Defined benefit scheme funding - the new regime takes final shape

The DB Funding Regime is comprised of three main building blocks:

1. funding and investment strategy;

2. statement of strategy; and

3. application.

The table below sets out the key aspects of each of these three building blocks.

What does the DB funding code cover?

The DB funding code covers three areas that overlap with the building blocks set out for the DB funding regime above:

1. The funding regime – this section provides TPR's overview of the statutory framework underpinning the new regime.
2. Long-term planning – this section is primarily focused on the regulatory expectations that apply to trustees and sponsoring employers when preparing and revising the strategy and the statement of strategy
3. Application – this section sets out how TPR expects trustees to approach other aspects of their valuations and how elements in the long-term planning section should be integrated into funding solutions

What has changed in the DB funding code since December 2022?

The final version of the DB funding code reflects a more balanced approach that seeks to promote long-term sustainability while allowing for flexibility and proportionality. It has also moved away from being prescriptive in key areas to, instead, follow a more principles-based approach. Integrated risk management remains at the heart of the DB funding code – if anything, it takes a more prominent position in the final version which should align with the approach many trustees take in practice.

Specific key changes between the 2022 draft and July's laid version of the DB funding code include:

• Open schemes – a new section has been included for schemes that remain open to new members and/or accrual of benefits. This permits greater flexibility for trustees of such schemes when determining the scheme's maturity and long-term objectives.
• Employer covenant – the final version of the DB funding code includes more detail on the role of the employer covenant (both in terms of the reliability of the employer covenant (i.e. covenant strength) and longevity (how long the employer is expected to be able to continue to support the scheme). There is also greater clarity on the trustee duty to continue to assess employer covenant after low dependency is reached.
• Investment risk – a prescriptive approach to determining the resilience of the scheme’s low dependency investment allocation has been replaced by a principles-based approach. This will permit scheme-specific approaches to risk-taking where appropriate, provided there is covenant support and the impact of a downside event is considered. The DB funding code also clarifies that the scheme's low dependency investment allocation is notional and does not constrain the trustee's broader investment powers.
• Scheme maturity – the FIS Regulations state that pension schemes should assess their maturity by calculating the 'duration of liabilities'. The DB funding code now specifies this as a 10-year duration until the scheme has satisfied all liabilities (eight years for cash balance schemes). To foster consistency in long-term forecasts, TPR mandates using economic assumptions from a set date (31 March 2023), as a fixed reference point for each valuation.
• Recovery strategies – trustees will have to evaluate how a recovery plan might affect an employer's continuous growth. The DB funding code clarifies standards for trustees regarding assessing the viability of investments in sustainable growth. It also outlines what employers need to contribute to support these evaluations (including recovery plan prerequisites). TPR believes that trustees should adhere to the fundamental rule of addressing deficits as soon as the employer can reasonably afford to do so. Trustees should judge affordability on a regular basis and, at a minimum, annually.

What are we still waiting for to complete the DB Funding Regime?

• Statement of strategy – the pensions industry awaits final details on the format and additional information that TPR will expect for a valid statement of strategy. Following TPR's consultation in April 2024 on this, there are concerns about the amount of information that will need to be provided. An update is expected in Autumn 2024.
• Covenant guidance – TPR has promised a consultation on guidance in relation to the employer covenant 'in due course'.
• Other guidance – additional guidance is expected from TPR on affordable contributions and recovery plans. TPR has also stated that its current DB funding and investment-related guidance will be reviewed.
• Regulatory compliance approach – TPR has promised to provide more details on the Fast Track and Bespoke compliance routes, as well as how it will prioritise valuations for deeper review.

What actions should trustees take?

• Training – the new DB funding regime marks a material change in the legislative and regulatory approach to scheme funding and investment. Trustees should ensure that their trustee knowledge and understanding remains up to date by reading updates from their advisers (such as this one) and organising training (which may involve input from legal, actuarial and investment advisers). There are also a wide range of webinars and seminars available that trustees may wish to attend or watch on demand.
• Schemes with valuations with effective dates in 2024 – the effective date of your scheme's valuation will determine to what extent you need to follow new statutory duties and the regulatory regime. However, even if your scheme's valuation has an effective date before 22 September 2024, TPR still expects trustees to be aware of the DB funding regime and try to align approaches.
• Focus on the scheme's long-term goals – regardless of the timing of the scheme's next valuation, trustees should engage with their:
  • advisers; and
  • sponsoring employers

to determine their long-term objectives for the scheme (to the extent this work has not already been carried out). As part of this, trustees should establish when their scheme is expected to reach significant maturity

• Engage with the scheme's advisers – for some schemes, compliance with the DB funding regime will not be onerous. They may have already set long-term objectives, are able to meet TPR's Fast Track requirements and have required documentation ready or easily obtainable. Other schemes may have a lot more work to do in order to meet the new requirements. Engagement with the scheme's legal adviser, actuary and investment manager and/or consultant will help trustees to understand the level of work that is likely to be needed.
• Engage with the sponsoring employers – many trustees will already be doing this, but this is a good opportunity for trustees to engage with the sponsoring employers (whether for the first time, or on a more formal footing) and to have them consider issues such as long-term objectives, approach to scheme funding, employer covenant and the use of contingent assets.

What actions should sponsoring employers take?

• Understand the new regime – although sponsoring employers do not have the same 'knowledge and understanding' duties as trustees, the new DB funding regime marks a material shift in approach and is detailed and complicated. Sponsoring employers should read updates from their advisers (such as this one) and may want to attend webinars or seminars covering this subject.
• Work with trustees to understand the financial impact – sponsoring employers will want to understand whether there will be increased demands for contributions to support the scheme and what impact this will have on the business (e.g. long-term investment plans, payment of dividends, corporate transactions). Sponsors may have their own advisers, but this shouldn't prevent them working with the trustees' advisers to get a more holistic view of the scheme.
• Be ready for information requests – trustees (and their advisers) are likely to need more financial information than they have for previous valuations. They may also need increased information to support enhanced employer covenant monitoring.
• Focus on the scheme's long-term goals – regardless of the timing of the scheme's next valuation, sponsoring employers should engage with their advisers and with the trustees to determine their long-term objectives for the scheme (to the extent this work has not already been carried out). This is an opportunity for sponsoring employers to proactively engage with the trustees and the process and ensure that key views are aired as early in the process as possible.

Summary

• TPR has published the final version of its code of practice on DB scheme funding. This will apply to valuations that fall on and after 22 September 2024 (although the code itself will not technically come into force until on or about 4 November 2024).
• This almost completes the pieces of the jigsaw of legislation and regulation that comprise the new approach to scheme funding which began with the Pension Schemes Act 2021. We are still waiting for a handful of documents, but trustees, sponsors and their advisors now have plenty of material to understand the new DB funding regime.
• For valuations with effective dates that fall on and after 22 September 2024, trustees will need to develop a funding and investment strategy and, in most cases, will need agree this with the scheme's sponsoring employer. This will need to be set out in a statement of strategy, which will have to be submitted to TPR.
• As part of developing the funding and investment strategy, trustees will need to consider the future of their scheme and develop a journey plan detailing how they will get there. For some schemes, this will impact on investment allocation, recovery plans, sponsor covenant assessment and monitoring. It may also impact on the setting of the scheme's technical provisions as part of the valuation process.

To discuss any of the points raised in this article, please contact Ben Goldby or Ian Chapman-Curry.