The government’s Department for Work and Pensions (DWP) has launched its consultation on Defined Benefit (DB) funding regulations. The changes will oblige DB schemes to document their end-game strategy in a statement for The Pensions Regulator (TPR) and are expected to see many schemes reaching a low dependency, low risk funding level over the next decade or so.
The government say the objective is “better, and clearer, funding standards, but not to move away from the strengths of a flexible scheme specific approach” and to “enable TPR to intervene more effectively” where required. It also acknowledges that while most schemes are well-managed, this is not universal, hence safeguards are necessary for the millions of people who rely on DB schemes.
Another change in the proposals defines the concept of employer covenant and its measurement in legislation for the first time.
In a Nutshell
The proposed changes are designed to drive DB schemes towards a “low dependency” funding level by the time they are “significantly mature”. Thereafter, it would “not be expected that any further employer contributions will be required to make provision for accrued rights and other benefits under a scheme”.
The regulations also mean that investment risks should be reduced where a scheme has a weak employer covenant, and funding deficits must be recovered as soon as a scheme’s employer(s) can reasonably afford. However open and immature schemes are not prevented “from investing in riskier investments where there are potentially higher returns, as long as the risks being taken can be supported”,
Smaller Schemes May Need Support
The DWP’s own impact assessment acknowledged that “the proposed changes are expected to have a disproportionate impact on small schemes”. In our experience of supporting smaller schemes, this is probably because they do not have access to the same resources as their larger counterparts.
As trustees, we’ll need to be fully abreast of the proposed changes. Whilst they have received a mixed response from the sector; there is however some good news, with industry funding trackers suggesting that many schemes may actually have a low dependency funding position. So now may be a good time to be thinking about derisking.
Statement and Strategy
The total investment risk that can be taken while journeying to the low dependency target, and the strength of the actuarial assumptions selected for funding purposes, are reliant on the strength of the employer covenant and how close the scheme is to maturity. Trustees will be required to develop a statement of strategy which sets out their contingency plans should any risks develop.
This strategy statement will include new details on:
- Maturity;
- Liquidity; and
- Investment Planning.
The latter of these has to be regularly reviewed, and if necessary, revised when there are changes in the employer covenant or funding position. All this essentially means that de-risking schemes will become compulsory which is arguably good for members but makes the role of trustees and sponsors a little harder.
For many schemes, there may be little or no change in direction and so the changes largely mean increased governance. However weaker employers may find meeting the requirements in a prescribed timescale challenging and stronger employers may be faced with accelerating the speed at which they need to pay off their deficits with potential for increased contributions. So it is vital that covenant and its impact on funding and investment is fully understood by trustees particularly in these unsettled times.
Planning Ahead
At 20-20 Trustees, we have been advising schemes to consider their journey planning and long term objectives for some time, which means our clients are already some way forward when it comes to their funding and strategic goals and should be ahead of the game when it comes to stressing the importance on low dependency.
Working through these new regulations is essentially forcing the compliance issue which we believe is a good thing; allowing TPR to be more robust in its regulation of DB schemes.
However, schemes must have the expert advice necessary to ensure a suitable investment and funding strategy and as trustees we will need to take care that the strong relationships we have built with scheme sponsors are maintained through any enforced strategy change.
The Clock is Ticking
The consultation closes on 17 October 2022 and it will be interesting to see what comments and questions our industry peers raise. Whilst much of the detail will follow in TPR’s consultation on the proposed DB funding code, there is no doubt that change is coming. So we urge schemes who may be uncertain about their obligations to get in touch for an informal chat.
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