The government has launched a consultation on draft regulations setting out the detailed requirements for the new funding and investment strategy that trustees of DB occupational pension schemes will be required to set.
By way of background, the Pension Schemes Act 2021 introduces an obligation for trustees of DB schemes to:
- Determine, and from time to review, a strategy for ensuring that benefits under the scheme can be provided over the long term (a funding and investment strategy).
- Prepare a written statement of that strategy.
Funding and investment strategy
The key principle underlying the new funding requirements is that by the time a scheme reaches significant maturity, it should have low dependency on the employer. “Low dependency” means that the scheme has sufficient assets to provide for accrued benefits and is not, under reasonably foreseeable circumstances, expected to need further employer contributions. To achieve this, trustees must determine a strategy for ensuring that by and after the time the scheme reaches the relevant date:
- Its assets are invested in accordance with a low dependency investment allocation.
- It is fully funded on a low dependency funding basis.
A scheme’s maturity is essentially how far the scheme is through its lifetime. The scheme’s maturity will be determined by the scheme actuary using a (weighted average) “duration of liabilities”. The point at which a scheme will be considered to have reached “significant maturity” will be specified in the Pensions Regulator’s new DB funding code of practice. It is likely to be when the scheme reaches a duration of liabilities of 12 years.
The “relevant date” will be set by the trustees and cannot be later than the end of the scheme year in which the scheme actuary estimates that the scheme will reach significant maturity. The trustees must review, and if necessary revise, the relevant date each time the funding and investment strategy is reviewed.
The strategy must specify:
- The funding level the trustees intend the scheme to have achieved as at the relevant date.
- The proportion of scheme assets the trustees intend to be allocated to different categories of investments on the relevant date.
- The way in which the trustees intend benefits to be provided over the long term e.g. whether to “run on” with low dependency on the employer or to target a transfer of liabilities to a consolidator or insurer within an agreed timeframe.
- If the scheme has not reached the relevant date, the expected maturity of the scheme at the relevant date.
In determining the scheme’s journey plan to the relevant date, the level of investment and actuarial assumption risk that the trustees can take must reflect the strength of the employer covenant (assessed using the principles set out the draft regulations) and how close the scheme is to the relevant date. In other words, the stronger the employer covenant and/or the further the scheme is from the relevant date, the more risk the trustees can take. The trustees must also ensure that the scheme’s investments have sufficient liquidity to meet expected cash flow requirements and to allow for unexpected cash flow requirements.
Trustees must determine their first funding and investment strategy within 15 months of the effective date of the first valuation after the draft regulations come into force. The strategy must be reviewed, and if necessary revised:
- Within 15 months of the effective date of each subsequent valuation.
- As soon as reasonably practicable after any material change in the circumstances of the scheme or the employer.
The funding and investment strategy must be agreed with the employer.
Statement of strategy
The written statement of the funding and investment strategy will comprise two parts. Part 1 must set out the funding and investment strategy itself. Part 2 must cover a range of supplementary matters, including details about implementation of the strategy and about the scheme’s maturity, level of investment risk, liquidity, funding level, employer covenant and actuarial assumptions.
The trustees must consult the employer on Part 2 of the strategy and the employer can request that its comments are included in the statement. The statement must be signed by the trustee chair. If the scheme does not have a chair, one must be appointed.
The statement must be prepared as soon as reasonably practicable after the funding and investment strategy is determined or revised. In addition, Part 2 must be reviewed, and if necessary revised, after any review of the strategy, whether or not the strategy is revised.
A copy of the statement must be submitted to the Pensions Regulator with a copy of the actuarial valuation to which it relates.
Other changes to the funding regime
The Pension Schemes Act 2021 amends the funding regime to require trustees to:
- Calculate the scheme’s technical provisions in a way that is consistent with their funding and investment strategy.
- Submit a copy of the scheme’s actuarial valuation to the Pensions Regulator as soon as reasonably practicable after receiving it. (Currently, only schemes in deficit on a technical provisions basis are required to do so.)
The draft regulations will make further changes to the funding regime, including requiring the scheme actuary to include an estimate of the following in the valuation:
- The scheme’s maturity as at the effective date of the valuation and as at the relevant date.
- The date on which the scheme is expected to reach (or reached) significant maturity.
- The scheme’s funding level as at the effective date of the valuation, calculated on the low dependency funding basis used in the funding and investment strategy.
The draft regulations will also add a requirement for trustees, when setting a recovery plan, to follow the principle that funding deficits must be recovered as soon as the employer can reasonably afford.
The draft regulations impose the same funding requirements for all DB schemes, regardless of whether they are open or closed to new members and/or benefit accrual. However, the government acknowledges that during the passage of the Pension Schemes Act 2021 through Parliament, concerns were raised that open schemes may be forced into inappropriate de-risking and that this could lead to unnecessary additional costs, and an end to such schemes. The draft regulations are therefore intended to work in a way that does not prevent appropriate open schemes from investing in riskier investments where there are potentially higher returns, as long as the risks being taken can be supported and members’ benefits are effectively protected.
For example, on each review of the funding and investment strategy, open schemes will be able to move the relevant date into the future, in which case they would not be required to undertake investment de-risking, if this is considered appropriate in the scheme’s circumstances. The government also expects the new DB funding code of practice to set out further detail on how the characteristics of an open scheme can be taken into account in the projection of scheme maturity.
The consultation closes on 17 October 2022. The draft regulations indicate that they will come into force some time in 2023. The Pensions Regulator has stated that it expects the new DB funding code of practice to become operational in September 2023. It therefore seems sensible for schemes to plan on the basis that the new requirements will come into force in late 2023.
Many schemes will already have some form of long-term funding target and journey plan in place. Trustees of such schemes should discuss with their advisers what changes might be required to those targets and plans in order to comply with the new requirements and at what point those changes should be made. Where schemes do not have a long-term funding target or journey plan in place, trustees should discuss with their advisers what actions they will need to take to comply and when those actions should be taken.