers and agree a way forwards.

Osborne Clarke comment

Measures to strengthen the DB scheme funding regime have been a long time in the making. The new regime has been evolving since the government's green paper in February 2017 and through to its 2018 white paper and, finally, the Pension Schemes Act 2021 and two iterations of draft regulations.

The government has repeatedly said that for most well-run schemes, which already have a "long term objective" and use an integrated risk management model to consider risks to funding, the new regime is not expected to have a significant impact.

The key, now, will be to have sight of TPR's revised funding code and fast-track parameters. These will provide the final detail that schemes need to prepare for these changes.