The Pensions Regulator (TPR) is consulting on changes to its code of practice for defined benefit (DB) funding, which will see a new twin-track compliance approach to valuations and create a clear benchmark
This the first of a two-part consultation on a revised defined benefit code and will implement measures introduced in the Pension Schemes Bill laid in Parliament in January.
The second consultation, planned for later in 2020, will focus on the draft code itself.
TPR is proposing a twin-track compliance approach to valuations, both options of which will enable schemes to meet their legal obligations.
Trustees will be able to choose either a ‘fast track’ or a ‘bespoke’ approach to completing and submitting a valuation of their scheme.
If a trustee can demonstrate their valuation meets TPR’s guidelines for a compliant scheme, it can follow the more straightforward but prescriptive fast track approach.
For those who cannot meet fast track guidelines, or choose not to, there will be a bespoke approach offering greater flexibility.
Trustees will have to submit more supporting evidence on their approach, including how they propose to manage additional risk, and may receive greater regulatory scrutiny.
David Fairs, TPR’s executive director of regulatory policy, said: ‘The launch of our consultation on a clearer framework for defined benefit funding is a significant moment for the schemes.
‘We want to make sure pensions have the necessary long-term approach to ensure savers get the benefits they expect. Today we are setting out our expectations about how trustees should manage risks in an integrated way when planning their scheme’s long-term funding and investment strategies.’
The Pension Schemes Bill will introduce a requirement for trustees to set a funding and investment strategy, described as ‘long-term objective’ (LTO) in the TPR consultation.
The regulator says it will require trustees to identify a scheme-specific long-term objective so that by the time the scheme is significantly mature (15 to 20 years from now for a scheme of average maturity), it is fully funded on a low dependency basis (potentially in the range of Gilts +0.5% per annum to Gilts +0.25% per annum for fast track compliance) and has investments highly resilient to risk.
The consultation examines the extent to which the employer covenant should remain a key aspect of scheme funding, including how it should be assessed and for how long reliance can be placed on it.
It also considers alternative support (such as contingent assets and guarantees) and seeks views on what reliance should be placed on this support, as well as what characteristics it should have in order to be recognised for funding purposes.
The TPR says it expects all schemes to take a level of investment risk that is supportable and the consultation sets out proposals for how trustees could demonstrate whether the risk in their investment strategy is supported (for instance through a simple stress test).
Where a funding shortfall arises, this should be funded by an appropriate recovery plan. The TPR is proposing employer affordability should be the key factor which determine the appropriate length and structure of the recovery plan.
In addition, the consultation looks at how the framework should apply to open schemes, including our expectation that members’ accrued benefits should have the same level of security as accrued benefits in closed schemes.
Fairs said: ‘With most defined benefit schemes closed to new members and/or future accruals, we can expect them to be significantly mature in 15 to 20 years’ time, with the majority of their members retired.
‘These schemes will be more vulnerable to risks associated with poor funding levels and shorter investment horizons. Therefore, trustees should aim to reduce their scheme’s reliance on the sponsoring employer as they mature.
‘We want to be confident our expectations are effective and appropriate for trustees and in turn the savers in these schemes.’
The consultation closes on 2 June. It is expected that the revised code will come into force at the end of 2021.