Scheme funding rules will be 'detrimental' to businesses, schemes and growth

Legislating schemes to buy gilts to match their liabilities could worsen systemic risks

clock • 5 min read
Patrick Bloomfield says the consequences will be detrimental to businesses, scheme members and economic growth
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Patrick Bloomfield says the consequences will be detrimental to businesses, scheme members and economic growth

The draft funding and investment strategy regulations for defined benefit (DB) pension schemes are too prescriptive and not fit for purpose and will worsen system risks by forcing schemes to buy gilts, according to Hymans Robertson.

The Draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 closes to consultation on 17 October but there are many concerns that it lacks flexibility.

While the consultancy said it supports the policy intention that schemes should be well funded and defensively invested around the time all their members have retired, it is "deeply concerned" by three key things.

First, that the draft regulations sacrifice scheme-specific flexibility, over-stepping into areas that should sit in The Pensions Regulator's (TPR) Code of Practice.

Second, the firm is concerned that what a business can afford to pay to its pension schemes would be prioritised over how a business needs to invest to grow.

Third, Hymans warned that the target investment strategies "leave no room for economically efficient investing and will supercharge systemic risks".

The consultancy said the regulations go in to too much detail dictating to pension trustees how their assets should be invested, pointing out that requiring schemes to effectively buy gilts to match their liabilities could worsen system risks like that seen in the liability-driven investment in recent weeks.

Partner Patrick Bloomfield warned that the draft regulations further than what has been put forward in TPR's 2020 consultation on DB funding and is not fit for purpose across an industry with such a wide spectrum of circumstances.

"The consequences of overly prescriptive regulation will be far reaching and detrimental to businesses, scheme members and economic growth," he said. "The amplification of systemic risks currently being witnessed in gilt markets has potentially dire consequences that will spill beyond pensions and into debt, mortgage, and foreign exchange markets."

He called on Department for Work and Pensions to redraft the regulations to remain broad and coherent with the current scheme-specific funding regime.

Hymans said in its response to the consultation: "Encouraging all schemes to have the same investment strategy and herding them into certain asset classes, will push up the cost of those assets and will exacerbate systemic risks. Recent weeks have highlighted the systemic consequences of pension schemes being regulated towards buying gilts. Legislating schemes to effectively buy gilts will make the situation worse still."

Some flexibility is considered to be essential, especially for schemes with greater long term covenant visibility and/or contingent support in place - but Hymans warned there is little scope for a scheme to be able to rely on ongoing employer support once it has reached significant maturity.

The consultancy pointed out that the government's 2018 findings showed that the current regime was working well for most schemes, warning that the new requirements risk "unduly constraining schemes that are acting reasonably". The increase in contribution calls to businesses will be "substantial".

Hymans is also concerned that within the proposals there are examples where the changes would not appear to achieve the intended risk reduction. Schemes with weaker covenants could be forced to de-risk too quickly and ‘lock-in' a deficit with the sponsoring employer being asked for unaffordable pension contributions.

Schemes that are already at or, close to significant maturity when the new regime is implemented could be forced to immediately de-risk and pay significant contributions to hit a much higher low-dependency funding target, the firm warned.

Industry disquiet

This comes amid increasing industry disquiet at the new funding code - with responses to DWP's consultation on DB funding rules, which closes next week, being critical about the flexibilities on offer.

In its response to the consultation yesterday, the Association of Consulting Actuaries (ACA) said that, while it strongly supported the overall objective of the funding code, it had "significant concerns" that the proposed legislation is insufficiently flexible and reduces the ‘scheme specific' element of the current funding regime - replacing it with an industry standard approach, only permitting limited variation in how schemes plan their journeys and set their ultimate destination.

The ACA said, based on these regulations, it would not be possible for the bespoke option outlined in TPR's 2020 consultation on a revised Code of Practice to be as flexible as it had hoped, and all schemes will be required to adopt fairly similar plans.

The ACA's comments come after WTW said draft regulations on DB pension funding would impose a narrow, simplistic and overly rigid framework on schemes and "should be sent back to the drawing board".

WTW head of retirement, Great Britain, Rash Bhabra said: "The seed from which these new regulations have grown was first planted in 2018, when the government acknowledged that the existing scheme-specific funding regime works well for most schemes but sought to make it easier for the Regulator to police the minority.

"Prioritising enforceability above all else has meant inserting too much prescription into what was supposed to be a principles-based framework. There is little flexibility around the ‘low dependency' positions that schemes must target, nor around how quickly they must get there. One-size-fits-all low dependency targets could crowd out investment in infrastructure and other secure income asset classes, concentrating investments - and the associated risks - in gilts and credit that target very low returns."

Lane Clark & Peacock (LCP) also urged the government to reconsider its "rigid" new rules on pension scheme funding - saying they could unnecessarily cost businesses and members up to £30bn, affect the government's growth agenda and bring 200 employers to the brink of insolvency.

LCP partner Jonathan Camfield said: "The result will be an unnecessary hike in the amount of money employers are expected to put into pension schemes, to the detriment of their ability to invest in their own future. And for some employers, these increased demands could be the final straw which pushes them into insolvency.

"At a time when there is so much focus on economic growth and boosting business investment, this does not look like joined up government. The DWP needs to re-write these rules to strike a better balance between security for pension scheme members and avoiding unnecessary burdens on the employers who stand behind them."

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