24 August 2022

On 26 July 2022 the DWP published its long awaited consultation on the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 (the ‘draft Regulations’). The draft Regulations detail the changes to be made by the Pension Schemes Act 2021 (the ‘PSA2021’) to Part 3 of the Pensions Act 2004 (‘PA2004’) and the Occupational Pension Schemes (Scheme Funding) Regulations 2005 (the ‘2005 Scheme Funding Regulations’). Whilst the PSA 2021 received Royal Assent on 11 February 2021, the changes it makes in relation to the funding of defined benefits schemes have yet to come into force, pending finalisation of the draft Regulations and a revised Defined Benefit Funding Code of Practice, a second draft of which is to be consulted upon by the Pensions Regulator (‘TPR’) later this year.

The DWP seeks views on the drafting of the Regulations, as well as its proposed amendments to the 2005 Scheme Funding Regulations. Consultation closes on 17 October 2022. In its 2022 to 2024 Corporate Plan, published on 13 June 2022, TPR said it would look to launch its second consultation on a revised DB funding code this autumn, with the Code to be operational from September 2023. These timescales may be ambitious given that the draft Regulations will need to be finalised before consultation on the Code can commence. TPR’s consultation on updated guidance for assessing and monitoring employer covenant is also awaited.

Who should read this update?

This update will be of interest to the trustees and sponsoring employers of defined benefit occupational pension schemes and their advisers.

Summary of the new requirements

Under section 123 of the PSA2021, trustees of DB schemes will have to:

  • Determine, review and, if necessary, revise a scheme funding and investment strategy, with the purpose of ensuring that pension and other benefits under the scheme can be paid over the long term
  • As soon as reasonably practicable after determining or revising the scheme's funding and investment strategy, prepare a written statement of strategy, reporting progress against their determined targets and send a copy of the statement to TPR.

Failure to comply with the new requirements may result in the imposition of civil fines under section 10 of the Pensions Act 1995.

Funding & investment strategy

A scheme’s funding and investment strategy must set out when the scheme will reach ‘significant maturity’ and how it will get there. This is the point at which the scheme is funded and invested so that, under reasonably foreseeable circumstances, no further employer contributions will be required to fund the benefits accrued by members (known as ‘low dependency’). The draft Regulations provide that a scheme reaches significant maturity on the date it reaches the duration of liabilities in years to be specified by TPR in the Code of Practice – expected to be 12 years. This is the latest time at which schemes will be expected to be invested in low dependency investments and to be fully funded on a low dependency funding basis.

To tie in with existing valuation cycles, schemes will need to produce their first funding and investment strategy within 15 months of the effective date of their first valuation after the Regulations come into force. The strategy must be reviewed within 15 months of each subsequent valuation and ‘as soon as reasonably practicable after any material change in the circumstances of the pension scheme or of the employer in relation to the scheme’.

Statement of Strategy

Trustees will be required to report on progress against the targets set in their funding and investment strategy in a written statement of strategy. The statement must include a section setting out what action the trustees will take if the main risks faced by the scheme in implementing the funding and investment strategy materialise, along with the current and future level of risk they will take in relation to the investment of the scheme’s assets.

Like the DC Chair’s Statement, the statement of strategy must be signed by the Chair and schemes will be required to appoint a Chair if they do not already have one. Whilst the draft Regulations set out the matters to be included in the statement, it will need to be submitted to TPR in the form it prescribes. All schemes must submit a copy of the actuarial valuation alongside the statement of strategy. Previously, trustees were only required to submit a copy of the actuarial valuation where a recovery plan was in place.

Points to note

Whilst some of the detail of the draft Regulations may change following consultation, the following points in the current draft merit closer examination:

  • Role of the employer

Section 229 of the PA2004 is to be amended so that in addition to the methods and assumptions to be used in calculating the scheme's technical provisions, the statement of funding principles, recovery plan and schedule of contributions, the employer’s agreement will be required to the scheme's funding and investment strategy. The existing modifications in the 2005 Funding Regulations remain, so that in those limited situations where trustees have sole power to determine the rate of employer contributions and no-one other than the trustees can reduce or suspend those contributions, the trustees need only consult the employer on the funding and investment strategy. However, if trustees must currently obtain the employer’s agreement to their triennial valuation, they will need employer agreement to the funding and investment strategy. As the PSA2021 progressed through Parliament, concerns were raised that this would fetter trustees’ powers of investment and would contradict section 35 of the Pensions Act 1995 which provides that trustees should not be required to obtain employer consent when selecting and making investments.

The draft Regulations seek to address these concerns by limiting the information on scheme investments to be included in the funding and investment strategy to the proportion of assets that the trustees expect to allocate to different categories of investment (e.g. equities, corporate bonds, gilts). Actual scheme investments will remain the responsibility of the trustees and need not be included in the strategy to be agreed with the employer. It remains to be seen whether this goes far enough in protecting trustees’ independence in selecting and making investments.

Unlike the funding and investment strategy, trustees must only consult the employer in relation to the preparation or revision of Part 2 of the statement of strategy. The statement must include confirmation that consultation has taken place and include any comments that the employer has asked to be included.

  • Employer covenant

The draft Regulations provide for the first statutory definition of ‘employer covenant’. Views are sought on the proposed definition, which largely follows existing industry practice. The draft Regulations provide that in determining or revising the funding and investment strategy, the principles that relate to the level of risk that can be taken in relation to both the investment of assets and calculation of a scheme’s liabilities as it moves along its journey plan, will depend on the strength of the employer covenant and how near the scheme is to reaching significant maturity.

In assessing employer covenant, trustees will need to consider the likelihood of employer insolvency, employer cash flow and other factors that may affect the performance or development of the employer’s business, to be set out in the Code of Practice. Covenant should be assessed in relation to the size of any scheme deficit or surplus by reference to the actuary’s estimated low dependency and solvency bases.

  • Recovery plan

When preparing or revising a scheme recovery plan, the 2005 Scheme Funding Regulations currently require trustees to take into account the scheme’s asset and liability structure, its risk profile, liquidity requirements and the age profile of the members. The draft Regulations propose introducing a new requirement under which trustees must follow the principle that ‘funding deficits must be recovered as soon as the employer can reasonably afford’. The DWP seeks views as to whether this principle should have primacy over the existing factors and asks whether those existing factors remain relevant.

It will be interesting to see if this requirement becomes law and, if so, how TPR will reconcile this with its statutory objective to ‘minimise any adverse impact on the sustainable growth of an employer’. It also remains to be seen what TPR’s revised DB Funding Code will say on the matter as the current version states:

 ‘Although affordability of deficit repair contributions is a factor to consider, this does not mean that an employer should be expected to pay deficit repair contributions at a particular level simply because it would be able to afford to contribute at that level or because it has been paying them at that level. Instead, trustees can use the flexibilities available in recovery plans to ensure that they are appropriately tailored to both scheme and employer circumstances’.

  • Investment risk

Following concerns raised during the passage of the PSA2021 in Parliament, the consultation expressly states that ‘we do not want good schemes to close unnecessarily or introduce a one-size-fits-all regime that forces immature schemes with strong sponsors into an inappropriate de-risking journey’. The DWP addresses this concern in two ways:

  • first, by acknowledging that schemes that remain open to new members will mature more slowly than schemes that are closed to new members and/or future accrual. As such, the ‘relevant date’ at which a scheme will be assessed to have reached ‘significant maturity’ will be moved further into the future at each valuation if the scheme has not matured; and
  • secondly, as stated above, by recognising that schemes further away from significant maturity may take greater investment risk as long as the employer covenant is strong.

However, despite the ministerial foreword stating that ‘the intention is to have better, and clearer, funding standards, but not to move away from the strengths of a flexible scheme specific approach’, given that all schemes must set a low dependency target, regardless of the strength of the employer covenant and/or whether there are supporting contingent assets, there seems to be limited scope under the Regulations for closed schemes to take on investment risk. The only potential exception to this is where schemes have reached low dependency after significant maturity. In those circumstances, the Government has asked for views as to whether greater risk-taking could be permitted if supported by a group company or third party contingent assets and if limited to, say, 5% of the scheme’s total liabilities.

  • Twin track approach

The draft Regulations make no mention of the twin track funding approach (‘bespoke’ and ‘fast track’) proposed by TPR in the first draft of the revised DB Funding Code published in March 2020. We will see whether and how these concepts have evolved when TPR publishes its second consultation later this year.

Next steps for trustees and sponsoring employers

  • Keep abreast of any changes made to the draft Regulations and keep an eye out for TPR’s second consultation on the DB Funding Code later this year;
  • Speak to your scheme or advising actuary to understand what changes may be needed to the scheme’s triennial valuation process and/or journey plan and engage early with the trustees/sponsoring employer to introduce any changes when required;
  • Appoint a Chair of Trustees if you do not have one.

We are well placed to advise pension schemes of all sizes on the new funding requirements. If you would like to explore this topic further, please contact your usual member of our Pensions team.

Key contact

Clive Pugh

Clive Pugh Pensions Partner and Head of Pensions Regulatory Investigations

  • Pensions Regulatory
  • Pensions Services
  • Pensions Legal Advice 

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