Respondents to the Pensions Regulator’s first consultation on its imminent defined benefit funding code have told the watchdog of their concerns over schemes “levelling down” to meet its fast-track valuation pathway, as well as noting their fears over a loss of flexibility.
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, which was launched in March 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.
Under TPR’s twin-track approach, schemes that choose a prescriptive fast-track funding arrangement would be subject to less regulatory scrutiny, while those choosing a bespoke arrangement would face stricter oversight.
Some may not be able to justify their current approach in line with the requirements of the new legislation, and there may be a cost implication of this
The Pensions Regulator
The fast-track parameters cover low dependency and investment strategy, technical provisions, investment risk and recovery plans.
In acknowledging responses to the 2020 consultation, TPR admitted that the fast-track “would represent a higher level of risk than many schemes currently have in place and, in some cases, may encourage some levelling down or increase in risk-taking”.
“However, we do not expect this to be significant as most schemes that are within our fast-track parameters are aiming to manage and mitigate the risks to members and the sponsoring employer,” it continued.
A loss of flexibility
The code seeks to put schemes on a path of “low dependency” on their sponsoring employers. Schemes will need to target a low-dependency investment allocation, under which their investments’ cash flows are broadly matched with the payments of their benefits.
Few schemes objected to the regulator’s twin-track approach, although some respondents raised concerns about the drawing of fast-track lines.
“Very many were concerned that bespoke could result in a loss of flexibility if it was measured by reference to fast-track,” TPR said. The watchdog believes that the bespoke pathway will offer schemes more flexibility to meet their own needs.
Concerns were flagged over the regulator’s available level of resource to assess the bespoke pathway – this pathway being burdensome and viewed as inferior to fast-track, and the risk of schemes levelling down to meet the threshold for fast-track.
“It remains to be seen whether the final regulations, and therefore TPR’s code, will ultimately be adapted to give DB schemes and sponsors appropriate flexibility while still ensuring the security of members’ benefits,” Barnett Waddingham partner Paul Houghton said.
“This lack of flexibility could lead to significant additional costs for some sponsors if schemes are forced to adopt a ‘low-dependency’ investment strategy in all circumstances once they are ‘significantly mature’.
“Recent market volatility has exacerbated the issue, with the timescales for schemes to reach a low-dependency position being materially reduced.”
Increased costs
The industry has warned of the costs that the new funding code may impose, particularly on smaller schemes. Employer covenant is central to the code and schemes will be expected to perform detailed analysis on their sponsors, which commentators have warned could be prohibitively expensive for smaller schemes.
In response to TPR’s first consultation on the code, the watchdog warned of a potential increase in the cost of DB pension provision.
“By the very nature of setting a fast-track line, some schemes will be below the regulatory parameters we have set out. For many, they will have justifiable reasons for this, and so there will be no impact of these proposals,” TPR said.
“However, some may not be able to justify their current approach in line with the requirements of the new legislation, and there may be a cost implication of this.”
The watchdog predicted that this would not be “significant in aggregate”, and that it did not foresee a large aggregate hike to employers’ deficit repair contributions.
One expert, meanwhile, raised his concerns over the cost impact that the new DB rules would have on large employers.
Smaller schemes face ‘significant’ costs with TPR DB funding code
While the Pensions Regulator foresees an initial hike in implementation fees followed by reduced costs in the long term, experts have warned that the new defined benefit funding code will be particularly onerous for small schemes.
“Despite TPR’s reassuring words, we remain concerned that the overprescription in DWP’s draft regulations will put disproportionate cost burdens on a small number of large employers,” Hymans Robertson senior actuary Patrick Bloomfield said.
“Standing in the snow today, it’s hard to see the case for making DB schemes even more secure when businesses are grappling with cost of living strikes, Brexit and recession pressures.
“With such wide-reaching ripple effects on pay rises, jobs and current workers’ pension savings, a more detailed impact assessment is essential, before parliament can pass this code and the accompanying regulations into law.”
