On March 3, 2020, the Pensions Regulator published the first of its two planned consultations on a revised DB funding regime. The first focuses on an entirely new approach for valuations and sets out eight principles underlying the new framework of “fast track” or “bespoke”. This consultation closes on June 2, 2020.
The second consultation is planned for later in 2020 and will focus on the revised DB funding code itself.
The key principles underpinning all valuations
The Regulator identifies eight core principles to underpin all valuations:
- Compliance and evidence – trustees should be able to compare actual risks taken to a tolerated position and demonstrate the mitigation and/or support available.
- Long-term objective – schemes should set a long-term objective so that on approaching maturity, they show low employer dependency and assets which are invested with high risk resilience.
- Journey plans and technical provisions – a journey plan should aim to achieve the long-term objective and investment risk should decrease over time.
- Scheme investments – the actual investment strategy and asset allocation should gradually be aligned with the scheme’s funding strategy. Sufficient security and quality of investment should satisfy liquidity requirements, and provide a reasonable allowance for unexpected cash flows.
- Reliance on employer covenant and covenant visibility – Schemes with stronger employer covenants can take more risk and assume higher returns in their technical provisions. Covenant reliance should reduce over time, and the Regulator suggests a reliance term of three to five years.
- Reliance on additional support – when opting opt for the bespoke approach, trustees can account for additional support (such as contingent assets and guarantees) when carrying out their scheme valuations. There must be sufficient support for the risk(s) being run, and the asset must be appropriately valued, as well as legally enforceable when required.
- Appropriate recovery plan – Technical provision deficits should be recovered as soon as affordability allows, while minimising any adverse impact on the sustainable growth of the employer.
- Open schemes – Members’ accrued benefits in open schemes should have the same level of security as members’ accrued benefits in closed schemes.
The dual approach: “Fast” or “bespoke”?
The Regulator seeks to introduce a twin-track compliance route which will enable schemes to choose between:
- “Fast-track” – Available to schemes able to demonstrate compliance with a range of funding and risk criteria set by the Regulator.
- “Bespoke” – Applying to schemes which either cannot meet all of the fast-track criteria or which choose to take additional risks where they can demonstrate the additional support of contingent assets or company guarantees.
The fast-track framework
The eight principles apply to an extent to either route, but under the fast-track approach trustees would be expected to submit a valuation that is compliant with the Regulator’s measurable guidelines. Trustees could then expect to provide less evidence and for their valuation to receive less scrutiny. The Regulator hopes to thus provide an easier route to compliance for trustees of smaller schemes, and will be unlikely to raise any concerns regarding the valuation. Deviance from the fast-track criteria would mean that the valuation would be treated as bespoke.
The bespoke approach
The eight principles apply to the bespoke approach too, and the fast-track boundaries will not apply. Trustees will submit their valuation, together with supporting evidence, explaining why and how their position differs from that of fast-track and how any additional risk is being managed.
However, bespoke arrangements are likely to receive more Regulatory scrutiny.
Suggested timeline for the development of the new DB funding regime
The current consultation closes on June 2, 2020. Once the Pension Schemes Bill becomes law, the DWP will then consult on draft regulations on new Regulator powers. After the second consultation, the finalised new DB funding code and the revised funding regime are likely to come into force in late 2021.
Although the Regulator does not expect the new approach to be onerous, there have been estimates that the proposals to curtail the lengths of recovery plans could cost sponsoring companies up to £5 billion. This tough line on tackling funding deficits could see schemes with strong employer covenants being expected to bring schemes to solvency funding levels within a much shorter timeframe.
In allowing schemes to vary from the fast-track, low-risk approach to compliance, the Regulator has attempted to avoid the pitfalls of an entirely compulsory framework. However, where companies with strong covenants have sought to stretch the limits of the current regime by putting in place unreasonably long recovery periods, they may find the Regulator seeking further information.
With the fast-track regime, the Regulator has sought to tread the line between an easily accessible route attracting most schemes and one that is so strict that it is rarely used. Some schemes may find it difficult to satisfy all the fast-track criteria in respect of each of the eight principles but where schemes opt for bespoke, the additional costs of evidencing compliance could outweigh the benefits.