The DB scheme funding regime under current legislation is based on the scheme-specific funding requirements. This existing regime established the statutory funding objective, under which DB schemes must have “sufficient and appropriate assets to cover [their] technical provisions”. The Pensions Regulator’s Code of Practice no.3 on Funding Defined Benefits sets out the practical framework for complying with the statutory funding objective.
The current scheme funding regime is being fundamentally reformed. The Pensions Schemes Act 2021 includes a range of amendments to the existing legislation which will impose new duties on the trustees of DB schemes.
The first step in setting out the detail of the new DB funding regime was taken by the DWP on July 27, 2022, when it published its long-awaited
consultation on the draft
Occupational Pension Scheme (Funding and Investment Strategy and Amendment) Regulations 2023. The consultation closes on October 17, 2022, and once the Regulations are finalised, the Regulator will be able to publish the second consultation on its revamped Funding Code, which is expected to flesh out much of the detail, including the definitions of key terms under the Regulations.
Trustees are expected to determine the date of their scheme’s “significant maturity” and choose a “relevant date” on or before the end of the scheme year in which this stage is reached. This will be the latest time that the trustees expect the scheme to be invested in a “low dependency asset allocation” and thus to be in a state of low financial dependency on the sponsoring employer. The consultation paper states that there is no intention to limit the investment strategies of open schemes, which will be able to take more investment risk on their journey to significant maturity.
We will cover the detail of the Regulations in our September briefing but two new provisions are likely to draw extensive commentary in the consultation process:
- Employer covenant and deficit recovery – the draft Regulations set out factors to be considered when assessing the employer covenant. They describe the strength of the employer covenant as the financial ability of the employer to support the scheme, along with any contingent assets in place. The Regulator’s new funding code is expected to set out extensive guidance. On funding deficits, the draft Regulations include an amendment to current legislation on the agreement of a scheme’s recovery plan, stating that “…funding deficits must be recovered as soon as the employer can reasonably afford”. This is stronger than the relevant provision in the current regulatory Code and the consultation asks whether this “affordability principle” should be given primacy over existing considerations in setting a recovery plan.
- Funding and investment strategy – under the Pension Schemes Act 2021, the existing legislation is amended to provide that the employer must agree the trustees’ funding and investment strategy, as set out in the statement of strategy. Despite this, the draft Regulations make reference only to consultation with the employer on the preparation of the statement of strategy.
The agreement requirement is ostensibly a fundamental change from the current position where restrictions on trustees’ power to make investments are not generally permitted to be subject to the consent of the employer.
Next steps
The publication of the draft Regulations represents the first step in a long process of establishing the new DB scheme funding regime. There is a great deal more detail to come in the Regulator’s new Funding Code, which is expected in “Autumn 2022”. However, we suspect this date may well slip, given the consultation on the draft Regulations has 12 weeks to run and the Regulator has already said it wants to “take the opportunity to learn” from the DWP consultation exercise. The Code will need to flesh out the finer points of the new regime; for instance, the draft Regulations include nothing on the Fast Track or Bespoke compliance arrangements set out in the Regulator’s first DB funding consultation of 2020. Neither do they define many of the key terms, which again is left to the Regulator’s Code. It is unlikely the Regulator can start a consultation on the new Code before the Regulations are finalised.
Trustees will want to get ahead of the game and consult their actuarial, covenant and investment advisers to consider the structure of their investment and funding strategy. Employers will need to assess the extent to which their scheme is impacted, particularly smaller schemes which may have a great deal of work to do to comply with the new requirements.
