The long-awaited Defined Benefit (DB) Funding Code of Practice (the “Code“) was laid before Parliament on 29 July 2024. The Code, which is expected to come into force in early October 2024, sets out TPR’s expectations for trustees and sponsoring employers in managing their DB schemes’ funding and investment risks. The Code is underpinned by key legislation, including:
- the Pension Schemes Act 2021;
- the Occupational Pension Schemes (Scheme Funding) Regulations 2005; and
- the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024.
The Code applies to valuations with an effective date on or after 22 September 2024. Schemes with valuation dates before this date do not need to comply with the Code, although TPR encourages any valuations before this date to be in line with the general principles of the new regime. For schemes with valuation dates between 22 September 2024 and when the Code comes into force, TPR is expected to communicate with affected schemes. It is recommended trustees take appropriate legal and actuarial advice in terms of the best approach to deal with these cases.
The Code places greater emphasis on long-term planning, risk management (including investment risk, longevity risk and employer covenant risk). In terms of complying with their duties, trustees are encouraged to consider complying with the Code via one of the following regulatory approaches:
- Fast Track: A standardised, lower-risk approach with clear guidelines and less regulatory scrutiny. The path generally involves minimal intervention from TPR.
- Bespoke: A more flexible, tailored approach for schemes that do not meet the Fast Track criteria. This route allows schemes to review their funding plans that are more tailored than the Fast Track requirements. However, schemes following this approach will need to demonstrate to TPR that the scheme remains sustainable and adequately funded over the long term. TPR will scrutinise this approach more closely.
Key Points
- The new DB Funding Code introduces significant changes to the regulatory framework for DB scheme funding and investment strategies.
- The Code emphasises the management of long-term planning and risk management aspects.
- Trustees are encouraged to consider a range of funding and investment strategies, and will be in a position to comply with the Code.
- Trustees should consider a range of funding and investment strategies, including the ‘Fast Track’ and ‘Bespoke’ routes.
Key Principles and Changes
The new Code introduces several key principles and changes that trustees and sponsoring employers need to be aware of:
- Long-Term Objective (LTO): The Code emphasises the importance of setting a clear long-term objective for the scheme, which outlines the desired end state for its funding and investment strategy. The scheme’s funding and investment strategy should be set out in a statement of strategy. The LTO should be realistic and achievable, taking into account the scheme’s specific circumstances and the employer’s covenant.
- Journey planning: this should be set with a strategic end game in mind – essentially, setting out how the scheme will reach low dependency and eventually one of a number of options which include buy-out, superfund (or other consolidation vehicle), active run-off with low dependency on the sponsoring employer.
- Covenant Assessment: The Code places a greater emphasis on covenant assessment, requiring trustees to systematically assess and monitor the employer’s financial strength and willingness to support the scheme. This assessment should be integrated into the scheme’s risk management framework, with clear triggers for action in the event of covenant deterioration.
- Risk Management: The Code promotes a proactive and integrated approach to risk management, encouraging trustees to identify, assess, and manage all material risks to the scheme’s funding and investment strategy. This includes considering both downside risks and upside opportunities.
- Flexibility: The Code allows for greater flexibility in funding and investment strategies, recognising that there is no one-size-fits-all approach. Trustees are encouraged to consider a range of strategies, depending on the scheme’s specific circumstances.
Key Points
- The new Code introduces the concept of the LTO and places a greater emphasis on covenant assessment and risk management.
- It allows for greater flexibility in funding and investment strategies, recognising that there is no one-size-fits-all approach.
- Trustees are encouraged to consider a range of strategies, including the ‘Fast Track’ and ‘Bespoke’ routes.
Implications for Trustees
The new Code has several implications for trustees:
- Proactive Approach: Trustees need to adopt a more proactive approach to risk management, regularly reviewing and updating their funding and investment strategies in light of changing circumstances.
- Stronger Governance: The Code requires trustees to have robust governance arrangements in place to ensure that they are effectively managing the scheme’s risks. This includes having clear policies and procedures for decision-making, risk monitoring, and communication with stakeholders.
- Enhanced Communication: Trustees need to communicate effectively with sponsoring employers and members about the scheme’s funding and investment strategy, ensuring that they understand the risks and opportunities involved.
- Advice: Trustees should seek expert advice from their actuary, covenant advisor, legal advisors and investment consultant to help them navigate the complexities of the new Code and develop appropriate strategies for their scheme.
Key Points
- Trustees need to adopt a more proactive approach to risk management and have robust governance arrangements in place.
- They need to communicate effectively with sponsoring employers and members and seek expert advice from their professional advisors.
Implications for sponsoring employers
The new Code also has implications for sponsoring employers:
- Transparency: Sponsoring employers need to be transparent with trustees about their financial position and future plans, providing the information necessary for a robust covenant assessment. TPR is expected to publish “in the next few months” employer covenant guidance, which will help trustees implement the Code’s requirements effectively.
- Statements of Strategy: Further to TPR’s consultation in March 2024 (click here for the article in Part 2 of June 2024 Pensions Compass), on 23 September 2024 TPR published its interim Response to its Consultation plus illustrative Strategy Statement templates for Valuations with effective dates from 22 September 2024 onwards. There are Fast Track and Bespoke templates for schemes which have yet to reach low dependency maturity and different templates for schemes which have reached this milestone. Further key points:
- Finalised Strategy Statements are to be filed digitally with TPR once the digital process is in place, not expected until Spring 2025;
- Schemes should continue to progress Valuations but should not file them or Strategy Statements until the new digital process is live;
- TPR will be issuing a full Response to its March 2024 Consultation “this winter”, to give more detail about the changes and simplifications reflected in the illustrative templates; and
- Valuations with effective dates before 22 September 2024 – these are to be completed in line with the existing 2014 DB Funding Code of Practice and documented and submitted via TPR’s
existing Exchange online service.
Key Points
- Sponsoring employers need to be transparent with trustees about their financial position and future plans.
- They need to be prepared to provide appropriate support to the scheme and work collaboratively with trustees to develop and implement funding and investment strategies.
What remains outstanding?
- Covenant guidance: While the new Code provides a comprehensive framework for DB scheme funding and investment, some areas still require further clarification. TPR is expected to publish employer covenant guidance, which will help trustees implement the Code’s requirements effectively.
- Statement of strategy: Further to TPR’s March 2024 Consultation, TPR’s full Response is due later this year.
- Fast track and bespoke compliance: TPR is expected to publish further guidance on these regulatory compliance routes.
Comment
The new DB Funding Code represents a significant step forward in the regulation of DB pension schemes. It provides a clearer and more structured approach to managing scheme risks, promoting long-term planning and sustainability. While the Code introduces new challenges for trustees and sponsoring employers, it also offers opportunities for greater flexibility and innovation in funding and investment strategies. By embracing these changes and working collaboratively, trustees and sponsoring employers can help to ensure the long-term security of their schemes and the benefits they provide to members.