The DWP has published draft regulations setting out how it plans to operate the funding regime following changes under the Pension Schemes Act 2021.
The DWP has published draft funding and investment strategy regulations for defined benefit pension schemes in order to amend the funding regime as required by the Pension Schemes Act 2021. The draft regulations set out new requirements for the funding and investment strategy of schemes as they move towards maturity. The objective is “better, and clearer, funding standards, but not to move away from the strengths of a flexible scheme specific approach”. The standards are intended to “enable TPR to intervene more effectively” where required.
Schemes will need to capture their approach in a written statement of their funding and investment strategy at the first valuation after the regulations come into force, but no target date is given for their implementation.
A key requirement of the new approach is that once a scheme is mature it should be in a state of low dependency on their sponsoring employer. The draft regulations propose measuring scheme maturity using the duration of liabilities determined according to a standard “weighted mean time” approach which will be further defined in The Pensions Regulator’s (TPR’s) Defined Benefit Funding Code of Practice. The DWP proposes that the relevant duration for determining what is “significantly mature” should not be set out in the Regulations, but instead set by TPR in its Code of Practice – with 12 years expected to be the proposed duration. The date on which the scheme is expected to have this duration is the “relevant date” on which the scheme must be fully funded on its low dependency basis.
To achieve a state of low dependency a scheme will need to be invested in appropriate assets which broadly match the expected liability cashflows and be highly resilient to changes in market conditions. The actuarial assumptions chosen should reflect this strategy and there should be no expectation of any need for further employer deficit contributions under reasonably foreseeable circumstances. The scheme should be fully funded on this basis when significant maturity is reached. Unlike the requirements that apply over the period to reaching maturity, the draft regulations propose that the low dependency target applies equally to all schemes regardless of covenant or whether there are supporting contingent assets, although DWP is consulting on some very limited relaxations to the investment requirements if high-quality contingent assets are available.
For the first time, employer covenant is defined in legislation. In considering employer covenant, Trustees will have to assess the likelihood of employer insolvency, the employer’s cash flow and how other factors may affect the business. These should be viewed taking into account the size of the scheme’s deficit on its low dependency and solvency bases. Contingent assets can be taken into account provided they are legally enforceable and provide sufficient support in the circumstances in which they may be required.
The amount of investment risk that can be taken while on a Journey Plan to the low dependency target, and the strength of the actuarial assumptions chosen for funding purposes are dependent on both the strength of the employer covenant and how near the scheme is to reaching significant maturity. In the statement of strategy the trustees will be required to set out their contingency plans in the event that any such risks materialise.
A new requirement is added to the technical provisions that the assumptions used in calculating the technical provisions on or after the relevant date are consistent with how the pensions and other benefits under the scheme will be provided over the longer term, as set out in the scheme’s funding and investment strategy. The impact assessment acknowledges that this requirement may lead to material increases in technical provisions for schemes that currently do not fund in this way.
While it has always been a TPR objective, the regulations also introduce a new legal requirement for any recovery plan to be met “as soon as the employer can reasonably afford”. DWP is consulting on whether this should have primacy over other Recovery Plan requirements.
During the Act’s Parliamentary passage, the Government committed to not fettering trustees’ investment powers. However, the statement of funding and investment strategy which needs to be agreed with the employer will include a specification of the intended high level allocation between asset classes at the relevant date. The consultation appears to acknowledge this shift in the Trustee’s investment powers at that date, proposing that flexibility remains because the Trustees will continue to be responsible for investing funds.
The regulations set out a number of detailed requirements for the statement strategy, which include a number of new requirements for information on maturity, liquidity and investment strategy. This will need to be revised at least at each future actuarial valuation, but will also need to be reviewed and if necessary revised if there is a material change in the scheme funding position, or a material change to the employer covenant.
The consultation states that the intention is that open schemes with “adequate sponsor support” should not need to “undertake inappropriate de-risking of their investment approaches”. However, the regulations require open schemes to comply with all the above requirements, with the flexibilities being that:
However, the requirements remain for such schemes to both set and fund for a journey plan to low dependency, even if they do not expect to ever reach significant maturity.
The consultation runs to 17 October 2022.
