New proposals set DB schemes on path to ‘low dependency’

The Department for Work and Pensions published its consultation into DB funding on July 26, following the introduction of the Pension Schemes Act 2021, which set out the framework for the government’s proposals on this topic.

The consultation, which closes on October 17, also proposes changes to the way scheme maturity is measured, a requirement for schemes to have a chair of trustees, and new rules for multi-employer schemes.

“Most DB schemes are well managed. However, despite the safeguards in place, best practice is not universal,” pensions minister Guy Opperman said. 

The DWP will be leaving a good proportion of the detail to TPR, who have promised to consult on their code in the autumn

David Brooks, Broadstone

“Our intention is to have better and clearer funding standards, while retaining the strengths of a flexible, scheme-specific approach. It is neither ‘one-size-fits-all’, nor about micro-managing schemes.” 

The DWP has left confirmation on detail in areas including its proposals surrounding scheme maturity to the Pensions Regulator, which plans to consult on its revised code of practice in the autumn.

Low dependency is distinct from self-sufficiency

The department assumes that 80 per cent of DB schemes already have a long-term objective in place, according to an impact assessment published alongside the consultation.

According to the document, a scheme in a state of low dependency is deemed to be sufficiently invested in a “low dependency investment strategy” and not require further employer contributions. 

It may, however, receive these for the further accrual of future pension rights for any of its active members.

The government said this is distinct from self-sufficiency, because unexpected circumstances could require additional support from a scheme’s employer and self-sufficiency cannot be guaranteed.

A low dependency investment strategy, meanwhile, would see a scheme’s assets invested in a way that matches investments’ cash flows broadly to pension payments and other benefits. It would also ensure that asset values are protected from short-term market downturns.

Trustees and managers will be required to set out the investment strategy’s asset mix at a high level, detailing exposure across different asset classes such as equities and bonds, but not information on actual scheme investments.

A funding position based on the low dependency principle will satisfy the investment strategy requirement and see an asset-liability ratio of 1:1.

In its consultation, the government asked respondents if its definitions for low dependency investment and funding strategies were appropriate and effective.

Schemes will need to send their funding and investment strategies to TPR.

Cardano managing director Alex Hutton-Mills said: “The DWP’s new regulations put covenant on a formal footing as the foundation of all DB pension strategies, but the focus on a low dependency funding position could be a step change in how liabilities are measured. 

“The risk for sponsors is that higher funding targets (and trustee prudence) further complicate decisions on the use of the ‘marginal pound’ at a time when management will be focusing on investment and liquidity decisions to ride out the current macroeconomic turbulence.” 

TPR previously set out in its code of practice in 2006 that trustees should aim for any funding shortfall to be eliminated as quickly as their employer could reasonably afford. This was dropped in 2014 after the watchdog was given an objective to minimise any adverse impact on the sustainable growth of an employer.

Where schemes are in deficit, trustees or managers will now have to devise recovery plans that “follow the principle that funding deficits should be recovered as soon as the sponsoring employer can reasonably afford” it said.

TPR to provide the finer detail

The consultation also sought feedback on the DWP’s proposals concerning scheme maturity. It wants to define the point at which a scheme is regarded as “significantly mature”, adding that “we think this level of detail regarding this metric may be more appropriate left to the regulator’s discretion, and therefore their code of practice rather than a matter for regulation”.

TPR’s first consultation on its code suggested that schemes reach significant maturity when their liabilities reach a duration of 12 to 14 years, but it is expected that its second consultation will set an objective of 12 years, DWP said.

Schemes will need to set a date, not later than the end of their scheme year, at which point it is expected to reach significant maturity.

The consultation asked whether this proposal would work, whether schemes already had long-term dates, and where funding and investment strategies are reviewed out of cycle with actuarial valuations, and if it would be more helpful to require these to be aligned with schemes’ most recent actuarial reports.

Broadstone technical director David Brooks said: “The question remaining for trustees and sponsors is whether this funnels schemes too fast and too hard by removing the upside opportunities of holding growth assets for longer. The pensions minister is at pains to point out that this isn’t a one-size-fits-all approach. 

“However, the DWP will be leaving a good proportion of the detail to TPR, who have promised to consult on their code in the autumn. It is here that the devilish detail may yet emerge.”

The consultation also asked for views on allowing for more risk-taking, provided that this could be supported by “high-quality contingent assets provided by another company within the group or a third party”. This could be limited to 5 per cent of a scheme’s total liabilities, and contingent assets could include cash in an escrow account, the DWP said.

Trustee boards will need chairs

Chairs of trustee boards will have to sign off schemes’ statements of strategy, under the DWP’s proposals. Schemes will have to appoint a chair if they do not currently have one.

Rules are also being amended for multi-employer schemes. For example, where an actuarial valuation is needed for an individual section of a multi-employer scheme, a funding and investment strategy and statement of strategy will also be required for that section.

TPR will now consult on its code of practice in the autumn, with the new code expected to come into force in autumn 2023*.

“Given the draft regulations and tone of the regulator’s responses to date, this looks unlikely to change fundamentally,” said Hymans Robertson partner Laura McLaren.

The DWP said that the impact of any changes to deficit repair contributions as a result of its funding and investment strategy proposals will be included in the regulator’s “business impact target” assessment. 

These costs would result from legislative changes; however, it is TPR’s revised DB funding code of practice “which will determine the scale of these costs”, it added.

“Giving long-term objectives a formal role in funding agreements makes sense,” said David Robbins, senior consultant at Willis Towers Watson.

“But the DWP has hesitated to say what consequences it intends this to have, either in terms of the deficit contributions that employers will pay or in terms of how much more secure members’ benefits will be.”

*This article previously stated that TPR's code would come into force in 2025 or 2026. This has now been corrected.