The new DB Funding Code… Remind me, why is this happening?
26 Jun 2020
Here’s a few thoughts on “why?”, before we all get lost in the weeds of liability duration or which covenant group you’re in. Hopefully they help make sense of the decisions that need to be made within the framework of TPR’s new DB funding code.
The new code is pretty common sense: aim for a decent amount of assets (defensively invested) before your scheme gets seriously into run-off. Most well-run schemes have been doing this for some time already.
Four sub-plots are worth pulling out to understand why this is happening:
- The code is borne from the DWP Select Committee’s questioning of BHS, Carillion and other collapses. The conclusion was that TPR had adequate powers but they were too hard to access, or at least too hard to access quickly.
The new Fast Track is a yardstick to measure against. If you’re on the wrong side, then TPR’s powers under Section 231 are in play. It’s clear and it’s quick.
- DB schemes are maturing. Over £1.6 trillion of liabilities need to run-off safely. If this doesn’t happen then the burden on UK business will be a systemic risk to the UK economy.
Most schemes are on track over the next 15 to 20 years, so long as funding keeps improving. But if funding goes sideways for a decade, the costs to catch-up will put companies out of business. Setting long term objectives is to make sure this doesn’t happen.
- Current legislation was designed for going concern companies with open schemes. It has many aspects that enable risk taking or contribution deferral. These loopholes need to be closed down to avoid inappropriate use on closed schemes by the odd rogue trader.
Forcing trustees and sponsors to agree a purposeful plan to get their scheme to run-off prevents schemes optimistically drifting in the hope of better funding.
- By volume, the DB industry is sub-scale: of the 5,500 DB schemes, 2,000 have less than 100 members and 4,000 have less than £100m of assets. The challenge of applying large-scheme good practice within a micro-scheme’s budget are obvious.
The new code is standardised, tailoring for a scheme’s maturity and sponsor strength. Actuaries can programme it and use it as a decent start point for schemes of any size at a reasonable cost. It doesn’t need to be perfect, it needs to be proportionate.
Against those challenges, TPR’s proposed DB funding framework is really quite good. That’s just as well, as I doubt it will change fundamentally through this consultation. What is still up for grabs is how TPR set the parameters within the framework.
There are a few competing forces which will determine where TPR ‘sets the bar’. Pressure to make Fast Track a stiffer test comes from the risk trustees ‘level down’ from stronger current funding plans. RPI aligning with CPIH is also a potential boost to funding to factor in. Set against this are COVID-19 market falls and post-Brexit recession risks. Operationally, TPR wants enough schemes to go through Fast Track so it can manage the workload of the schemes that choose to go ‘Bespoke’.
One potential casualty of the new code is pension savings for today’s workers. Within the DB world, costs will increase for open private sector DB schemes, making it harder to stay open. Outside the DB world, every £1 spent funding a DB deficit is £1 less to spend on DC savers. The embedded political decision to favour those who built up a private sector DB pension is so deeply enmeshed with other issues, I’m not sure it’s been acknowledged or debated.
Some trustees will choose to manage their scheme to optimise within this new regulatory standard. Some will look through it to genuinely manage the risks of paying their members' pensions. Whichever path you choose, I hope this helps make sense of the way TPR is trying to shepherd its flock.