Looking to the long-term: a new regime for pension scheme funding

New legislation means trustees must follow a more structured approach to scheme funding in future, with a long term objective plus a plan to achieve it. This approach mirrors existing good practice and there is no need to wait for final regulation to get started.

| 5 min read

It goes without saying that defined benefit (DB) pension trustees need to understand how they will pay benefits to members over the long term, without putting undue financial pressure on the scheme sponsor.

In practice, that seemingly simple equation has been anything but straightforward. Schemes have been subjected to a bewildering array of different methods to value liabilities, such as technical provisions, PPF/section 179 and Solvency. Recovery plans to meet liabilities have sometimes stretched over decades, and sponsors been faced with repeated requests for additional deficit repair contributions as a result of poor investment performance or inaccurate data.

However, regulations introduced in the Pensions Schemes Act 2021 mean that trustees must follow a much more structured approach to long-term scheme funding in future. The details of the new regime will be set out in a forthcoming DB Funding Code from The Pensions Regulator (TPR), in the biggest reform of scheme funding since 2005.

Until now, agreeing a long-term objective for a pension scheme (such as self-sufficiency or buyout) and establishing a funding plan to achieve it has simply been good practice. But under the new requirements, trustees and sponsors will have to agree and document a long-term objective (LTO) for their scheme. Trustees must also detail how they will achieve that objective in a funding and investment strategy for their scheme, and create a written statement that details how the scheme will implement the strategy.

Another important change from current practice will be a clear link between the scheme’s technical provisions (i.e. the amount required to cover its liabilities) and the scheme’s LTO. The value of technical provisions is likely to increase over time to ensure a scheme can hit its long-term funding target, which could affect sponsor contributions.

TPR will set out the parameters it expects schemes to include in their long-term funding plans in its DB Funding Code. These will include recovery plan length and stated level of investment risk, among others. TPR will use schemes’ three-yearly actuarial valuations as an opportunity to focus on making sure they are on track to meet their LTO.

Assessment will take one of two approaches: a ‘fast track’ process, with minimal involvement from TPR and a ‘bespoke’ assessment for schemes that are not or cannot use the parameters set out by TPR.

Timetable for change

Although the Pension Schemes Act 2021 received Royal Assent in February 2021, work is still very much in progress to determine how the regulations will be implemented in TPR’s DB Funding Code.

TPR has committed to running two consultations about the code: one on the principles and approach to the regime, and a second about its business impact.

The first of these ran from March to September 2020. TPR is set to issue a draft version of the Code by the end of 2021. The second consultation is also expected to be issued towards the end of the year.

There’s still no date when the final Code will be introduced, but current expectations are that it is likely to be late 2022 or early 2023. That will give time for both TPR and DWP to lay the groundwork for its implementation.

While trustees and sponsors are not yet required to adopt an LTO or long-term funding plans, doing so now will pre-empt future regulatory requirements. However, research from Charles Stanley Fiduciary Management found that only 24% of professional DB scheme trustees have set a long-term funding target so far, with a further 47% saying that they expect to set one in the next 12 months. A quarter (25%) say that they will address this in the next 12-24 months.

Pros and cons

The new Long Term Funding approach is a logical, consistent way of assessing the funding condition of a pension scheme and planning for its future. It’s a significant change from the current legislation, but it will provide trustees, sponsors and TPR with more certainty about DB schemes’ future plans. Although it heralds a tougher approach to scheme funding from TPR, early signs suggest that most schemes should be eligible for the ‘fast track’ approach.

There is still a lot of missing detail that trustees and sponsors will need before they can become truly compliant with the Code. For sponsors, details around the way that technical provisions might increase over time in relation to long-term funding targets will require more detail. Trustees may also be keen to understand more about how they will be required demonstrate that they are managing risk within their investment strategies.

While the fine details of the new DB Funding Code are still under construction, there is nothing to stop trustees from setting LTOs and long-term funding plans now, and monitoring their position regularly. Charles Stanley Fiduciary Management has been encouraging schemes to take this approach informally for over a decade, and it is a proven way of assessing a scheme’s condition and planning for the future.

Source: Charles Stanley / Censuswide. Research was carried by Censuswide among 55 professional trustees of UK DB pension funds. The survey was completed between 21/07/2021 – 04/08/2021.

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Looking to the long-term: a new regime for pension scheme funding

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