To Comply or Explain? That is the question!
12 Dec 2019
We’re on the brink of a new DB Funding Code from The Pensions Regulator (TPR), a stronger and more directive Code with significant implications for many trustees and sponsors. It’ll introduce a set of standards covering funding targets, recovery plans, and even investment strategy. Trustees will need to comply with this set of “fast track” standards or justify a different “bespoke” approach.
Here, we consider what you can do to prepare, and what might influence your decision to ‘comply or explain’.
So, what will the new Code include?
Exact details are still subject to consultation but at a high level, the Code will set out a fast track funding framework. If a scheme follows this framework, then TPR will not intervene. Various comments from TPR indicate that this framework will include the following 5 features:
- Long Term Objective (LTO): a single long-term objective for all schemes will be required, regardless of scheme size and covenant. It’s anticipated that the bar will be set at gilts + 0.5% p.a. or gilts + 0.25% p.a.
- Timeframe to LTO: trustees will need to target reaching the LTO by the time their scheme is “significantly mature” which could mean by the time most members are pensioners.
- Technical Provisions (TP): we expect a prescribed discount rate which will vary depending on scheme maturity and strength of employer covenant.
- TP recovery plan: we expect a maximum recovery period, linked to covenant, affordability and possibly scheme maturity. We may also see the end of back-end loading and investment return assumptions above the prescribed discount rate.
- Investment risk: a maximum level of investment risk could be introduced, influencing investment strategy for those going down the fast track route.
Most valuations crossing TPR’s desk relate to small schemes. Around 50% of all schemes are less than £20m and 80% are less than £100m*, giving a clue to TPR’s motivation for introducing fast track compliance. Under fast track, it should be more efficient for TPR to ensure that these small schemes are meeting a set of minimum standards.
However, schemes won’t be forced down the fast track route. They can adopt a bespoke approach, which will be subject to regulatory scrutiny.
Common features of a bespoke approach will include a lower LTO, lower TPs or a longer recovery plan. It’s tempting to think that the bespoke approach won’t feel different to the current funding regime. But it won’t be plain sailing. The burden of proof will shift to the trustees so “going bespoke” is likely to feel more onerous than the current regime.
What might influence your decision to go fast track or bespoke?
When making the decision, you need to consider what’s best for your members. Bespoke is likely to be more suited to schemes with strong sponsors, contingent assets or a conviction to create value through assets or liabilities in a way that’s not recognised through the fast track approach.
In comparison, fast track is likely to be better suited to schemes who want a lower governance cost and more mature, better funded schemes who want to focus less on adding value through investments and more on planning for the end game.
A critical element will be where TPR sets the bar for the fast track framework. Too low and scheme funding could level down, reducing member security. Too high and it’ll be unaffordable, with TPR inundated with “explain” letters.
What can you do to prepare?
Here are 3 keys actions you can take to prepare for the new Funding Code:
- You can start by benchmarking your current approach against the segmented expectations set out in TPR’s latest annual funding statement. And understand where your scheme sits in the universe of other DB schemes.
Not sure what segment you fall into? Our segment identifier tool can tell you which segment is most relevant to your scheme in just 5 simple steps. Our benchmarking analysis report gives insight into what other schemes are doing, what might trigger regulatory intervention and whether your scheme might be at risk.
- As details emerge through the consultation, test the impact on your scheme and prioritise areas for review. For example, if you meet one element of fast track but not another, is there a way you can reshape your current funding and investment strategy to avoid the need to go bespoke?
- Engage with your sponsor on this – work collaboratively to identify your preferred approach.
The first of two consultations on the new Code is expected early next year. We’d encourage you to respond to the consultations; that’s the chance to have your say and influence the content of the new Code.
If you’d like to discuss the impact of the new DB Funding Code for your scheme or would like any help responding to the consultations next year, please get in touch.
* From TPR’s Scheme Funding analysis