New Pensions Regulator Defined Benefit Funding Code laid before Parliament

The Pension Schemes Act 2021 (Act) and The Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 (Regulations) set out the legislative framework of the new defined benefit (DB) funding regime. The new Code provides practical guidance for trustees on how to comply with the DB funding regime. It will replace the current Code published in 2014.

The new Code is not a statement of the law but a court or tribunal must take it into account when determining if legal requirements have been met, and it is not necessary for all the provisions of the new Code to be followed in every circumstance, except where the Regulations provide otherwise.

The overriding principle of the new funding regime is that steps must be taken to recover deficits as soon as the employer can reasonably afford. Trustees should assess affordability on a year-by-year basis.

Trustees must prepare a Funding and Investment Strategy (FIS, and it must be agreed with the sponsor employer, depending on the pension scheme’s own rules) setting out how they will fund members’ benefits over the long term. This is based on the principle that investment risk should be supportable, and that when a scheme is significantly mature, it should not plan to need further support from the sponsoring employer. A scheme’s maturity is to be measured by its “duration of liabilities” on the low-dependency basis: in broad terms, this is the weighted average time until benefits are expected to come into payment.

The Regulator favours a principles-based approach to assess that the level of risk being run is supportable. Trustees need to look at the employer’s “cash flow and future cash flow” when assessing the covenant, as well as the “future development and resilience of the employer’s business”. In other words, reliability and longevity.

There are no restrictions on trustees’ ability to invest in line with their fiduciary duties.

When?

The Regulations came into force in April 2024. Although the new Code is not yet into force (likely to be November 2024), the new funding and investment strategy regime will, broadly, apply to all valuations with effective dates from 22 September 2024 onwards. The scheme’s first FIS must be determined within 15 months of the effective date. The valuation and FIS should be considered “together as one”.

Why?

There are still around 5,000 private sector occupational DB pension schemes in the UK. The concern which the new funding regime aims to address is that whilst aggregate DB funding levels have improved in recent years, financial markets and economic conditions are changeable and funding positions can quickly deteriorate. The DB landscape has changed, and most schemes are now closed and maturing.

What does it mean for trustees and sponsor employers?

• Trustees may face increased compliance costs. For example, more information needs to be submitted to the Regulator.
• Scheme sponsor employers may face further costs as a result of changes to funding targets and recovery plans (and as there are more moving parts), although for schemes who already have a liability driven investment strategy, the impact may not be that significant.
• Where buy-out is an option, the FIS need not be long or complicated.

What’s next?

Expect further updates from the Regulator on employer covenant, Statement of Strategy, recovery plan; DB funding and investment-related guidance and more guidance on its regulatory approach including detail on the Fast Track and Bespoke submission routes and (possibly) guidance on relevant benchmarks around liability driven investments.

As a general comment, the Government and the Pensions Regulator have faced criticism that the new funding regime is killing off DB pension schemes by encouraging increased risk aversion and securing members’ benefits as soon as possible. There are also calls to the Government to require scheme surpluses to be used to satisfy members’ reasonable expectations of discretionary benefits before any return of surplus to the employer.

If you require legal advice on the Pensions Regulator’s Defined Benefit Funding Code, contact our Pensions team.