UK Pensions Briefing: A “full and ambitious agenda”: busy Pensions Regulator publishes its Annual DB Funding Statement and Corporate Plan

Annual DB Funding Statement

The backdrop to the 2023 DB Funding Statement is a funding landscape that has changed considerably over the past year. The Regulator notes that most schemes’ funding positions should have improved given increased gilt yields; open schemes, particularly immature ones, should benefit from lower estimated costs for providing future benefits. Only a minority of schemes should have seen deterioration in their funding positions, most likely those who were unable to meet LDI collateral calls during the spike in gilt yields in September and October.

Nevertheless, the Regulator has taken a cautious approach with its guidance, emphasising risks that schemes face. Notably, although covenants may now appear “proportionately stronger” as schemes have shrunk, the economic outlook is not favourable. Employers may be affected by ongoing high inflation, lack of economic growth, higher borrowing costs, and uncertainty over geopolitical instability. These same factors, of course, may translate into investment risk.

The Regulator’s guidance has three major sections respectively dealing with the implications of different funding positions for trustees, investment, and covenant. 

Funding positions

On funding positions, the Regulator has provided 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 between technical provisions and buy-out (“Group 2”); and those with a funding level below technical provisions (“Group 3”).

• For Group 1 schemes, the Regulator states that trustees must consider how best to lock in their funding gains. Whilst it acknowledges there are different options, including moving towards buy-out or continuing to run the scheme, none are perfect and trustees should consider the risks as well as the benefits of each. The Regulator warns that there is limited capacity in the insurance market, and notes that placing a scheme in the best position for a buy-out involves considerable time and expense, and potentially a strategic reallocation of assets to those preferred by insurers. Meanwhile, trustees of these schemes may be under particular pressure from employers for reduced or suspended contributions and from members for discretionary increases given high inflation; trustees will need to think carefully about investment strategy and covenant resilience when considering these requests.
• For those Group 2 schemes that have a long-term funding objective and a timescale for achieving it, trustees are encouraged to consider translating any significant improvement in funding into an acceleration of that timescale, for example strengthening technical provisions or reducing investment risk ahead of schedule. Those approaching buy-out levels may wish to start getting insurance ready. Interestingly, the Regulator refers to the draft funding code as a “direction of travel” for trustees in this Group: trustees who have not agreed a long-term funding target should do so as a priority, and it is good practice for all trustees to consider how they can align with key principles in the code.
• Unsurprisingly, the Regulator states that trustees of Group 3 schemes should be focused on achieving technical provisions, with any deficit being recovered as soon as the employer can reasonably afford. Trustees who have seen significantly improved funding levels should consider applying some of the gains to a less risky funding and investment strategy. Those who have seen an expected improvement in funding levels might consider their current strategy successful, subject to covenant considerations. If there has been a fall in funding levels, then trustees should think through their funding and investment strategy from scratch. All Group 3 schemes should consider where they fit within the classification table set out at the end of the 2023 DB Funding Statement (adapted from previous annual DB funding statements) for more specific expectations of trustees and employers in relation to funding as well as covenant and investment.

The Regulator separately observes that over the last eighteen months mortality has begun stabilising at a higher level than before the pandemic, which has positive implications for funding levels. It cautions, however, that it will take some time before any new trends become clear and any changes to assumptions should be appropriate and justifiable.

Investment

The Regulator notes that over the past year, asset allocations may have diverged from expectations. With better funding positions, schemes will probably look at de-risking. This may involve reduced leverage for geared LDI, substituting matching for growth assets, and reducing exposure (or at least reconsidering the trustees’ approach to) illiquid assets. On the other hand, open and non-mature schemes may see merit in sustaining their current levels of risk.

Trustees are also advised to refer to the Regulator’s guidance on using leveraged LDI, given the operational risks exposed in September and October 2022.

Covenant

As noted above, the Regulator emphasises the potential impact of a challenging economic climate on employers, even if covenants now look better in relation to scheme sizes. It singles out refinancing risk as particularly relevant given rising interest rates. As a result, it suggests that trustees should undertake different scenario analyses to understand schemes’ sensitivity to changes and how quickly any deterioration could occur. Volatility and uncertainty mean that trustees should be engaging regularly with management to understand forecasts and challenges.

The Regulator suggests that trustees might also wish to expand the scope of their covenant analysis, with a greater focus on the longevity of the covenant. Although the Regulator does not link this explicitly to the principles of the draft funding code, this does chime with the code’s emphasis on more sophisticated covenant analysis.

The Regulator has indicated that later in the year it will set out proposed changes to its guidance on Assessing and Monitoring the Employer Covenant and related guidance. This will include detail around covenant visibility, reliability, and longevity and incorporation of ESG factors into covenant assessment.

The Corporate Plan

On April 21, 2023, the Regulator published its Corporate Plan for the period 2023 to 2024, the final year of its 3-year planning cycle. The Plan confirms:

• The new DB funding code is expected to come into force in April 2024, rather than in 2023. The revised code will need to reflect any further changes to the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 once finalised by the DWP. 
• The new General Code of Practice (formerly known as the single code) should be published by the end of June 2023.
• No further light is shed on the timing of the new notifiable events regime.

The Regulator also plans a whirlwind of activity over the next year including:

• Improving how it monitors and assesses market risks and events, with a view to potentially increasing the collection of data on scheme asset allocations, including LDI.
• Working with the FCA and DWP to deliver a value for money framework for DC savers and taking action to improve those schemes which are underperforming is a core priority. Consolidation will be encouraged where schemes fail to improve. The Regulator recognises that an enhancement of its powers may be necessary.  A response to its latest consultation is due this summer, following which work will begin on the development and implementation of new policy.
• Having launched its strategy to prevent scams, the Regulator is increasing its focus in this area.  It recognises success relies on effective collaboration with other regulators and partners in industry and law enforcement. It plans to continue its work in driving schemes to comply with the pledge to combat pension scams, together with the Pension Scams Industry Group (PSIG) Code principles. 
• Continuing regulatory initiatives on equality, diversity and inclusion and climate change in Q1. It is monitoring compliance with current climate change requirements and plans to set out clear expectations in the new General Code.
• Assessing and supervising DB superfunds coming to market. The June 2020 superfunds guidance will be reviewed and the Regulator intends to publish guidance on alternative DB consolidation models.

The Corporate Plan also outlines the Regulator's plans beyond March 2024, including:

• A transformation of the approach to protecting DB savers’ money. Regulation will change: a new twin-track approach will drive both ‘fast track’ and ‘bespoke’ engagements with schemes and an “enhanced, data-driven approach” to monitoring funding risk.
• Exploring options for better protecting value at decumulation for DC savers, following the call for evidence that closed in July 2022. 
• Starting work to consider whether there should be a professional trustee on each trustee board, whether professional trustees should be accredited or whether there should be an authorisation process established for professional trustees. The aim is to improve governance standards. 
• CDC schemes – the Regulator stands ready to assess any applications and any CDC schemes that are authorised will be subject to ongoing supervision. After the response to the recent consultation is published (concluded in March 2023) the Regulator will produce a revised code and guidance.
• Dashboards – the Regulator will continue to help schemes to prepare for dashboards and will put in place a framework enabling swift action where duties are not met. It is, as yet though, unclear how long the dashboards “reset” will take.

Into the future

The Corporate Plan is packed with ambition and highlights a full regulatory agenda. The Regulator says it will keep its operation under review to ensure it responds to risks and continues to improve. It intends to be “digitally enabled and data driven”, with aiming for advanced, integrated platforms delivering a streamlined operation. To this end, its budget has increased by £1.7m to £118.9m, with a total of 980 staff projected for 2023-24. It will also focus on the value for money it provides. Centring on economy, efficiency and equality, it plans to track its spend across various office processes. It will also relocate to a new office in Brighton where it will aim for a net zero carbon emissions target by 2030.

If you would like to find out more about the issues covered by this briefing or have any other pensions legal query, please reach out to your usual Norton Rose Fulbright pensions contact.