The summer has barely ended (if it ever started), but with pumpkin spiced lattes already hitting the high streets and Christmas decorations looming on the horizon, it feels as if September slipped away unnoticed. But (arguably?) eclipsing the joys of Halloween, Bonfire Night and Christmas offered up by subsequent months, September 2024 held the honour of marking the introduction of the most significant changes to the DB scheme-specific funding regime for almost 20 years, which kicked in for actuarial valuations on or after 22 September.
It has been a long journey by any standards, but the final plank in the new regime was laid at the end of July, with the publication of The Pension Regulator’s new DB funding code, which is currently making its way through Parliament.
When passing judgement, it’s important to remember that TPR is largely hamstrung by what the legislation says. Without digging back over lost battles, there are a number of frustrating structural issues embedded in the regulations along with a few sections that are horribly opaque. Once the regulations were finalised it was beyond TPR’s powers to fully address those issues, and it was always going to be a struggle for TPR to create a masterpiece based on such shaky foundations. On the whole, however, I think they have done a pretty good job of addressing the concerns we raised around the first draft. In particular, some of the overly prescriptive sections that could have been unhelpful have largely or completely disappeared; the final version is much more focused on the principles that TPR expects trustees to follow, with a lot of the detail stripped back.
We also need to keep in mind the status of the Code and the position that it plays in the funding regime. With one notable exception the Code does not set out ‘requirements’ that schemes must follow; rather it sets out TPR’s expectations and interpretations of the legislative requirements (where they are open to interpretation). On that basis, having clarity in the Code is helpful, but ultimately the Code cannot and should not tell trustees or sponsors what is ‘right’ for their scheme; they still need to take advice and reach their own conclusions of what is right for their scheme taking the Code into account, just as they have done since the scheme-specific funding regime was first introduced. On that basis I think the Code gives us enough of a steer on TPR’s thinking, without unduly constraining creative thinking. Whilst some might bemoan the lack of clarity and direction, I regard a principles-based approach as providing much more scope to reach agreements that reflect each scheme’s unique circumstances, and I think that will serve members’ interests better than schemes being ‘herded’ by TPR’s views.
The Code is a pretty long read at almost 100 pages and there are inevitably a few dry sections (even for actuarial tastes), but rather predictably I do think it’s worth investing the time to read it. But what are my main points of note, focusing in particular on areas where I believe there is either room for alternative interpretations of what the legislation requires, or where there are still outstanding questions?
01
The use of 31 March 2023 market conditions to assess a scheme’s maturity (which is hardcoded into the regulations) feels to me to be a pretty inelegant solution (as it uses an otherwise irrelevant date in the determination of a scheme’s relevant date), but TPR has done what it can to mitigate the problem by defining a 10 year liability duration (eight years for cash balance schemes) as being the point at which schemes are deemed to reach ‘significant maturity’. That’s at the weaker end of the range that they had been considering, which will give most schemes more flexibility in setting their ‘relevant date’ than they might otherwise have been facing.
02
Giving no credit for surplus assets in this test strikes me as a pretty odd way to construct things, but TPR has helpfully avoided compounding the problem by removing the overly prescriptive text that was in the first draft, and instead focusing on the principles involved (and I would suggest that there is scope for a wide range of views on what constitutes a strategy that is ‘highly resilient to short-term adverse changes in market conditions’, even more so when there is a surplus).
03
TPR states in the Code that ‘Most employers will only have reliability over the short to medium term (three to six years)’ and that ‘for most employers, reasonable certainty over covenant longevity will not exceed ten years’. Although I would expect the industry to adopt these concepts in most cases, it remains to be seen how this will be applied in practice, how consistent schemes’ assessments of covenant will be with TPR’s views and how strenuously TPR will test trustees’ conclusions. Further guidance on covenant assessment is expected from TPR later this year.
04
Whilst the final version of the regulations did little to address these concerns, the Code attempts to stress that the low dependency investment allocation that trustees will be required to determine as part of their strategy (and which in most cases will need to be agreed with the sponsor) is only a notional portfolio. As such trustees are not obliged to follow this asset allocation in practice and setting a strategy under the new regulations does not cut across the trustees’ investment powers. However, the Code can only go so far in papering over one of the more unsatisfactory cracks in the legislation, and it remains to be seen how this will play out in practice.
05
That could lead to strengthening or weakening of funding targets in a move away from scheme-specific solutions. TPR has helpfully stressed that Fast Track is purely a tool to help with assessing valuation submissions and meeting the Fast Track requirements does not automatically mean that the scheme has satisfied the legal requirements. It will, however, be interesting to see how this affects valuation negotiations.
06
Whilst the new requirements add to the existing regime (and nothing is subtracted), there are a number of slightly circular elements to how the new regulations are structured, which will affect when decisions need to be made; in particular an initial view on the solvency position and low dependency funding basis will need need to be taken early in the process, as these are used in assessing the sponsor covenant and in assessing when the scheme reaches significant maturity. These ‘placeholders’ will then need to be revisited later in the process and if any changes are made the trustee will have to assess whether that has any implications for other decisions that have been made.
07
The legislation defines low dependency as a point where further contributions from the employers ‘are not expected to be required’. TPR’s interpretation as set out in the Code is that this expectation should hold ‘under most reasonably foreseeable scenarios’ and TPR also expects that the scheme’s running costs need to be reserved for once the scheme is in a low dependency state. Whilst that is one plausible interpretation of the regulations, I suspect it might not be the only one that could be argued.
08
The Code states that the technical provisions assumptions should be the same as or stronger than the scheme’s low dependency funding basis (after the relevant date); I would argue that this isn’t the only possible interpretation but only time will tell whether anyone will pursue that argument.
09
The scheme’s technical provisions must then be calculated consistently with this statement; the possibility of having to set technical provisions on a ‘buyout consistent’ basis could lead to schemes simply stating that they intend to run on, given the potential for unintended adverse consequences for technical provisions, even if in practice they have aspirations to buyout.
10
That may however be a good thing, as it provides more flexibility for TPR to adjust its approach to gathering information without having to amend the Code itself. The statement of strategy is perhaps one of the more misunderstood elements of the new regime, so I will just flag that it is purely a mechanism for reporting to TPR, with no requirement for the statement to be disclosed to members (and TPR’s interim consultation response published at the end of September suggests that the form of the statement will be sufficiently tailored to TPR's requirements for it not to be helpful to members).
There are clearly a lot of questions to be considered as trustees, sponsors and advisers get to grips with the new regime. We held a webinar with TPR on 27 September that provides more insight into TPR’s thinking, but I have no doubt that the first round of valuations under the new regime is going to be an interesting journey for everyone involved!
