Continuing our recent theme of highlighting changes for pensions introduced under the Pension Schemes Act 2021 (PSA), here we discuss changes the PSA makes to the DB scheme funding regime. We also pick up on important aspects of the Pensions Regulator (TPR)'s new DB funding code. As for other areas, we expect further legislation to flesh out and clarify many areas. But highlights for employers of DB schemes (and of course scheme trustees) are worth noting now.
In brief, the PSA amends the "scheme specific" funding regime of Part 3 of the Pensions Act 2004. TPR's new DB funding code will bolster the regime too. Although it is unlikely that the revised regime will be introduced until early 2022, we are recommending that scheme trustees and sponsors start to reflect the principles in funding discussions.
Important funding changes under the PSA and TPR's proposals for the funding code include:
- determining a long-term funding objective (LFO) for the scheme and putting in place an investment strategy to meet the LFO;
- preparing a written statement on their funding strategy, called a "long-term funding plan"; and
- getting ready for TPR's new twin track approach to triennial scheme valuations.
DB scheme sponsors and trustees will need to consider their ultimate goal for the given scheme's funding and set a clear plan for achieving the goal within a realistic timescale. This should recognise how the parties would expect the balance between investment risk, contributions and covenant support to change over time. Triennial valuations will become markers on the journey.
Funding and investment strategy (the long-term funding plan)
There will be a new obligation falling on trustees to determine a funding and investment strategy, prepare a written statement on it and submit a copy of it to TPR and keep their strategy under review. The strategy will be important for the "twin track" valuation approach discussed below.
As part of their strategy, trustees will set out how they intend to ensure that the scheme in question will continue to meet its benefit promises in the longer term in a written statement of strategy called a long term funding plan. Of note is the requirement that trustees will have to confirm in their strategy the intended funding level and investments at particular dates (which regulations will set out).
In the main, trustees will need the employer to agree to the strategy. This could suggest that employers may start to be able to have a say in scheme investments; we think that this is probably not the government's intention and so expect regulations and / or guidance to clarify this. In particular, the current interaction of the funding regulations and employer powers related to contributions has the effect of requiring that trustees consult only with employers where the scheme rules do not give the employer power to set, suspend or reduce contributions. Trustees, in these circumstances, are in a relatively stronger position. We do not yet know if new regulations will change this.
As a final note, the new criminal offences regime under the PSA covers any provision of false or misleading information to TPR in relation to a funding and investment strategy (which would be punishable by a fine and / or up to two years in prison).
TPR's twin track approach to valuations
TPR's new approach to valuations will be "twin track" with an option available for "fast track" objective funding and a "scheme specific" alternative. The proposal is that the new funding investment strategy will form part of the twin track route, with the fast track option requiring relatively simple information on the valuation and trustees' approach to risk management. TPR has noted that schemes with a weak employer covenant (willingness and ability to fund the scheme) and those which are relatively mature with a high proportion of pensioner members would be encouraged under the new code to have a lower level of investment risk.
Where trustees follow a bespoke approach, they will have to show funding arrangements in detail in their statements, giving an explanation of how they have diverged from the fast track method and their reasons for that. Trustees will also need to show how they are mitigating any additional risk.
We shall continue to update you on new requirements under the PSA and shall shortly be sending out our second flyer with greater detail on the new funding obligations.