Pensions Regulator promises a “reasonable approach” as DB funding code now laid before Parliament

The Regulator’s finalised draft of the DB funding code is the final piece of the jigsaw in the new funding and investment strategy regime. After much delay the new code was laid before Parliament on July 29, 2024.

The DWP’s explanatory memorandum to the draft Code reflects the funding regulations (which came into force on April 6, 2024), consultation responses received and extensive engagement by the Regulator with the pensions industry. It is described as providing “further flexibility for scheme specific approaches to risk-taking and for open schemes”.

There are several key changes reflected in the code since the version first consulted on in December 2022:

• Low dependency asset allocation – this ensures trustees are targeting a low dependency funding basis by the relevant date in the Funding and Investment Strategy. The code makes clear there is no requirement to invest in line with low dependency but there is an expectation that for most schemes this will be in members’ interests. The Regulator has made clear there is significant flexibility to take investment risk while complying with the low dependency principle and there are no restrictions in the code on trustees’ ability to invest in line with their fiduciary duties. The code now reflects that the regulations define the low dependency investment allocation as providing a highly resilient funding level to short-term changes in market conditions.
• Significant maturity – the regulations give the Regulator the power to specify the duration of liabilities in years at which schemes reach significant maturity. The initial consultation suggested the duration of liabilities for significant maturity as 12 years. In the new draft code, this has been reduced to a duration of 10 years for schemes with DB benefits and 8 years for schemes with cash balance benefits. This move reflects changes in market conditions.
• Open schemes – the regulations explicitly allow open schemes to consider new members and future accrual of benefits when determining the future maturity of the scheme, based on the covenant of the employer. The Regulator has now built in more flexibility on future accrual and new members and trustees can take account of this when determining future maturity. Schemes which have a good flow of new members will not need to take steps to de-risk their investments in their investment strategy, provided the risks are supportable. The draft code has a new specific section outlining expectations for open schemes.
• Employer covenant assessment – the draft code has been updated to align with the regulations and to provide greater clarity on how to assess the employer covenant reliability and longevity periods. The Regulator sets out its expectations on how long these periods should be for a typical scheme and acknowledges that some employers may be able to demonstrate that a longer period is appropriate for them.
• Assessing maximum risk over the journey plan – the formulaic test to determine the maximum level of risk that can be supported by the employer covenant has been replaced with a principles-based approach. This should provide trustees with the flexibility to recognise the different ways in which schemes can assess risk as well as the different types of support that may be available.
• Recovery plans and reasonable affordability - the draft code makes clear that trustees must follow the overriding principle that deficits should be recovered as soon as the employer can reasonably afford. In considering the recovery plan, trustees must take account of certain matters including the impact of the recovery plan on the sustainable growth of the employer. Trustees should assess affordability on a year-by-year basis, with steps taken to reduce the deficit set in line with this assessment.

Alongside the draft code, the Regulator has also published its response to the December 2022 consultation on the code, as well as its response to the fast track and regulatory approach consultation.

Guidance from the Regulator on the employer covenant and the format for statements of strategy is still awaited.

Comment

The improved clarity and flexibility in the revised draft code has been welcomed and trustees will now be able to assess what the new funding regime means for their scheme.

The delay to the laying of the code before Parliament means that it will come into force after September 22, 2024, the effective scheme valuation date triggering the start of the new code’s applicability. Some schemes with valuation dates immediately after September 22 may find themselves “between codes”, with the new code coming into force mid-valuation. The Regulator has said that such schemes “can use the new DB funding code as the base for their approach”. It intends to contact such schemes and “take a reasonable regulatory approach”.

The final draft reflects the pensions landscape as it now is following the gilts crisis of 2022 and the Mansion House reforms subsequently announced in 2023. The Regulator has been able to take a balanced approach to its oversight of the code given the significant improvements in DB scheme funding levels since the first draft was published.

The Regulator has also taken into account alternative options for schemes such as running on, dealing with surplus and the emerging superfunds regime.

The delay in introduction of the new code also means that trustees face a less pressured environment for making strategic decisions. Schemes that are now well on the way to being fully funded have the opportunity to review their strategies and objectives and to reassess the full range of options available to them.