New DB funding code could cost employers up to £34bn

TPR published its draft code on December 16, alongside two consultation documents – one for the code itself and one for scheme valuations’ “fast-track” option, which will form part of its twin-track DB funding approach. TPR received 127 responses to its first consultation on the code in 2020.

The fast-track option is not part of the DB funding legislation, which is intended to come into force in October 2023, and is therefore not included in the draft code.

The 14-week consultation, which runs until March 24 2023, invites responses to a regime that explains how DB schemes will be expected to set out long-term funding objectives and journey plans to explain the path to meeting these goals. TPR will expect schemes to reduce their reliance on sponsoring employers as they reach maturity.

There is still time for the government to think again and give schemes and their employers time to adjust to the new funding regime

Michelle Wright, LCP

The Department for Work and Pensions published its own consultation on DB funding rules in July, which set out the expectations it shares with TPR for “low dependency” on sponsors. The government said that it would leave the finer details of the regime to TPR, observing that “it is here that the devilish detail may yet emerge”.

According to LCP, a key challenge for sponsors with the new regime is that their scheme may not be funded on a low-dependency basis, and/or may not be planning to be funded at this level by the time they are mature. 

And while the government’s consultation did not include an official estimate of the impact of the new rules, the documents published by TPR revealed several scenarios, with one dictating a cost of £34bn to sponsors.

Pensions Expert reported in December that while the regulator foresees an initial hike in implementation fees followed by reduced costs in the long term, experts have warned that the new DB funding code will be particularly onerous for small schemes.

TPR has calculated the potential bill if all DB pension schemes that are currently funded below the proposed level were to “level up” to the prescribed level, and assuming that none of the schemes that are funded above that level chose to “level down”, LCP said.

However, the watchdog stated that this scenario is not one expected in practice – as schemes will use the flexibility available through the bespoke route and some may take the opportunity to level down – “rather, it is included to illustrate a more extreme impact”.

Also, TPR’s estimates were based on market conditions as of March 2021, and scheme funding will have generally improved since that date due to the rise in gilt yields.

‘Additional burden’ for sponsors

LCP noted that even if the final figure turns out to be lower than £34bn, “there can be little doubt that for some employers these new rules will represent a significant new or additional burden”.

In August, the consultancy warned that the new funding rules may lead to “potentially severe outcomes”, while Mercer predicted that the regulations would “accelerate pension liability buyouts and the demise of DB schemes”.

LCP partner Michelle Wright argued that the “government needs to be open about the potential impact of these new funding rules”.

“The legal requirement to improve funding for schemes will apply at the first regular ‘valuation’ of the scheme as soon as the new law is passed, which for some could be later this year,” she said.

“Employers could face demands from pension schemes collectively running into tens of billions of pounds over the following five years or so.”

The consultancy noted that even for the sponsors that can meet the new funding obligations, the legal requirement to clear deficits ‘as soon as reasonably affordable’could curtail other business activities in some cases, such as paying dividends, improving wages of the current workforce, or investing in the business.

Wright added: “While everyone wants to see company pension schemes properly funded, this needs to be done in a proportionate way, rather than imposing rigid new rules overnight. In many ways, these new proposals are responding to the funding problems of years ago, when today’s world of pension scheme funding looks completely different.

“There is still time for the government to think again and give schemes and their employers time to adjust to the new funding regime,” she continued. 

“Without this, some businesses could find they simply cannot afford what they are being asked for and could be at risk of insolvency, which is an outcome in no one’s interest.”

In response to LCP's analysis, a TPR spokesperson said: “Reasonable affordability is central to the regulations and our DB funding code, including that the sustainable growth of the employer should be taken in to account. Employers will not be forced into contributions that would drive them to insolvency."

They reiterated that the scenario which led to the £34bn figure "was included as part of our sensitivity analysis and illustrates an extreme scenario. As we stated, it is not one that we would expect in practice".

“The DWP regulations and proposals we have set out for consultation include flexibility for schemes and employers and take a proportionate approach," they added.

Pensions Expert understands an impact assessment will be published with the final regulations and code.

A DWP spokesperson said: “Our intention is to have better – and clearer – funding standards, whilst retaining the strengths of a flexible, scheme-specific approach. It is neither ‘one size fits all’, nor about micro-managing schemes. Every scheme will be treated on its merits.

“Millions of people rely on defined benefit schemes. Our new measures will help ensure they are protected for the long-term.”