Scheme Funding
The long-awaited Government consultation on new funding and investment regulations for DB occupational pension schemes was finally launched over the summer. The new regulations are expected to come into effect from September 2023 (at the earliest) and so affect actuarial valuations from that date. The consultation also paves the way for the second draft of the Pension Regulator’s new Funding Code of Practice which, apparently, has been further delayed following the recent gilt market crisis but is still expected by the end of 2022.
Key points in the consultation
While some of the details in the final regulations are still to be ironed out, the direction of travel is clear and has been for some time. Schemes will be required to determine a Long Term Funding Target (LTFT) and devise a Journey Plan to reach this destination. Schemes will need to attain their LTFT by the time they have reached “significant maturity”.
The reference point for achieving this state is known as the “relevant date”, and is determined as being no later than the end of the scheme year in which the scheme reaches significant maturity. By the relevant date, a scheme will need to be both fully funded on its LTFT and invested in assets consistent with this measure.
The LTFT will need to be a low dependency measure whereby it is not expected to have to rely on the sponsoring employer for further support. Natural destinations will be full buy-out of the scheme with an insurance company, self-sufficiency or transferring to a consolidator.
It had been expected amongst some that The Pension Regulator’s new Funding Code of Practice will define “significant maturity” as when the scheme’s liability duration reduces to 12 years – the idea being this would broadly reflect a scheme made up almost entirely of pensioners. In light of rises in gilt yields over 2022, however, this may not hold true and schemes could find themselves reaching significant maturity far earlier than previously anticipated. It will be interesting to see if this figure now changes in the draft Funding Code of Practice.
Setting a LTFT and Journey Plan to get there will require trustees and sponsoring employers to review and agree on their funding and investment strategies. This will mean specifying:
- The LTFT measure; e.g. buy-out with an insurance company, transfer to a consolidator or continue on a self-sufficient basis;
- The funding level the scheme is expected to achieve at the relevant date;
- The scheme’s expected investment allocation at the relevant date;
- For schemes which have not yet reached their relevant date, the expected maturity at the relevant date.
Trustees of schemes that are close to their relevant dates and / or which have weaker employer covenants will be expected to take less risk in their Journey Plans, with greater flexibility for schemes which are further away from their relevant date and / or which enjoy support from a stronger employer.
Trustees will need to document their plans in a Funding and Investment Strategy Statement (or ‘FISS’, another new acronym for the pensions industry), which will need to be submitted to the Pensions Regulator along with the usual documentation from the actuarial valuation.
In terms of Recovery Plans, the draft regulations require that funding deficits must be recovered as soon as the employer can reasonably afford. This might sound good in theory. However, this proposal has raised concerns amongst some sponsors who may feel the need to consider the long-term business plans and growth of the employer is being diluted in the decision-making process. As always, the best schemes are likely to be those supported by a strong employer.
Reviews of the longer-term funding and investment strategies are expected to take place alongside the usual actuarial valuation process, with the first such taking place within 15 months of the effective date of the first actuarial valuation after the regulations come into effect. Out of cycle reviews may be needed under certain circumstances; for example, following a significant change to the covenant strength of the sponsoring employer.
Action
While the new regulations are not yet finalised and are not expected to come into effect for around another year, trustees and sponsoring employers should engage with their advisers now and start making plans on how they will deal with the new funding and investment requirements.
