In the Society of Pension Professionals’ (SPP’s) first regular column for Professional Pensions, the organisation’s president takes a look at the revised defined benefit (DB) funding regime.
The core principle underlying the new DB funding regime is that all pension schemes should target a suitably low level of risk by the time they are significantly mature. This is a sound principle, which I strongly support.
Such strategies are already commonplace, with most pension schemes having funding plans that allow for investment risk to reduce, targeting ‘low dependency' over the long-term.
The Department for Work and Pensions' March 2018 white paper - Protecting defined benefit pension schemes - also acknowledges this, with its opening statement: "The government believes the system is working well for the majority of DB schemes … but accepts that we need a tougher approach for those few whose irresponsible decisions impact on their pension scheme."
Nevertheless, under the current proposals, many well-funded schemes with credible plans in place will still have a considerable amount of work to do to comply with the new requirements.
DB funding code consultation
The draft code that The Pensions Regulator (TPR) is currently consulting on is a highly technical and prescriptive guide, covering investment strategy, funding reviews, covenant assessment and risk management.
Alongside this, TPR is consulting on the details of their proposed fast track regulatory approach. Under fast track, those who meet a series of quantifiable tests can expect little or no regulatory intervention. However, TPR stress that fast track is their view of tolerated risk, and schemes still need to comply with the detailed requirements of the code.
The draft code also sets out details of what must be included in the so-called statement of strategy', which all schemes will have to prepare and review at each valuation. The requirements are extensive, including:
- Details of the low-risk funding target, how investment returns are assumed to change over time and how maturity is expected to evolve.
- The current strategic asset allocation, the target low-risk asset allocation and how the assets are expected to transition to the low-risk allocation.
- An assessment of the employer covenant, including details of cashflow and liquidity, TPR's defined covenant metrics relating to visibility, reliability, prospects, longevity, and how this supports scheme strategy.
- An assessment of the main risks, how risks will be managed and monitored and the actions to take if progress is not as expected.
Will this influence outcomes?
The new regime will help drive improvements for the few schemes where risks are not being appropriately managed already, but it is debatable whether it will have much impact on the outcome in many cases.
TPR's own analysis shows that 51% of schemes will meet fast track. This increases to almost 60% if we exclude those that fail because of their deficit recovery plan, which will normally be due to reasonable affordability constraints. Many more will be close enough that they can meet the tests with some minor adjustments. Typically, these schemes will already be funded on a low-risk basis, or close to achieving this. Nevertheless, they appear to be subject to largely the same compliance burden.
Of course, low-risk does not mean no-risk, and the approach taken must be supported by the covenant. For example, if trustees identify certain key risks faced by their sponsoring employer, there are actions that can improve the scheme's position in the event of those risks crystalising (including, in extreme situations, the risk of insolvency).
The detailed and prescriptive requirements of the code will not necessarily help trustees to identify these situations, though, and may push them towards box-ticking rather than thinking through their own specific circumstances.
Thankfully, the code highlights the need for schemes to take a proportionate approach, although there are some inconsistencies, and it is not always clear how this should be interpreted. The SPP looks forward to working with TPR to help ensure the new regime works as intended, by targeting the few who take advantage of the flexibilities in the funding regime, without disrupting the well-established plans of the many.
Steve Hitchiner is president of the Society of Pension Professionals and a partner at Barnett Waddingham