The Pension Schemes Bill, introduced in Parliament on 15 October 2019, contained some significant new funding requirements for defined benefit (DB) occupational pension schemes. If the requirements are introduced as proposed it is likely to mean most corporate sponsors will be required to pay more money into their DB schemes more quickly than anticipated.
The proposed new requirements would mean that schemes need to set a long-term funding and investment target, in addition to their ongoing statutory funding target (or “technical provisions“). Schemes will also be required to increase their technical provisions over time to ensure that the long-term target is met by the time they are significantly mature.
Although the Bill has fallen as a result of Parliament being dissolved ahead of the general election on 12 December, it is likely that new statutory funding requirements along these lines will be re-introduced by the next Government (whatever their persuasion) in a new Bill after the election. The Pensions Regulator is also due to consult on a new Code of Practice on DB funding in the New Year and this is expected to build on the proposed new statutory requirements.
Therefore, corporate sponsors and trustees of DB schemes should consider how these new requirements may impact their scheme’s funding arrangements.
New statutory DB funding requirements
Funding and investment strategy
The new requirements contained in the Pension Schemes Bill would require trustees to determine and keep under review a strategy for ensuring that pension benefits under their scheme can be provided in the long term.
This will be known as a scheme’s “funding and investment strategy”.
The strategy must specify:
- the funding level that the trustees intend the scheme to have achieved as at the “relevant date” (the meaning of which is to be set out in regulations), and
- the investments that the trustees intend the scheme to hold on that date.
Generally speaking, trustees would be required to agree this strategy with their scheme’s sponsoring employer(s).
The Bill does not specify the date by which these targets would need to be met, as this will be set out in regulations. However, the Regulator has previously indicated that it expects schemes to hit their long-term target by the time they are “significantly mature”, which it considers to be when they reach peak cash flow, and we would expect any future regulations to reflect this.
Significantly, once a scheme’s funding and investment strategy has been set, the scheme’s technical provisions must be calculated in a way that is consistent with this strategy. It is not clear precisely what this means. However, we understand that in its new funding Code, the Pensions Regulator will essentially say that it expects a scheme’s technical provisions to increase over time to ensure that a scheme’s long-term funding target is met. The provisions contained in the Pension Schemes Bill would appear to give statutory effect to this requirement. This marks a significant shift in the statutory funding regime.
As soon as reasonably practical after determining or revising their scheme’s funding and investment strategy, trustees will also be required to produce a written statement which must set out, among other things:
- the extent to which, in the opinion of the trustees, the funding and investment strategy is being successfully implemented, and where it is not, the steps they propose to take to remedy the position (including timings),
- the main risks faced by the scheme in implementing the funding and investment strategy and how the trustees intend to mitigate these, and
- reflections of the trustees on any significant decisions taken by them in the past that are relevant to the funding and investment strategy (including any lessons learnt).
Trustees will be required to consult with their scheme’s employer when preparing or revising this statement but they will not be required to agree the contents of the statement with them.
If schemes fail to put in place a funding and investment strategy the Regulator would be able to exercise its powers under section 231 of the Pensions Act 2004. This will include a new power for the Regulator to impose its own funding and investment strategy on a scheme.
New funding Code of Practice
The Pensions Regulator had intended to introduce a new Code of Practice on funding DB schemes in Spring 2020, with a two stage consultation process due to have started this Summer. However, the Regulator has been waiting for the Pensions Bill to be published before launching its formal consultation. Although the Bill has now been published, the Regulator has indicated that, in light of the current political uncertainty, it will not commence its consultation on the new Code until the New Year.
When it is published the first stage of the consultation will focus on the principles and framework that will underpin the on the new Code. The second stage will then focus on the content of the Code itself.
The new Code is expected to build on the Regulator’s 2019 annual funding statement and to reflect the Regulator’s tougher approach to pensions regulation. It is due to set out a two tier approach:
- fast-track, and
In order to qualify for the fast-track process for approving a scheme’s valuation and recovery plan, trustees will need to ensure that their scheme’s valuation and funding arrangements meet certain prescribed criteria, which will be set out in the new Code. In most cases, these are likely to require conservative valuation assumptions and shorter than average recovery plans.
Schemes that cannot meet the prescribed requirements to qualify for the fast-track process, or that choose not to, will need to go down the bespoke approval route through which they will be required to justify any departures from the requirements prescribed in the new Code to the Regulator.
The Code is also due to set out an expectation for trustees to set a long-term objective for their scheme (i.e. buy-out, self-sufficiency or consolidation) and to put in place a strategy for achieving this. In doing so, the Code will build on the proposed new statutory requirement for DB schemes to put in place a funding and investment strategy.
When will these changes come into force?
Although the proposed Bill has fallen, it is likely that new funding requirements along these lines will be re-introduced by the next Government (whatever their persuasion) after the election. However, the timing of this is uncertain.
In any event, the Pensions Regulator is due to consult on a new Code of Practice on DB funding in the New Year. Although the Regulator has indicated that it would prefer for the Code to be underpinned by the new statutory funding requirements, the new Code could be introduced before, or even without, any changes to primary legislation. Therefore, the new Code is likely to come into force sometime next year regardless of what happens with the Bill.
Impact of proposed changes
The proposed new requirement for trustees to put in place a long-term funding and investment strategy for their scheme and for a scheme’s technical provisions to be set by reference to this would mark a significant change to the statutory funding regime for DB schemes.
The overall intent is clear, the Government and the Regulator want:
- schemes to identify their intended destination (be it buy-out, self-sufficiency or consolidation), and
- to ensure that corporate sponsors pay sufficient contributions to ensure that their scheme’s long-term funding target is hit by the time the scheme is significantly mature.
These proposals may begin to impact ongoing funding negotiations between sponsors and trustees, even before any new statutory requirements come into force. They are likely to strengthen calls for sponsors to put more cash into their schemes more quickly. As a result, we are likely to see an increase in the number of sponsors who offer contingent assets as an alternative to cash as a way to improve the funding position of their scheme and the security of members’ benefits.