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DB funding framework: all change?

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Helen Powell

PSL Counsel

London

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04 March 2020

The Pensions Regulator (TPR) has begun what it terms a 'robust and lengthy debate' on a new framework for DB funding – this is the first step in the process towards a new funding Code. Trustee and sponsor engagement is key, as your responses could influence the detail of more specific guidelines to be consulted on at the next stage. 

Key points

  • The current consultation focuses on proposed principles that would underlie all valuations, and a new twin-track regulatory approach to valuations (fast track and bespoke). The fast track approach is intended to set out an appropriate ‘objective’ funding standard based on compliance guidelines, and will involve less regulatory intervention. The bespoke approach will allow schemes that do not meet all the guidelines or prefer a different approach to demonstrate how any additional risk compared to the fast track guidelines is supported or mitigated.
  • There will be a further consultation later this year on the detail of those guidelines as part of a new draft funding Code that will outline the twin-track structure, the requirements for using the fast track, and the principles to apply when using the bespoke route.
  • In a shift from current thinking, TPR is consulting on whether, and the extent to which, the employer covenant should remain a key aspect of scheme funding, as well as the extent to which (and purposes for which) reliance can be placed on alternative funding support (such as contingent assets and guarantees). TPR is keen to understand if there are any workability issues or unintended consequences from its proposals.
  • Some new terminology is introduced – schemes should reach 'low dependency' by the point of 'significant maturity'. Low dependency means that a scheme's funding and investment strategies result in a low chance of requiring further employer support (and any support required would be low relative to the size of the scheme). 'Significant maturity' is not yet defined but is likely to mean the point at which most benefits are in payment and schemes have a remaining liability duration of 12-14 years.
  • Trustees would be able to choose their preferred approach at each valuation (and would not be bound by a previous choice). TPR considers that the twin-track approach will increase transparency of trustee decision-making and risk-taking, and that it will allow TPR to target its resources more effectively.

 

Proposed principles

TPR is seeking feedback on proposed key principles to underpin all valuations, including:

  • Long-term objective: a new requirement for trustees to set a scheme-specific long-term objective (LTO) is due to be introduced via the Pension Schemes Bill – you can read more about the background here. By the time schemes reach significant maturity, TPR will expect low dependency on the employer and for assets to be invested with high resilience to risk, a high level of liquidity and a high average credit quality.
  • Journey plans and technical provisions: trustees will be expected to develop a journey plan to achieve their LTO. Trustees should plan to reduce investment risk as the scheme matures and reaches low dependency. Technical provisions (TPs) should be clearly linked to the LTO, and the two should converge over time.
  • Employer covenant and recovery plans: TPR considers that, for most schemes, visibility of the employer covenant is limited to three to five years at most and trustees should assume a reducing level of reliance on the covenant after that. TP deficits should be recovered as soon as affordability allows, while minimizing any adverse impact on the sustainable growth of the employer. Schemes with recovery plans outside fast track parameters (for example, six years) would need to justify this, including demonstrating equity between dividends and deficit reduction contributions.
  • Contingent assets and other support: TPR recognises that alternative support can be an important tool for trustees and employers; schemes can account for additional support when carrying out valuations provided that it provides sufficient support for the risk(s), is valued appropriately, and is legally enforceable and realisable at its necessary value when required.
  • Evidence: trustees and employers should understand the scheme’s funding and investment risks and be able to provide objective evidence of how these have been assessed and are being managed.

 

Other points to note

TPR is seeking feedback on whether reliance on the employer covenant should be factored into the fast track (and if so, how), or whether this should be limited to the bespoke approach. It also asks whether, if the covenant is to be taken into account, all schemes should aim for a recovery plan of a standard length, or whether there should be different thresholds for different covenant grades.

The compliance guidelines are expected to cover areas including: the funding target and assumed journey plans; technical provisions; appropriate recovery plans (including clear limits on length) and investment risk. The assumptions set by the guidelines, including the extent to which TPR decides to prescribe these and how often they will be reviewed, will be of key importance. TPR will consult on the guidelines in the next consultation, and its proposals will depend partly on responses to this consultation and how these feed in to its impact assessment for the new framework.

Depending on the guidelines developed by TPR, the fast track framework is unlikely to be suitable for many larger schemes with more complex arrangements – schemes with arrangements that are ‘better’ than fast track but that do not meet all the guidelines will also need to use the bespoke route. 

The consultation contains some illustrative examples of both the fast track and bespoke approaches. 

 

Have your say

The consultation closes on 2 June 2020. TPR is planning to issue a further consultation later this year, and the current plan is for the new code to come into force at the end of 2021. However, timing for the new framework is linked to the passage of the Bill and accompanying regulations. Both this, and the length and detail of the current consultation, suggest that the timeline of late 2021 for the Code to come into force may shift.

As well as the consultation document, TPR has also published a press release, a short overview document, and supporting analysis on setting the LTO under the fast track guidelines. Although the consultation document is a weighty read, the overview document is a helpful guide to key chapters for review and we suggest that trustees and sponsors start with this when assessing the implications of the proposed changes. 

This is a particularly important consultation that could have a significant impact for many schemes; we recommend that trustees and their advisers take time to consider the implications for their scheme and to respond to the consultation.