UK Pensions Briefing | Pensions Regulator publishes its Annual Funding Statement 2024 and Corporate Plan 2024-27 in “rapidly shifting” pensions market

Annual DB Funding Statement

On April 24, 2024, the Regulator published its DB Funding Statement focussed on trustees of schemes with valuation dates between September 22, 2023, and September 21, 2024 (“Tranche 19” schemes).

The backdrop to the Statement is the significant changes in market conditions in recent years, and the Regulator expects trustees to review their funding and investment strategies even if they do not have a T19 valuation. Thus, the Statement is relevant for all schemes.

Being the last Statement before the introduction of new requirements for funding and investment strategies in September 2024, the Statement’s tone differs from previous years. With the new DB funding regime very much in mind, the Regulator sets out the range of options for well-funded schemes.

The revised DB funding code, together with updated covenant guidance, is due to be published over the summer. Whilst it doesn’t technically to apply to schemes with valuation dates before September 22, 2024, the Regulator’s view is that it would be good practice for trustees currently in the midst of triennial valuation discussions to consider the steps to be taken to comply with the new regime ahead of time. Such forward planning will avoid having to make significant change before the next valuation in order to comply with the new regime.

Key messages

The shorter than usual Statement sets out the following main points:

• Most schemes have seen a significant improvement in their funding levels, with over half of them exceeding their buy-out funding levels. Trustees and sponsors should therefore seize the opportunity to reassess their long-term strategies for their scheme.
• Where funding levels have improved, trustees should consider whether the existing strategy and risk level is in members’ best financial interests. Possible redirection towards the generation of additional surplus by running on, consolidation and entering an insurance arrangement are all alternative options.
• Schemes which remain in deficit on a technical provisions basis are urged to be mindful of the employer covenant and focus on achieving a recovery plan. This should be as short as possible, taking into account affordability for the employer.
• The effect of far-reaching risks such as climate change and future political or economic instability should be considered by trustees in terms of their scheme’s covenant, investment and funding strategies.

General considerations for schemes currently undertaking a valuation

The Regulator has pulled together its thoughts on the general DB funding improvement levels. Covenant reliance will have reduced in many cases, but trustees could be under pressure from employers requesting contribution reductions as well as members asking for discretionary increases to pension benefits. Trustees are urged to take a holistic view of the scheme’s circumstances.

Open schemes may have seen a material reduction in their estimated liabilities, and given their typical immaturity, may have seen bigger shifts in funding levels. These trustees are likely to be focussing on technical provisions rather than long-term funding targets. Trustees of open schemes may therefore be maintaining greater covenant reliance for longer than their closed counterparts and they may be considering employer requests to use surplus to subsidise future accrual.

Despite a healthy scheme funding position in the majority of cases, trustees should not lose sight of ongoing global geopolitical instability, together with climate change, and their possible effect on investments and the employer’s future business prospects and thus scheme covenant.

Funding positions

The Regulator expects the scheme categorisation it set out in its 2023 statement to remain relevant in the coming year and provides separate guidance for each of three groups of scheme: those with a funding level at or above buy-out (“Group 1”); those with a funding level above technical provisions but below buy-out (“Group 2”); and those with a funding level below technical provisions (“Group 3”).

• For Group 1 schemes, the Regulator expects trustees to understand the risks and benefits for members of the various end-game options. Where buy-out is considered, the impact on possible future discretionary increases should be borne in mind. Whether trustees choose running on and its attendant investment risk, consolidation or a buy-out arrangement, they should be mindful of their duties. They may need to take advice about the risks and benefits of following a particular course of action.
• For Group 2 schemes, the Regulator expects trustees to review the long-term objective and the timescale for reaching it. Emerging options such as consolidators (including the proposed public sector consolidator via the PPF, currently under consultation) and capital-backed journey plans should be explored for their possible benefit to members’ interests. Trustees should consider all options and not merely accept their scheme’s status quo. Guidance on DB alternative arrangements for consolidation is due later this year.
• For Group 3 schemes, trustees’ focus should be first on bridging the gap. Risk-taking should be supported by the employer covenant, with the deficit being addressed as soon as the employer can reasonably afford it.

A summary of key actions for trustees and employers

Trustees and employers should:

• Reconsider the scheme’s long-term strategy, risks and opportunities. Are consolidation, running on for surplus or a buy-out arrangement likely to benefit members financially?
• Establish which of the Regulator’s three classifications most closely fits the scheme. Next, look at whether the Regulator’s expectations for that scheme type are aligned with the scheme’s existing approach on covenant, investment and funding.
• Where a scheme’s valuation date falls before September 2024, consider the actions which could align the scheme generally with the new funding approach for the future.
• Look at global, climate and political risks when considering the scheme’s future journey.

Comment

With a new funding regime on the horizon, and many schemes in healthy surplus, it is unsurprising that this year’s Statement is positive in tone and shorter than usual. Trustees are being urged to look to their scheme’s end-game and to look at the full gamut of options available, bearing in mind that different strategies could have different member outcomes.

Next year’s statement, when the new funding regime has been in action for a few months, should be an interesting read.

The Corporate Plan

In comparison to this year’s streamlined DB Funding Statement (see above), the Regulator’s Corporate Plan for 2024-27, issued on May 3, 2024, is positively hefty and runs to 22 pages.

The Plan outlines the Regulator’s ambition to protect members’ savings, oversee schemes and “evolve the regulatory framework and enable market innovation”. It sets out the Regulator’s priorities for the next three years as the pensions industry:

• Accepts the key challenge of the new DB funding regime.
• Moves towards a landscape with fewer, larger schemes.
• Acknowledges that global instability creates a challenging backdrop for employers and savers alike.

The Regulator plans to engage differently with the industry, having recently launched its three new directorates of compliance, market oversight and strategy, policy and analysis.

The coming year

The Regulator affirms that its headline priority for 2024-25 will be embedding the new DB funding regime. It has an ambitious list of 19 “key priorities” across protecting savers’ money, enhancing the pensions system, innovating savers’ interests and investing in its own people.

The new DB funding regime will require investment in the Regulator’s data and systems infrastructure. It will also necessitate enhancing the Regulator’s market oversight as the new funding regulations and DB funding code are adopted by schemes. The Regulator sees as key in this aspiration supporting a market for consolidation and risk transfer, and it intends to work with the DWP to support future DB superfund legislation. It will also support the government in establishing the PPF public sector consolidator after the consultation is complete.

As for the DC sphere, the coming year will see the Regulator evolving its approach to master trust supervision to challenge trustees’ focus on value for money ahead of any new legislation. It sees ongoing engagement with the industry as central in its continuing work on the value for money programme and environmental, social and governance aims.

Beyond 2024-25

Once the new DB funding regime is operating, the Regulator’s focus will increasingly shift towards the delivery of the DC value for money framework. Innovation is to be promoted across the sector, most notably in tackling deferred small pots and decumulation solutions.

In the auto-enrolment sphere, the Regulator intends to work with the DWP and stakeholders to prepare for the extension of the regime by the admission of younger workers and removal of the lower qualifying earnings threshold.

On trusteeship, the Regulator intends to enhance the system by raising standards generally. It will engage closely with the professional trustee industry and promote the new general code. It also acknowledges a significant shift in the increase in professional trustees and concentration of the trustee industry. It notes that mergers and acquisitions across professional trustee companies have made these entities systemically important for the delivery of good outcomes.

More widely, the Regulator plans to make greater use of data to improve its monitoring of trustee standards, including the development of a trustee register.

Budget

The Regulator’s funding is derived from a grant from the DWP to finance its Pensions Act 2004 duties (levy-funded activities) and a separate grant from general taxation relating to its auto-enrolment work. The budget for 2024-25 is expected to be £112.1m which represents a £10m reduction from the previous financial year, the Regulator having committed to achieving efficiency savings of 5 per cent in its levy-funded work and 23 per cent in connection with auto-enrolment activities.

The future

The Regulator has set out an impressively ambitious list of 23 “priority outcomes” across its regulatory and enabling work for 2024-25. These are as wide-ranging as ensuring DC schemes offer value for money and promoting growth in the consolidation market to overseeing auto-enrolment compliance and protecting savers from scams.

With a General Election later this year, the political uncertainty of the immediate future may hamper the Regulator in its realisation of some of its objectives.