Articles - All change for scheme funding

Nearly 15 years on from the launch of the then new scheme-specific funding regime for defined benefit (DB) schemes which replaced the minimum funding requirement (MFR), we are expecting consultations from the Pensions Regulator (TPR) which could introduce the biggest changes in scheme funding since that date.

 By Jane Beverley, Principal and Head of Research, XPS Pensions Group
 A tale of two consultations
 There will be two consultations on a revised DB funding code. The first will look at broad options for a clearer DB funding framework, and is expected in summer this year ‘depending on the legislative timetable’.
 The second consultation on the wording of the draft code itself is now not expected until 2020, which means that it is likely to be the end of that year before the revised code is in force.
 However, whilst it may be at least 18 months before the new code is in force, TPR has already made its direction of travel clear, particularly in its latest annual funding statement, so trustees and employers should already have a good idea of what to expect and be able to prepare for some aspects of the new regime.
 Looking to the long term
 The 2018 White Paper announced that all pension schemes would be required to have a ‘long-term objective’ and that trustees would have to report on progress against that objective in a DB Chair’s Statement. TPR has anticipated this legislative development in its 2019 annual funding statement, by introducing an expectation that trustees and employers should set a ‘long-term funding target’ (LTFT) and be prepared to provide evidence that their shorter-term investment and funding strategies are aligned with it.
 For closed schemes, the LTFT should involve reducing their reliance on the employer covenant over time and reaching a position of low dependency on the employer by the time they are significantly mature. Whilst TPR acknowledges that the situation for open schemes may be different, it still expects trustees and employers of such schemes to adopt an LTFT and to provide the same level of protection for accrued benefits as if the scheme were closed.
 Not the MFR
 The other main change in the scheme funding regime will involve TPR providing a much more detailed picture of its expectations for funding, including ‘setting clearer parameters … around journey plans and associated technical provisions based on scheme specific factors’ and requiring stronger employers to fund their deficits over a shorter period. The latest annual funding statement already provides a firm steer that TPR now views a recovery plan in excess of seven years as ‘long’.
 David Fairs, Executive Director of Regulatory Policy, Analysis and Advice at TPR, has been at pains to say that the new regime will not be ‘MFR 2.0’ and that it will continue to provide the flexibilities of a scheme-specific framework, but the very fact that he feels the need to say this suggests that there could be some profound changes on the way for DB funding.
 There will be two routes to compliance with the scheme funding legislation: a ‘fast-track’ route through which schemes can demonstrate compliance with the new requirements, and a route under which trustees and employers can ‘choose a more bespoke approach subject to further evidence being provided and greater regulatory scrutiny’. How different the fast-track route will be from a prescribed regime like the old MFR remains to be seen.
 Investment stress tests
 TPR’s 2019 annual funding statement was the first to set out how it expected trustees to set their investment strategy in the light of their specific level of funding, covenant strength and maturity.
 A much stronger focus on investment risk and strategy also seems likely to be a key theme of the revised code, with David Fairs promising ‘proposals for how trustees could demonstrate whether the risk in their investment strategy is supported, for instance through a simple stress test’. It may not, however, be easy to devise a simple stress test that is meaningful across the whole universe of DB schemes.
 A new type of regulator?
 The annual funding statement provides a strong indication that TPR will be taking a much more directive approach to scheme funding, albeit with scope for trustees and employers to pursue alternative bespoke approaches, at the cost of more advice and more regulatory scrutiny.
 It’s likely that over the next year or so we should all get a better idea of what a ‘clearer, quicker, tougher’ regulator actually looks like, and nowhere more so than in TPR’s consultations on a revised DB funding regime. Trustees and sponsors should engage with those consultations when they finally appear, and in the meantime should be considering what they can do to prepare for the new framework.

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