The New DB Funding Code: Key Updates for Trustees and Sponsors

Introduction of the Final Draft DB Funding Code and Key Regulatory Updates for 2024

On Monday 29 July 2024, the Pensions Regulator (“TPR”) laid the final draft Defined Benefit (“DB”) Funding Code¹ before Parliament. It will be laid for 40 sitting days before it comes into effect. TPR has also published the responses to its consultations on the Code and Fast Track including the updated Fast Track parameters².

The Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 came into force in April 2024 and apply to pension schemes undertaking funding valuations with effective dates on or after 22 September 2024. The regulations specifically point to the Funding Code, which sets out TPR’s expectations as to what parties must do to comply with the new regime.

TPR acknowledges that there will be a delay between the 22 September 2024 effective date and the Code being finalised. This delay has occurred due to an earlier than expected General Election which prevented the Code being laid before Parliament until now. TPR will communicate with and provide support to schemes undertaking actuarial valuations with effective dates before the Code is finalised to limit disruption. It has confirmed that schemes with valuation dates in this period can use the final draft DB Funding Code³ as the basis for their valuation and should expect a “reasonable” regulatory approach.

Under the new DB Funding Code, for the purposes of determining their funding and investment strategy, trustees must determine the following:

• Their long-term objective (which explains how they intend to provide benefits over the long-term, e.g. run-on, buyout, transfer to a consolidator).

• Their low dependency funding target, which will include the funding level they intend the scheme to have reached on a low dependency funding basis at a particular date – known as the “relevant date”. The relevant date must not be later than the end of the scheme year in which the scheme is expected to reach (or reached) the point of “significant maturity” (although it can be before this deadline).

• The investments they intend to hold at the relevant date.

• Where relevant dates are set in the future, details of the journey plan setting out how the scheme will progress from its current funding position to its low dependency target.

Compared to the earlier draft Code, there were several key changes and confirmations, which we’ve noted below.

Key Updates and Clarifications in the Final DB Funding Code

The final draft DB Funding Code introduces several significant updates aimed at strengthening the governance and financial resilience of DB pension schemes:

1. Point of Significant Maturity:

• A scheme reaches significant maturity when its liability duration, calculated on a low dependency funding basis, falls below a threshold number of years.

• Definition of Significant Maturity: This has been revised to 10 years for DB schemes and 8 years for schemes with cash balance benefits. In the earlier draft, significant maturity was set at 12 years.

2. Low Dependency Investment Allocation:

• The Code makes it clear that the LDIA is a notional investment allocation from which a low dependency funding basis can be derived and supported.

• There is a broadening of the definition of matching assets.

• The prescription around how trustees should test the high resilience of their LDIA has been removed. However, the final draft Code states that a suitable test has to be carried out.

• The final draft Code retains the expectation that an LDIA targets interest rate and inflation hedge ratios of at least 90% of the scheme’s low dependency liabilities.

3. Simplifications for Smaller Schemes:

• Ease of Compliance: Smaller schemes with 200 or fewer members can use simplified calculations, making compliance more accessible and less onerous.

There is also further commentary in the final draft Code on other matters including open schemes, recovery plans, employer covenant and journey planning.

Understanding the Fast Track Parameters

The Fast Track approach is an addition to the DB Funding Code, designed to offer a more standardised pathway for schemes to achieve their funding targets. It includes specific parameters and guidelines that schemes can follow to meet regulatory expectations with less regulatory intervention, provided they adhere to these benchmarks.

Key Fast Track Parameters:

1. Low Dependency Funding Basis: Prescribed discount rates and inflation assumptions based on market data, specifically the Bank of England’s gilt yield curve data. The maximum discount rate is set as gilts plus 0.50% p.a.

2. Technical Provisions (“TPs”) Funding and Investment Risk: Details on acceptable funding levels and investment risks have changed. There is a sliding scale for minimum funding levels (the minimum funding level is determined as a percentage of the scheme’s liabilities calculated on the low dependency funding basis). For illustration, at a duration of 20 years this is 83.5%, at 15 years it is 92% and at 10 years (significant maturity) it is 100%.

3. Recovery Plan Lengths: Guidelines for schemes needing to address funding shortfalls. Broadly, recovery plans must be less than 6 years for schemes before their relevant date (the point at which the scheme must reach low dependency), and 3 years for schemes at or after their relevant date.

4. Employer Covenant: Assessment criteria for the financial health of the sponsoring employer.

Fast Track parameters will be reviewed annually to reflect changing market conditions, with a comprehensive review every three years.

Next Steps for Trustees and Sponsors

1. Review Current Funding Strategies: Evaluate your scheme’s current funding strategy against the final draft DB Funding Code and Fast Track parameters.

2. Engage Your Actuary: Work closely with your scheme actuary to confirm compliance with the new Fast Track parameters or develop a rationale for a Bespoke approach if needed.

3. Stay Informed: The full details, including the consultation responses, are available on the Pensions Regulator’s website.

At Spence, we are committed to helping trustees and sponsors navigate these regulatory changes. Our expert team is ready to provide guidance and support to ensure your DB pension scheme’s compliance and long-term success.

Contact us today to learn more about how we can assist you in adapting to the new DB Funding Code and Fast Track requirements.

Useful Links

1. Draft defined benefit (DB) funding code of practice and regulatory approach consultation | The Pensions Regulator
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2. Response to Fast Track and regulatory approach consultation | The Pensions Regulator
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3. Response to our draft DB funding code of practice consultation | The Pensions Regulator
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Matthew Toal

Actuarial & Investment

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