The new regime is broadly based on the principle that schemes should set a journey plan that aims to reduce reliance on the sponsor over time. Whilst that will be a familiar concept for many schemes, especially those that are closed to new or existing accrual, there are several new definitions to understand and requirements to get to grips with – relevant date, high resilience, low dependency and covenant reliability to name but a few. Trustees and sponsors need time to get up to speed, even if they are very familiar with the previous version of the regime. The statutory deadline for completion of the valuation remains at 15 months, so starting early is advisable. The new Statement of Strategy poses some particular challenges for timelines, and the time required to collate the information required from the actuary, covenant adviser and investment consultant should not be underestimated.
Schemes have spent a lot of time and effort in developing their current funding plans – if these are deemed to be consistent with the requirements of the new regime, there might be a temptation to agree a LDFB at the weaker end of the range so that it doesn't infringe on the existing funding arrangements.
However, trustees may wish to think again given the increased significance of the low dependency measure - the Government has said that it is minded to use full-funding on a low dependency basis as the point at which sponsors can potentially access surplus, with the change expected to come into force in 2027. Even though no details have been provided, the LDFB seems to be an obvious candidate for this purpose so that the Government doesn't have to define a different low-dependency measure.
Setting a low LDFB target now could therefore have unintended consequences for future discussions around access to surplus. If trustees do adopt a LDFB at the weaker end of the range, they should consider positioning this carefully with the sponsor, so that it doesn't come as a surprise if they aren't prepared to release surplus without additional funding buffers on top of the LDFB.
The concept of a long-term target strategy that is 'highly resilient' to changes in market conditions sounds disarmingly simple, but there are a number of twists in the new regime, particularly for schemes that are well funded and/or running a low-risk investment strategy. Schemes are not allowed to take credit for any surplus when assessing resilience – well funded schemes are therefore still having to think very carefully about how best to satisfy this requirement even if they are already largely independent of the sponsor in the 'real world'. Schemes running a strategy with a relatively low target return are also having to be more creative in how they demonstrate resilience – simply running the scheme's asset allocation through the type of stress test outlined in the new funding Code may not produce the expected outcome.
TPR now expects schemes to reserve for non-investment expenses that are expected to be incurred after the relevant date, unless the scheme rules require the sponsor to pay those expenses. It has also become increasingly clear that TPR expects this reserve to extend for the lifetime of the scheme unless the funding and investment strategy states definitively that the trustees expect the scheme to move to buyout within a defined timeframe.
Expense reserves set in this manner can be significantly higher than those typically adopted under the previous funding regime, and are therefore likely to require careful consideration and negotiation between the trustees and the sponsor. Whilst TPR does envisage a more proportionate and pragmatic approach to setting the reserve where the relevant date is some way off, there can still be a material amount of work involved in projecting a scheme's running costs many years into the future in a way that stands to up potential external scrutiny.
Even though the Statement of Strategy (SoS) is simply a submission to TPR and doesn't necessarily have any wider use, it is becoming increasingly clear that it's a lengthy document that takes time to complete. The SoS is much more involved than the valuation information that schemes are used to submitting under the previous regime. It requires detailed input from the scheme's actuarial, covenant and investment advisers and responsibility for signing it off sits with the trustee chair as an individual. The first part of the SoS also needs to be signed at the same time as the valuation, rather than being completed afterwards, which needs to be factored into timetables.
As part of its interim response to its consultation on the SoS in September 2024, TPR helpfully created the concept of a "low risk scheme", with three different definitions to cater for various scenarios. If trustees are able to confirm the scheme meets one of these definitions then the disclosure requirements are somewhat lighter. This was a welcome development, especially for schemes that are well funded and/or hold annuity policies to back a significant proportion of their liabilities.
However, on close reading, only two of the definitions are likely to be used in practice - unless TPR allows a relatively loose interpretation of where "full benefits for all members have been secured with an insurer" few schemes seem likely to clear this hurdle, making one of the three definitions largely defunct. Exercises such as data cleansing and GMP equalisation that are often completed following a buy-in could mean the requirement is satisfied only shortly before a scheme starts to wind up!
In our view, the most likely of the three definitions that will be used is the one that requires a scheme to be Fast Track compliant and in surplus after a stress event - however, see below…
Our expectation is that many schemes will want to consider whether they meet the Fast Track requirements, with the proportion of schemes opting for this route increasing as schemes become better funded. Whilst some of the more 'challenging' Fast Track requirements, such as the need to use rather cautious assumptions about future price inflation, are well known, there are a number of less obvious areas where existing funding arrangements might fall foul of the requirements. If not picked up early these might upset plans at the last minute, possibly leading to increases in the level of Technical Provisions. Particular areas that can cause issues include schemes where the valuation makes allowance for early or late retirement and assumptions for future salary growth below the level of price inflation (for example, where increases to pensionable salary have been capped).
All in all, there is much for trustees and sponsors to consider as they work through their first valuations under this new regime, with the potential for more challenges along the way than might be expected.
