Scheme Sessions Vol1.2025 - A year of the new DB funding regime: where are we now?

Elizabeth Gane: So, thanks very much everybody, thank you for joining us and giving your time today to help us with today's webinar.

So why on earth did we think that this was a good topic our opening scheme session of the year? Well one of the things that continues to hit the headlines today is around DB Funding and in particular what we see in a lot of headlines about is improvements in the funding positions of many schemes.

The funding regime itself has undergone quite significant change recently, so we have the new rules last year requiring trustees to put in place funding and investment strategy, looking at the schemes funding position on a more long term basis, targeting full funding on a low dependency basis by the time it is significantly mature.

Somewhat belatedly those changes were followed by a revised version of the Regulator's DB Funding Code which did flesh out that legislation in a bit more detail. And then we eventually got some revised covenant guidance from the Regulator.

We have also seen changes to the way in which trustees submit funding valuations and how the Regulator reviews funding valuations, the introduction of fast track and bespoke valuation routes.

Those new changes obviously apply to all schemes with an effective date of valuation after 22 September last year, so not many schemes have yet been through the process, so, this all does still feel quite new in the sense of actual practicalities. But as we approach the one year mark work under the new regime has started for plenty of pension schemes. So, it did seem like the perfect time to look at some of the issues we have seen cropping up in practice.

So, what are we going to be looking at today? Well first of all Hannah is going to speak to the legal aspects of the DB funding regime, then Cath will speak to the trustee point of view and then we will hand over to Laura for the actuarial perspective and then I will pull together the questions that we have had in the Q&As and we should have a bit of time to sort of look at those at the end of the session before we wrap up and I am looking for a prompt finish at 10:00.

So, without further ado I will handover to Hannah. Thanks Hannah.

Hannah Beacham: Thanks Liz. Good morning, everyone, really happy to be here with you this morning for the first of our scheme sessions webinars. For those of you I have not met before, as Liz said, I am a Legal Director in the team here at Gowling and my background experience is in advising both trustees and sponsors of occupational pension schemes in relation to all aspects of the pensions law including providing support to trustees and sponsors in their valuation and funding discussions.

Now as I am sure you all know we have had some very recent updates to the situation around DB funding and so in a slight change to the billed schedule I would like to spend just a few minutes this morning talking through the key provisions in the new Pension Schemes Bill which are relevant to DB funding. So hopefully that will be helpful for those of us who have not had an awful lot of time to start digesting the detail of that yet. I'm then going to go on and share a few observations about the legal issues which we have been seeing in practice since the introduction of the new funding regime.

So, starting with the Pension Schemes Bill, this was laid in parliament in last week on 5 June and it contains some changes to the rules around re-payment of surplus. To put that in context, under the current legislation, surplus can only be repaid to an employer from a scheme that is not in winding-up if firstly, there is a power under the rules to do so, and secondly, before 6 April 2016, the trustees passed what was called a section 251 resolution preserving that power. Surplus can also currently only be repaid if it exists on a buy-out basis as certified by the scheme actuary and even if those requirements are met the process for re-payment is quite long and difficult to work through. In particular, trustees need to satisfy themselves that re-payment of the surplus is in members best interests and that is a provision that is currently set out in the legislation and can be a difficult conclusion for trustees to reach and so as things stand, in our experience, re-payment of surplus from ongoing is quite rare.

So, chapter two of the new Pension Schemes Bill contains some provisions which seek to make changes to the existing surplus provisions in the legislation. However, the amendments which were published last week do not yet tell us the full picture or everything that we need to know about how this will work in practice. The government have said that they plan to consult on further regulations setting out more details during the course of next year, and they currently expect all of this new law to come into force in late 2027. So, there is a little while to go yet before you will know exactly how this might work.

Based purely on what is in the Pension Schemes Bill, we do know that for ongoing schemes the legislation is going to be amended to introduce a new trustee power, so that is a trustee power rather than an employer power, to modify scheme rules by resolution in two ways. Firstly, if scheme rules do not already have a power in them to repay surplus on an ongoing basis, a resolution may confer that power on the trustees subject to any restrictions in that resolution, which again are determined by the trustees. Secondly, if scheme rules do already have a trustee power to refund surplus the resolution will be able to relax or remove any restrictions which currently operate in relation to that power.

Now further details are going to be set out in legislation in those regulations I mentioned, imposing certain restrictions on trustees' ability to exercise that power to amend their scheme by resolution and this is the additional detail that we do not know that much about yet. But the Pension Schemes Bill and the consultation around DB funding and investment does contain some headlines as follows.

Firstly, we know from the primary legislation, the draft Pension Schemes Bill, that the regulations will place conditions, and they will require an actuarial certification that those conditions have been met. In particular, the regulations will prescribe how the value of a scheme's assets need to be determined for the purpose of a surplus payment, so there will be further detail in the regulations around what certification an actuary needs to give before there can be a refund of surplus.

Now to get some further clues about what those conditions will look like, in the consultation response which was published the week before last, the government has said that it is minded to move from a test based on the buy-out basis to the low dependency basis in order to reflect the greater emphasis on long term planning, which was introduced last year. The impact assessment for the Pension Schemes Bill also suggests that there will be a funding threshold for extraction. The illustrative buffer it uses in that impact assessment is 110%, so 110% on a low dependency basis, although it is very clear to say that is just a proxy or a placeholder and does not necessarily reflect what the future regulations will say, so I think a further piece of work needed there around understanding whether there will be a single threshold above which surplus may be released for all schemes or whether it might be a more scheme by scheme approach. As you would expect the government has also said that it intends to work closely with the Pensions Regulator in order to development guidance.

Turning now to the requirement that I mentioned earlier that trustees currently need to satisfy themselves that re-paying surplus is in members best interests. The consultation response says that it is unclear to the government whether the current requirement in section 37 actually adds anything to trustees existing fiduciary duties, and so the Pension Schemes Bill proposes to repeal that provisional altogether. However, that does not mean that trustees will no longer have to ask themselves the question about members interests but what is mean is they will still be required to act in accordance with their ordinary fiduciary duties to take members interests into account in making surplus extraction decisions.

So hopefully that gives you a feel of what the Pension Schemes Bill says about DB funding. No doubt we will continue to see commentary and debate about this over the coming weeks as people get into the detail of this, but for the time being hopefully that gives you a good overview.

Moving back to the main topic of today's webinar which is about what we are all seeing in practice since the introduction of the new DB Funding code. Speaking from my experience as a pensions lawyer, the main areas where we are being asking to advise is around the legal aspects of employer covenant.

Now as we all know the Regulator defines covenant as an employer's legal obligation and its financial ability to support a scheme. Now this is nothing new but the DB Code sets out how the Regulator expects trustees to assess employer covenant and in some cases trustees I think are deciding that they need to do more than they perhaps have done in the past, in order to ensure that they meet those Regulatory expectations. So, for example, professional covenant advice is now increasingly the norm even for smaller schemes and schemes where perhaps trustees have a really good insight into the company's finances and previously would have carried out a covenant assessment very much themselves.

Going through a more rigorous third party covenant assessment or appointing covenant advisors for the first time also means that we are seeing some trustees are having to seek legal advice on questions which are perhaps going back to basics for the scheme but they may have not turned their mind to for some time. So, for example, understanding who are the statutory employers who are actually on the hook to fund the pension scheme, particularly where you have had a complex scheme with lots of different employers who may have left over time.

Another question which comes up in practice is how far can trustees legally rely on the covenants support provided by the wider corporate group and again thinking about the trustees, do they really understand the position on insolvency, how the scheme sits in the overall list of creditors.

Moving on now to contingent assets. Many schemes have got contingent assets such as parent company guarantees or charges or other forms of security and these can often be complex and may have been put in place some time ago. It is therefore really important, we think, for trustees to revisit these documents from time to time and make sure that they understand them and that they remain fit for purpose.

Some of the issues we have seen come up in practice are for example checking that contingent assets are still valid and enforceable, and while trustees probably got a legal opinion when that contingent asset was put in place, it is important to make sure the trustees understand whether anything has changed since then. So, for example, where trustees have guarantees from companies which are in the EU, the Brexit legislation may have impacted some of the jurisdiction clauses in those guarantees and so it is important the trustees have gone back and checked those for changes of circumstances.

More fundamentally does the trustee understand any limitations, constraints or restrictions that exist in those contingent assets and are those being properly factored into the covenant assessment? So, for example, the DB Code is very clear that there is a difference between how the Regulator views a true look through guarantee where a guarantor effectively stands in the shoes of the scheme employer for all purchases versus a more limited guarantee with constraints and limits on it.

Moving on I also wanted to briefly mention information sharing. Now in order to assess covenant trustees need information from their scheme employers. Now the arrangements that might be in place to get that vary from scheme to scheme. So, for example, if you have a publicly listed scheme sponsor there might be a lot of information in the public domain however if it was a private company then they may be much more reliant on provision of information from the company’s treasury or finance teams to the trustees.

Now many schemes do already have formalised information sharing agreements with their sponsors, but for those which have not the DB Code I think is another reason to do that. It is good practice we think to have an information sharing agreement in place, along with appropriate confidentiality agreements, and we have certainly seen an increase in the amount of work around putting those in place over the last year or so.

So that concludes my thoughts on the legal aspects, I am now going to handover to Cath who is going to share her experiences from the trustee perspective.

Cath Williams: Thanks Hannah and good morning to everybody. So, I have been reflecting on the conversations we are having at Aretas with schemes, with sponsors,] with advisers and there is a common theme here and it is very much one of preparation.

So it is about bringing advisers together early to get a picture of the likely positions, so are you ahead or behind where you expected to be? When will you reach significant maturity? How quickly can you get to your target with a strategy underpinning your journey plan and what type of risk does that carry? I think it is really helpful to have a reasonable idea of this before looking at covenant in detail, so the current adviser is able to report back on supportable risk, reliability and longevity periods in a way that lines up against your journey plan and the risk that is inherent within that plan.

So, what is the expected position and the initial covenant analysis likely to mean for that recovery plan length?. The need maybe to strengthen the overall package of security, to maybe increase expense reserve. So, you can signal the direction of travel to your sponsor, so they have got time to take advice and to plan too.

And for many well funded schemes, there are certain aspects of the Code that are just not relevant but for some it does give trustees levers, you know those who need the weight of the Regulator behind them. So you want to consider if and how you may use those leavers and gather that evidence and support to provide sound reasoning to meet Regulator expectations. Typically, your more complex, your larger schemes, maybe schemes that do not naturally fit the regime, they will have expertise on the board, you know, proactive advisors and they should be well prepared to demonstrate solid grounding for following a bespoke approach. But more poorly funded smaller schemes with lay trustees boards, you know typically time, resource poor, they are going to need more support than previously. You can no longer get through evaluation just having a conversation with your actuary, and will need help to consider proportionality.

So being really clear who is accountable for what and when, the information in the statement of strategy is material, I have heard it described as quite clunky, you know, to fill out, so gets teams talking to each other earlier to co-ordinate, deliver and build in time to discuss that with a sponsor.

Even if your valuation is not due until next year or even 2027, you know, think ahead now for how actions that you take now are going to influence or even constrain your strategy in the future. So whether that would be changes to investment strategy or covenant events, re-financing, what you do not want to do is store up problems, you do want to have to go back to your sponsor to say you know that guarantee that we thought could be used to assess affordability just is not now worth what we were led to believe, what we thought it would be.

Achieving the best outcome, the right outcome, is always going to be first and foremost. You agree a strategy that works for your objectives and then make it work from a compliance perspective, then decide whether that means fast track or bespoke. So, essentially do not let the tail wag the dog.

There is nothing to fear from bespoke, I think we all know that, you know as long as you can reason and evidence and justify your approach you do not need to compromise strategy, you do not need to go for something that is sub-optimal just to tick that box.

You want to avoid getting covenant in a vacuum, it is likely to be an iterative process and if you cannot marry your objectives with covenant metrics from your base level analysis then you will need to go back to those objectives and refresh and review as needed. And I think that it does necessitate a change in trustee mindset when thinking about covenant, you know ratings have always been something we have anchored ourselves to and understand, you know, why there still is that desire to have that comparability, but we cannot cling to that because we now live in a world of different metrics.

There are some areas that we have seen as challenging, guarantees start those conversations around guarantees early, many trustees sponsored advisors, you know we all will have experienced some pain in those original negotiations for guarantees that have been in place for some time and now faced with going back to say, you know, they no longer offer the value you thought they did. If your covenant is reliant on that guarantee, plan what you need to do now even if you valuation is still some way off.

And this is something every scheme needs to take their own advice on but from discussions that I have had with covenant advisors, you know guarantees needed to be all monies, evergreen and have an affordability clause for them to be "look through" and pushing that conversation up the chain to the parent, you know, is somewhat challenging, we should expect it to be challenging and we will take time to have those discussions so very much need to factor that in.

I would say do not compromise strategy, you know we all know fast track is not the target, it will raise some challenges I am sure for trustees and advisors to defend strategy but the Code was essentially in my mind designed to solve a problem that for many schemes no longer exists. So, focus on objectives and not just anchoring to the fast track.

And it is a whole package that should be balanced through the lens of the Regulator so, for example, in a mature scheme, you know, targeting run on, you could expect a push from a sponsor to push out relevant dates to push out recovery plans and that may be something to be able to get comfortable with if that can be balanced against strengthening of targets or other covenant enhancements. And finally, there are schemes of course that remain not to be a natural fit, so whether that be regulated industries, you know we look at covenant very different from your typical sponsor, look at balance sheet capacity for supportable risk or whether that scheme is open to accrual.

And of course there are still many fully funded schemes out there where covenant just does not support the investment risk but without that, without a longer recover plan, without a risk for some asset returns to do the heavy lifting they may never ever get to a well-funded position so we do need to look for sensible outcomes and I think this goes back again to engaging early planning with your advisors for the specifics of your situation and the evidential need to support your strategy.

I will hand over to Laura.

Laura McLaren: Thanks Cath, good morning, everyone and thanks very much for having me. I was asked to share some perspectives from working with schemes on their initial valuation, sort of coming at it from I guess, a scheme perspective, and there were a couple of points I wanted to draw out. Firstly, I wanted to underscore some of the points that Cath has made around the benefits of bringing together your funding, investment and covenant advice early.

There are a couple of things worth noting around assumption setting and particularly the, sort of, expense reserve requirements and then, yes, come sort of back to fast track versus bespoke and this idea that certainly, you know, strategy should drive approach rather than sort of compliance approach constraining strategy.

So starting with the benefits of sort of joining up your actuarial, investment and covenant advice. Certainly the new funding regime requires the process to be much more integrated as Cath said, even for some schemes that are very well funded there is an additional governance burden and it is how you manage and navigate that and given where a lot of scheme funding is there, will be quite a big focus for many schemes on keeping that compliance as proportionate as you can. So previous valuation processes may have been, I guess on reflection, a bit more linear and I think under the Code there is an expectation that that is going to encourage much more of an iterative process with more sort of regular touch points where you are sort of bringing together advice testing that and then sort of repeating.

The low dependency objective and a journey plan ultimately needs to be a function of your time, maturity, covenant and investments and I have actually got that just sort of shown on a picture on the next slide. A couple of, you know, key inputs to that are what is your long term plans, so the Code does set out that your plan should be aligned with long term strategy and in terms of are you able to run the scheme on, is it buy out, clearly that the recent changes that Hannah has already discussed could have an impact on some of that thinking. So, well funded scheme that is probably going to need to sort of start thinking about that now.

If you are aiming for buy-out then there is probably a question around how sort of clear and settled that objective is and the extent to which you sort of want to build that into plans. I think the reality is that we will see more schemes with sort of a low dependency target that is a bit of a milestone still en route to any sort of end game objective.

Time, I think Cath mentioned, that clearly the amount of time that you have to reach your low dependency objective is a key input so getting your actually to calculate the scheme's duration and timescales early so that you know the sort of timeframe that you have got to work with and then it is all about reliance on risk and covenant so you need to be able to demonstrate that your investment risk is supported by covenant and think about how that support will change over different phases of your funding and investment strategy.

I guess to the extent that the scheme is well funded and you are running fairly limited levels of funding and investment risk then that does require less reliance on the employer covenant and you can certainly, sort of, reflect that in the way you approach your analysis so sort of more complexity within the plans and more kind of detail and explanation, TPR are going to expect to see less complexity and risk, the more, sort of, proportionate you can be in how you approach things. I mean, there is certainly no point doing lots of detailed work around discount rate assumptions if you have not understood that covenant and investment risk and interactions with supportable risk up front.

So yes, I think start early, more bitesize iterations involving all advisors, understand your timeframes, risk and reliance and I guess whether you can take advantage of any of the specific categories in TPR's guidance for low risk schemes. So, if you are a scheme that is actually in surplus on a low dependency funding basis, and can tolerate an investment stress and still be in surplus then that actually will help you cut through some of that detail that you need to provide in the statement of strategy, so worth kind of identifying all of that pretty early.

So okay, moving onto assumptions then. Trustees will have set assumptions for valuations previously but there is some additional emphasis that is placed on requirements, and you will see from the slide that the point I wanted to draw out was making sure that the assumptions do reflect your scheme experience. So as an example, if you are assuming that on average members take maximum tax free cash at retirement. then you want to make sure that you have got some scheme experience to back that up so that might require getting some more data to check that. It is also worth noting that historically the main impact of assumption setting was on just sort of the present value of liabilities and now sort of within the Code's framework there are other impacts that extend to the schemes duration which is calculated on your low dependency objective basis so that will actually feed in not just to the present value of the liabilities but also to the timeframe that you have got to significant maturity and the duration linked fast tracked tests.

So there are some assumptions that actually can have little to no impact on the present value of liabilities, such as, you know, the allowance that you make for early and late retirement but they can't have more of an impact on that duration piece because the effective timing of the benefit payments even if terms are reasonably cost neutral. You have similar considerations for things like commutation and mortality where updating the assumptions might reduce the liabilities which may be, sort of, seen to have a positive impact but also shorted the duration, so have a sort of opposite effect in terms of where you need to get to by when.

So overall just wanted to sort of stress, sort of, more emphasis on the evidence that you are using to set these assumptions. Well funded schemes might be a bit more relaxed on this stuff but certainly where kind of implications for cash are more tightly balanced then you can see that these sort of things might matter a bit more than they have in the past.

Then onto expenses, mentioned that sort of expense reserves are something that might be new for a lot of schemes and actually can be quite material and trustees will need to look at the circumstances for their own scheme and make some assumptions based on their individual position. And I have drawn out a couple of pointers on where to start with that.

Firstly, check the scheme rules and that will help give us the over whether an expense reserve is needed. So the Code sort of sets out that scheme should include an expense reserve in their low dependency target unless the sponsor has a legal obligation to the expenses, and even in that case a sort of expense reserve is still encouraged but they do acknowledge the sort of risk of overfunding if that can't be managed through say an escrow type arrangement.

In terms of assumptions the sort of starting point is likely to be current expenses but you will want to think about actually how reflective they are in sort of long term levels, maybe how you are going to adjust for one off project spends, you might need to take care not to overly anchor those long term expenses to recent experience and then you are going to think about how do you project out expenses longer term, so do those expenses increase with inflation? What about a number of years into the future if you sort of take current expenses, project those out over the lifetime of the scheme with sort of no rundown, then in many cases that is going to give you a pretty high number in terms of the reserve that you would end up with, even allowing for the fact that those farther out years get smaller in present value terms.

So I think in most cases you are going to want to build in some sort of reliance either for them to reduce at a rate that reflects that expenses might be coming down a bit as the scheme gets smaller in size or actually thinking a bit around, sort of, some eventual point at which you would be, sort of, insuring and winding up the scheme depending on exactly how you framed your end game objectives. For some schemes, they may be thinking about, sort of, X years of ongoing expenses plus then a sort of buyout cost being kind of built into this reserve.

And the other point that is sort of going to feed in in terms of how material the numbers and expenses might be is the scheme maturity, so the staring point is to think about reserving for all non-investment expenses that are expected kind of after the point of significant maturity so you can see sort of the further you are away from that significant maturity point the sort of less impactful in PV terms that will be but some schemes might also be thinking about whether they should be reserving for some of those pre-significant maturity expenses to protect the…, particularly when you think about the period sort of beyond covenant reliability so you may have sort of a post covenant reliability pre significant maturity period that you want to be thinking about in plans.

And I included, you know, some figures on this slide just to bring to life the materiality of this and the difference for sort of small versus large schemes and mature versus immature schemes, and you can see sort of I guess a couple of points, one is expenses are likely to be proportionately greater for small schemes rather than large schemes and that is, you know, largely because it is well known that, sort of, all the costs of running a DB scheme do not scale down with assets.

And the other point being kind of, yes, more impactful for mature schemes because you are closer to that significant maturity point. So looking at the sort of small mature kind of illustrative numbers that I have put there where you see actually that could have a kind of 5% funding impact which is clearly, you know, material in the context of funding discussions, so you want to make sure you have thought about this sort of thing early on in the process and you are factoring that into numbers. It is not the sort of thing you want to leave too downstream and then trying to kind of add that on quite late in the day.

And then the final couple of points I wanted to just draw out and Cath has touched on some of this already, was just that, sort of, fast track is not the only route under the Code. The Regulator has quoted a figure of 80% of about schemes being able to go fast track at no additional cost but when you look, sort of, at all the valuations crossing TPR's desk, the majority do relate to small schemes, so you have got sort of about, I think, just over a third of the DB landscape are less than sort of £10 million, and actually sort of 80% of the 5,000 odd schemes are less than £100 million so depending on, kind of, where schemes sit I do not think…you know, it's not going to be 80% potentially at that bigger end.

And you know just because 80% of schemes can go fast track it does not mean that 80% will. Bespoke is a sort of equally valid route and there can be lots of good reasons why a scheme would opt to go down a bespoke route. A lot of schemes will already have plans in place to get to some sort of low dependency objective and certainly the Funding Code should not mean that you need to sort of rip up plans and start again. In most cases those schemes are going to be in a pretty good place to demonstrate a solid grounding for a bespoke approach.

I think it is fair to say maybe, you know, some of the very first schemes looking at valuations, there may be is a little bit of trepidation around not wanting to be on the radar for very onerous engagement with TPR and we do not yet have a lot to go on in terms of exactly what that is going to look like because, you know, TPR have only just launched their online system. So, we have not quite seen, you know, how they intend to engage although they are trying to put out some positive messages around using the data that schemes submit through that system in the first instance and not necessarily signposting that in all cases, they are going to engage more actively or come back and ask for lots of extra information.

But, you know, certainly I think that is a consideration, but I think in most cases we would be saying, sort of, you should definitely be balancing that against, sort of, letting strategy drive approach rather than as they say sort of compliance driving your strategy.

Certainly, you know, I think fast track is though a useful reference point and so even if you are a scheme that is going bespoke most of the time you will still be thinking a bit around how your plans do compare to that fast track reference point and there may be advantages in aligning some of that where you can and where that is relatively straightforward or sort of folds out of existing plans. That is really just a cut down on some of the scrutiny that you might be expecting from TPR. I guess they have sort of indicated that that is probably the way that they will approach some of their review and analysis.

And then just, sort of, finally I guess I wanted to sort of just draw out some of the reasons why plans might be bespoke, and I have pulled out some examples just on the next slide of here is where I think strategies actually are more likely to be suited to a bespoke route.

As well as sort of thinking about being able to tolerate more risk in your low dependency objectives a common reason that I am seeing in practice is so that you can take a bit more investment risk over the period to significant maturity and in some cases sort of looking to underwrite that with, say, a contingent funding mechanism or some sort of contingent asset support but as you can sort of see on the slide there are a whole range of sort of strategies that might affect, one of them being, you know, potentially schemes that are targeting run on, they may want assets, you know, under that strategy, you might want to be able to potentially generate a bit more return and sort of looking at the principles in the Code around low dependency, investment allocations, you know, is likely to give you a bit more flexibility than the narrower fast track tests and you know being able to leverage a bit more flexibility for surplus is probably going to steer you away from wanting to be too prudent in that low dependency objective so you are not, sort of, constraining what is deemed to be surplus.

But other examples and open schemes and you know, stressed schemes, are potentially another flavour of scheme which is going to struggle to go fast track and it actually might have no option but to go down more of a bespoke route. So yes, I think ultimately, you know, bespoke offers offer a good amount of flexibility for a range of circumstances and I've sort of said it a couple of times in terms of, sort of yes, let the strategy drive you to the approach and not vice versa, I think the extra compliance is likely to be quite manageable if it fits your circumstances.

Elizabeth: Lovely, well thanks very much Laura and thanks Cath and Hannah for your thoughts there. It will not surprise you to hear that your presentations have generated quite a lot of questions in the Q&A box. There is quite a lot of those are around Pension Schemes Act and surplus but I'll start I think with just one which picks up on the guarantees point and Hannah this is possibly one for you.

So, we have had a question that says what does "look through" mean in the context of guarantees. I wonder if you could give us a bit more flavour on that please?

Hannah: Yes, thanks Liz. So if you remember when I was talking about a "look through" guarantee these are guarantees which the Regulator views as being strong enough that the trustees can rely on the covenant support of the guarantor in place of the sponsoring employer so effectively look through to perhaps the wider group or the parent company. The DB funding code does not say a lot about what a look through guarantee is but if you dig into the contingent asset guidance which is produced by the Regulator that does have a checklist of criteria that a guarantee has to meet in order to be a look through guarantee. So, those criteria are firstly that the guarantee has to cover the full section 75 deficit. It has to cover not only the position on an insolvency, but it also has to be capable of being called if the sponsor were to miss payments under the schedule of contributions and in particular any deficit recovery payments under a recovery plan.

There needs to be a legal mechanism allowing the trustees to look through to the guarantor's cash flows when setting contributions and the Regulator says that if this is not present then the Regulator's powers are only restricted to looking at the affordability of the statutory employer on a stand alone basis so you have to be able to look through to the cash flow of the employer.

Look through guarantees have to be evergreen, so they have to have no time limitations on them, they have to exist for as long as they are needed.

The next one is a bit subjective, but the Regulator says that the guarantee has to contain no onerous conditions that could compromise either the Regulator or the trustees' ability or powers under the guarantee so I think that is a question where legal advice will be helpful to understand whether there are any onerous or unusual provisions and guarantees.

Unsurprisingly a look through guarantee has to be enforceable in both the UK and any relevant overseas jurisdictions, so that comes back to the point that ensuring overseas guarantees are enforceable in that jurisdiction and the Regulator says clearly they would have expected the trustees to have appropriate legal advice, usually a legal opinion to support that and finally the Regulator also throws in that they would expect you to have an information sharing protocol and that is one of the reasons why formal information sharing protocols are becoming more common.

So, it is quite an onerous list of requirements, but it is helpful I think that there is that check list that you can work through for your scheme.

Elizabeth: Thanks Hannah, that is helpful. I'll move on I think because we have had quite a lot of questions around the Pension Schemes Bill and particularly around use of surplus, so it would be good if I could, sort of, cover as many of those as possible in the, sort of, 10 minutes or so that we have got left because that seems to be something that people are really interested in.

I am not sure whether this is one for Cath or Laura or possibly both of you but we have had a question about now the government has made clear what its plans are around surplus and use of surplus, do you think schemes will look again at their end game and where they are going? Do you think they might be more or perhaps less minded to run on and build up surplus?

Cath: Shall I offer a few thoughts first? So I think these are conversations that trustees have already been having to some extent, you know in anticipation of the Bill, and sponsor conversations to come, and I think any decision needs to be a conscious decision, you know, you should not be sleepwalking into any one strategy so I certainly welcome having these conversations and the flexibility that they provide.

It does give pause for thought to reflect on objectives and in a run-on scenario particularly, you want to be thinking about what that long term target is given that surplus release is, you know, linked to low dependency and for those schemes in those scenarios, you know what does that low dependency look like? You know, it is a figure we know, I guess we never truly know buy out until, you know, you get to the point of going to the market but it's got to be sensible to have a buffer above that low dependency.

I think we will want to be monitoring insurer and consolidator pricing and essentially having a fall back plan, even if you are going down the route of run on and thinking about surplus sharing and, sort of, managing that downside risk.

You will want to look at de-risking plans, you know you need to get the economics to work so which may mean putting some return back on and if you are going to put some return back on and put some risk back on how does that impact the level of buffer that you would want to hold against that risk?

The smaller end I think unlikely you know to change end game plans possibly for risk transfer and you know, ensuring consolidator options. But it is a specific decision and again it is about having a proactive conversation around that. You know there is a minimum level of cost and resource involved which you know tends to point to circling back round to those end game plans at the smaller end still being the right path for them, but it will differ depending on the relative size of the sponsor to the scheme.

And finally just thinking about, sort of, setting those strategies I would say a traditional guilt plus basis I think would likely be a bumpy journey when trying to plan for surplus release. Run on lends itself to more an asset-based discount rate and that is something I would be keen to explore in those scenarios and I am sure something that Laura has some thoughts on as well.

Laura: Yes, happy to sort of chip in a few thoughts Cath, and you have covered a lot of ground there, would sort of totally agree in terms of seeing kind of experience being that trustees and sponsors are taking a pause to sort of digest the changes and think about whether that does impact end game plans. You have touched on a lot of the factors that I would see feeding into those conversations so the scale of the scheme, the potential to have the, sort of, right economies of scale for run on, the risk appetite, the covenant support and you know governance whether you actually have that governance appetite to run a scheme on for another ten or 20 years.

And then, sort of, member outcomes and some really interesting discussions happening around, you know, if you are going to be able to share that surplus with members, what does that look like, how does it play out in terms of factors like intergenerational fairness, there is clearly a balance around the sort of thresholds at which you would start to release surplus and then the pace at which you sort of do that, it will make an impact in terms of which different members get and that is the sort of analysis that you know we are starting to look at with schemes as they, sort of, turn some attention to developing these sort of frameworks.

I think more generally in terms of Funding Code, valuation discussions, I think actually the Funding Code because it does require trustees and sponsors to set down some of these long term plans, I think that potentially will, sort of, get people round a table and sort of actually sort of galvanize some of these discussions if they have not happened already.

I think a key point is that you probably do not want to be sort of locking in funding and investment plans now in a way that is going to, sort of, restrict that future flexibility even, you know though, the sort of statutory override power might be still a number of years off and the government consultation is signposting 2027 but I think ideally if you are sort of setting plans now that will be flexible enough to accommodate a surplus sharing framework then that is ideal.

You mentioned Cath I guess the attractiveness of using a sort of more dynamic discount rate approach and I would definitely agree, It was one of the boxes on my bespoke slide was, sort of acknowledging, sort of, dynamic discount rates, fitted a bit better than the guilts plus world that fast track sort of pulls you into, so certainly the Funding Code does support the use of a more sort of asset backed discount rate approach where you can sort of base that on the asset return on cashflow matching assets, so you know, kind of the advantage of that being, sort of, you know, taking credit spreads an example of those widen the value of your assets reduce if you are sort of in a guilts plus world then that has sort of funding deteriorating under a more dynamic approach then actually it will make the schemes funding position much less sensitive to those sort of short term asset movements, and arguably if you are holding assets with more of a long term view and you are holding those assets through to maturity then you are a bit less worried about some of that short term work to market volatility and, you know, I think for sponsors, you know, those sort of funding approaches that will reduce the chance that you need to call on extra cash will be pretty attractive.

So yes, I think for schemes that are thinking about run on then that sort of asset backed approach will definitely be a key consideration.

Elizabeth: Thanks both for your thoughts on that one. I think I have got time probably just for one more question and actually I think this is a really good question because it ties in to some of the stuff that Cath and Laura you were just starting to touch on there.

So, we were touching on, sort of, surplus and surplus sharing, and sort of you know what that might look like for members, but this is a question for Hannah, I think. We have had a question about whether you think that the government is going to actually mandate what surplus can be used for. We were talking very much there about this being within the trustees' gift to negotiate but I would be interested in your thoughts on that.

Hannah: Yes, thanks. I think obviously never say never. We cannot say what might be consulted on the future. I think based on the consultation process that has happened to date the government has already considered and rejected the possibility of giving trustees a statutory power to make surplus payments directly to members for example, and they instead decided to give trustees a power to share surplus in a way which is consistent with and can be exercised in accordance with their existing overriding fiduciary duties as trustees.

And I think the government has also not suggested explicitly that it wants to set any rules out in regulations about how surplus must apply, and I think that would actually be quite difficult to draft because it must be a very scheme by scheme and employer by employer decision as to what surplus could reasonably be used for. You would want to look for example at how that surplus had arisen, who the members of the scheme are, whether the employer still has, you know, a significant workforce that they might want to apply that surplus for the benefit of say funding future pension contributions for those future employees.

So, I think where we are at the moment and unless there are any radical changes, in terms of more mandation I think it is going to be a scheme by scheme decision and that trustees will continue to be responsible for negotiation with their sponsors as to what works best in their particular circumstances.

Cath: I think just adding to a point I guess a trustee view to that as well Hannah is, it is about to design a framework that is going to be safe for both trustees and sponsors. I think it is just as important to sponsors to make sure that there is a path that is safe for them to release that surplus. You know, reflect on the fact that after all the downside risk sits with them. There is no sharing of deficit. I am thinking about the implications of the Pensions Act on company directors and the ability of the Regulator to use its powers and its levers against directors. There is motivation there on both sides to make sure that the mechanism for release of surplus will be a safe one for everyone.

Hannah: Yes, completely agree Cath.

Elizabeth: That is great, thanks very much Hannah and Cath for picking that one up.

I can see that we are sort of rapidly running to the end of the session. We have loads more questions from people and thanks very much for the questions that you have given. We haven't got time to pick them all up now but what we will do is we will follow up with anybody who we have not, whose question we have not got to, we will follow up with you by email after the session.

So, I suppose just some closing thoughts from me. I mean first of all thanks ever so much to Hannah, Cath and Laura for your insights. I think it has given me certainly some food for thought. I was pleased actually that we got the new Bill. I know you probably were not but I was pleased that we got the new Bill because I think it has given us something, you know, given that we were going to be together anyway today, I think it is, you know, a really good opportunity for us to just start thinking about what the practical implications of the, particularly the new surplus rules might be in the context of schemes and moving forward and end game planning and what have you.

I think for me the big thing I am going to take away from the Funding Code piece is it feels like this is a bit of a change in mindset for trustees. I think trustees are going to need to start thinking about funding and valuations sooner perhaps than they have had to in recent years.

There is lots to think about in terms of guarantees and look through guarantees, covenant reviews, what is their long term strategy, and they do need to start thinking about it all early.

I thought it was really helpful to see some of the examples that Laura put up around when bespoke might be applicable to schemes, certainly from my point of view, I thought that was really really helpful so thanks very much for that Laura.

And on that note, I will just finally say thanks again to our speakers. The session will be followed with a feedback form which we will send to you. I would be really grateful if you could fill that in and return it to us, it will help shape our future sessions and it is good to know what people are interested in and what they would like to hear us talk about.

And then the final thing is just to look out for the invite to the second Scheme Session webinar which will be on its way.

Thanks very much everybody, I will see you soon, thank you.