The Defined Benefit Funding Code: Q&A | PLSA
The Defined Benefit Funding Code: Q&A

The Defined Benefit Funding Code: Q&A

23 May 2023

Leading industry commentators share their thoughts on the forthcoming Defined Benefit (DB) Funding Code and its implications for pension schemes

Authors: Fred Berry, Lead Investment Consultant, The Pensions Regulator, Joe Dabrowski, Deputy Director – Policy, PLSA, Martin Hunter, Head of Integrated Funding, Railpen, Rob Orr, Head of Technical and Comms, SAUL Trustee Company and Chair, PLSA DB Committee, Rachel Pinto, Partner, Herbert Smith Freehills.

What are the key outstanding challenges from the latest DB Funding Code consultation?

Fred Berry: Our consultation, which closed on 24 March, has generally been well received by the industry. We’re now carefully considering responses to identify where we can be clearer, and where we can develop our thinking further. We’ll then look to finalise the Code to reflect these responses and the final regulations over the coming months. We’ll continue to engage with industry throughout.

We’ve been clear that we and the industry will have enough time to prepare for the changes which result from the Funding Code. To ensure this is the case, we now expect the regulations and the Code to come into force together in April 2024.

Of course, it’s also important for trustees to understand what evidence and explanation will be required in the Statement of Strategy. In the summer, we’re planning to consult on the information we want to collect and how we’re going to collect it to ensure it is as un-burdensome as possible, while giving us what we need to carry out our duties appropriately.

Martin Hunter: One of the key outstanding challenges relates to the treatment of open DB schemes in the draft DB Funding Code and the DWP’s draft regulations. While I’m pleased to see the draft Code state that the scheme actuary can include some allowance for new entrants and future accrual when projecting the maturity of open schemes, I believe this allowance would need to be limited in order for open schemes to comply with the proposed legal requirement for all schemes to set a “relevant date”. Limiting this allowance could lead to a material increase in costs for many open schemes, potentially threatening their viability, and damaging the retirement outcomes of many current and future pension savers.

Rachel Pinto: While the draft Code contains some welcome flexibility, there are several areas where it appears to be at odds with the draft regulations. For example, while the Code indicates that trustees retain the right to set their own investment strategy, the draft regulations suggest that trustees are required to adopt a low dependency asset allocation on and after the relevant date regardless of the circumstances. Similarly, a court might well take a narrower view of what constitutes a “highly resilient” investment strategy for the purposes of the regulations, compared with the strategies permitted under the Code.

Tiffany Tsang: We’re pleased that the new DB funding regime is developing and taking shape. However, one of the big challenges for the industry has been around the consultation on the Code taking place without having settled regulations in place. This has made it difficult for the industry to determine how some of the final requirements will end up and therefore adds extra challenges for trustees to try to prepare for these reforms.

The general feedback from our members was that more time is needed by the industry to consider all the implications of the new funding regime, and for trustees to work with employers to determine how best to comply with the new requirements, so the six-month deferment to the commencement date of the Code and the regulations is welcome.

What would be top of your wish-list for the final Code?

Fred Berry: There’s really only one thing on our wish-list, and that’s for our Code to genuinely help trustees plan for the long term and put themselves in the best position to pay the benefits promised.

We recognise the backdrop has changed since our first consultation and we’ve had plenty of opportunity to see if our approach works in the real world. But we continue to believe that the purpose and direction of the DWP regulations and our Code remains the right approach. Long-term planning and risk management remain key tenets of good scheme management across all market conditions.

As for the detail of the Code, once we’ve considered responses to our consultation and have seen the final regulations, we’ll know where we’ve got it right, and where we might need to develop our thinking further.

Martin Hunter: I would like to see the DWP’s regulations amended to explicitly state that the scheme actuary can include a reasonable allowance for new entrants and future accrual, when projecting a scheme’s maturity into the future. Schemes which are not expected to mature over time, as may reasonably be the case for some open schemes, should be made exempt from the requirement to set a relevant date and target low dependency by this date.

Rob Orr: I’d like the final Code to continue to adopt a flexible approach. For me, this is particularly relevant for those schemes that are not maturing, or have a very long time-horizon before reaching the point of significant maturity.

Rachel Pinto: The other key issue that needs to be resolved is how significant maturity is determined. Duration for many schemes has reduced significantly in recent times and the current methodology for measuring duration is too volatile, making it unsuitable as a reference point for strategic planning. Therefore, it is essential that the government and the Regulator adopt a more stable measure of maturity.

Tiffany Tsang: The flexibility in the draft Code and TPR’s pragmatic approach to interpreting many of the requirements in the regulations is definitely welcome. But one of the main concerns of our members is that the Code assumes most schemes are closed and moving to end-game in the not-too-distant future. As a result, the various requirements that relate to open schemes are spread throughout the whole Code. Based on feedback from PLSA members (60% of those we recently surveyed), we believe it would be very helpful for open DB schemes if all the requirements that are relevant to them were packaged together in one section/chapter within the final Code. The same applies to the requirements for multi-employer schemes.

What should DB schemes be doing now to prepare for the Code?

Fred Berry: We now expect the new requirements to come into effect in April 2024. As the changes will be forward-looking, only schemes with valuation dates after the commencement date will be affected.

This means the existing code and related guidance will remain in place until then. We recently published our latest Annual Funding Statement, which provides specific guidance on how to approach valuations under current conditions.

While the regulations and Code are finalised, there are still steps trustees can take to prepare. Trustees should consider, if they haven’t already, adopting a long-term funding target, agreeing it with their employer, and setting their journey plan to reflect this. More detail is in our AFS.

Rachel Pinto: While we can expect some changes in the final Code and regulations, the direction of travel is clear. Therefore, trustees and sponsors of DB schemes should assess the potential impact of the new regime on their scheme and its funding arrangements. They should also assess how close their scheme is likely to be to reaching significant maturity, as this will determine, to a large extent, how immediate the impact of the new regime will be.

Rob Orr: Although the final Code will apply to valuation dates after implementation, it would be sensible for trustees and employers with current (or imminent) valuation dates to be thinking about the themes coming out of the draft Code and how these might be applied to their schemes in practice now.

Tiffany Tsang: There are a number of things that trustees could be doing now, ahead of the April 2024 commencement of the new DB funding regime. We believe they should take advantage of the six-month deferment to work with their employers and advisers to determine how best to comply with all the new requirements.

It’s important to point out that not all DB schemes are the same or are at the same stage in their journey to maturity (in terms of duration, how they measure risk etc). For some trustees, the new funding regime and covenant requirements will have a significant impact on how they approach assessing covenant and will have a knock-on effect on how they manage risk in their scheme, while for others it may simply reinforce the procedures which they already have in place. But regardless of what stage schemes are at, early preparation by trustees will be important to a successful transition to the new funding regime – particularly for those schemes with valuation dates shortly after 1 April 2024

What do you think will be the biggest operational challenge for schemes?

Fred Berry: We’re not looking to reshape the DB landscape, but to embed the existing good practice we see in the market.

However, we recognise there will be change for all schemes, and we’re considering the impact of this and how we support trustees as they transition into the new regime. This includes reviewing our associated funding guidance and how we might engage with schemes approaching their valuation.

One area of change will be how trustees approach providing more and different information in their Statement of Strategy (SoS). We have a team dedicated to getting the balance right between the SoS being a useful tool for schemes and getting the information we need to regulate effectively while not unnecessarily increasing trustee burden and cost. We have already started engaging with industry ahead of our consultation – if you’re interested in getting involved, please follow the link at the bottom of the article.

Martin Hunter: One of the biggest operational challenges for schemes is likely to be time. The new requirements of the DWP’s draft regulations and the expectations of TPR’s draft DB Funding Code are likely to involve a significant amount of time, resource, and therefore cost, for schemes. Part of this challenge will be due to any additional steps to develop the funding and investment strategy (although much of this is likely to be considered already by many schemes), part will be due to the additional time taken to properly record and report the funding and investment strategy, and part will be due to the additional elements that will need to be agreed or consulted on with employers.

Rob Orr: Although the operational challenges will only really be known once the regulations and Code are in force, the Code is likely to lead to an extra compliance burden for trustees and employers. One way to help would be for TPR to produce a template or checklist showing the types of information to include in the necessary Statement of Strategy in future, given the amount of information required to be provided.

Tiffany Tsang: A number of PLSA members (40% of those we recently surveyed) believe that the inconsistencies between some of the requirements in the Code and the regulations are particularly problematic, and pose one of the biggest operational challenges for schemes. As things stand, there’s concern that compliance with the draft Code may not necessarily result in compliance with the regulations (as they’re currently drafted).

It will be important for the industry to have consistency between the requirements in the Code and the regulations, to give trustees certainty about how to implement the reforms. And where such inconsistencies exist, in our view the regulations should be amended wherever possible to reflect the (more flexible) Code requirements.

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