The Pensions Regulator ("TPR") has begun its consultation on a revised code of practice for defined benefit ("DB") pension scheme funding. TPR currently expects the revised code to come into force in late 2021.
TPR is running the consultation in two parts:
- The first consultation started earlier this week and ends on 2 June 2020. It considers TPR's proposed new regulatory approach, the principles underpinning the new framework, and how those principles could be applied in practice.
- The second consultation is planned for later in 2020, and will focus on the code itself.
In this legal update we highlight some of the key points arising from the first consultation.
1. Twin track approach
- A key proposal is that the revised code sets a twin track approach ("Fast Track" and "Bespoke") for trustees to demonstrate that valuations meet with legal requirements.
- The "Fast Track" approach will be available to schemes that can demonstrate compliance with a number of quantitative tests, which will vary depending on covenant and scheme maturity. It will likely lead to more limited TPR scrutiny of a valuation.
- The "Bespoke" approach will give schemes more flexibility to take account of their specific circumstances. It will be open to schemes that cannot satisfy the "Fast Track" requirements, or whose trustees choose to take additional risks (and can explain how the risks are to be mitigated). Under the "Bespoke" approach, trustees will need to explain how and why they have deviated from the "Fast Track" approach.
2. Long-term planning
- TPR expects trustees to identify a scheme-specific long-term objective so that by the time the scheme is significantly mature, it is fully funded on a low dependency basis and has investments that are resilient to risk.
- TPR uses the term "low dependency" as an alternative to the frequently-used "self-sufficiency", as it better reflects the fact that, even at a strong level of funding, a scheme is still exposed to a small amount of risk and is therefore not entirely self-sufficient.
- Trustees will need to set a prudent journey plan to the long-term objective, including an appropriate level of de-risking over time.
- TPR's view is that it should not require schemes to fund on the assumption that they will buy out or enter a consolidation vehicle. These are trustee/employer decisions that may require a higher funding level than low dependency, and the cost will be driven by market forces.
- Technical provisions should be set that are "consistent" with the long-term objective. They are to be seen as "stepping stones" on the journey to achieving the scheme's long-term objective.
3. Employer covenant
- The consultation considers the extent to which the employer covenant should remain a key aspect of scheme funding, including how it should be assessed and for how long reliance can be placed on it.
- The relationship between covenant and the scheme's long-term objective also receives attention, with TPR making clear that trustees should be able to demonstrate how the assessment of the covenant has been taken into account in the long-term objective.
- Schemes whose covenants are strong can take more risk and assume higher investment returns, but reliance on the covenant should be reduced over time. Indeed, under the "Fast Track" approach, TPR states that reliance on the covenant should be minimised to the period a typical covenant is visible for (e.g. three to five years).
- The consultation also considers the use of alternative support such as contingent assets and guarantees, acknowledging that the use of contingent assets may be appropriate if trustees can demonstrate how they provide support.
4. Investment risk
- TPR expects schemes to take only a supportable level of investment risk.
- The consultation invites responses on how investment risk is measured, what the appropriate maximum level of investment risk should be and additional requirements around liquidity and quality of assets.
5. Recovery plans
- Any funding shortfall should be supported by an appropriate recovery plan.
- The consultation emphasises that recovery plans should have an appropriate length and shape, whilst minimising any adverse impact on employers.
6. Open schemes
- The consultation contains a specific section on open schemes.
- This section makes clear that members' accrued benefits in open schemes should have the same level of security as accrued benefits in closed schemes.