The new DB Funding Code… does it deliver?

On 2 September the first consultation on a new DB code of practice on scheme funding drew to a close.  This is the biggest shake-up in DB funding for more than a decade and it will have implications for many, perhaps most, DB pension schemes in the UK.

Here, we explore the consultation and look at some of the key points still up for debate. 

Top 3 things trustees said they would find most useful:

Earlier this year, we asked 100 trustees of DB pension schemes (1) to pick up to 3 features they would find most useful in the new code. This is what came out on top:

• A single long-term objective for all schemes (50%). Setting a long-term objective is at the heart of the revised code. Under Fast Track a single long-term objective for all schemes will be required, regardless of scheme size and covenant. Although subject to further consultation, the code suggests this could be set somewhere between gilts + 0.5% p.a. to gilts + 0.25% p.a.

• Setting a specified timeframe for reaching that long-term objective (47%). Under the proposals scheme maturity will be key. Over this period technical provisions will need to converge to the staging posts along the journey.

• Maximum recovery plan lengths (44%). We expect maximum recovery periods, linked to covenant, affordability and possibly scheme maturity. Subject to further consultation, the code suggests recovery plans could be limited to between 6 and 12 years, allowing longer recovery plans for weaker covenant groups where affordability is more likely to be constrained.  It’s likely we’ll also see the end of back-end loading and investment return assumptions above the prescribed discount rate, along with maximum levels of accepted investment risk in schemes’ strategies.

So, for many, there’s quite a lot to like and the proposals which define Fast Track funding will bring more clarity to what ‘good’ (or at least compliant) looks like.  That’s just as well, as it seems unlikely the framework will change fundamentally through this consultation.

However, with the devil in the all-important detail to come, let's look at the key points still up for debate…

What should trustees and sponsors be watching for more on?

How TPR will set the Fast Track parameters (and process for their review)

What is still very much up for grabs is how TPR sets the parameters within the framework and the governance to keep them under review as the economy evolves. Understandably, the Covid-19 pandemic may bear heavily on this. Given developments since the consultation was published it is likely that the parameters noted above will need to be set towards the more flexible end of the spectrum so Fast Track remains an achievable target for most schemes. With this first consultation focussed on the principles underlying the new code, it’s not until the second consultation that we’ll get more on the specific details and parameters.

What Bespoke targets are acceptable and TPR’s scrutiny/enforcement processes

Fast Track doesn’t need to be perfect, it needs to be proportionate – so long as flexibility is there through the Bespoke route for those that need or want it. Our surveys suggest around half of schemes think they might use Fast Track, whilst half think they are more likely to end up Bespoke.

However, there are some concerns around the potential overreach of the Fast Track regulatory approach, and TPR’s enforcement evolving in such a way that this undermines the scheme-specific nature of the Bespoke route, with schemes having to demonstrate that the outcome is the same or better than Fast Track or how any additional risk is being managed and supported. Schemes will be watching closely for further detail on what TPR considers acceptable Bespoke valuations and the supporting evidence needed.

How TPR will address other concerns

There are several other areas in the consultation where some trustees and sponsors may have particular concerns including the treatment of open schemes. Other aspects such as how TPR will manage the risk of schemes “levelling down” funding plans and the potential for gaming the system if covenant has more impact on recovery plan length than technical provision strength, are also up for discussion.

What happens next?

TPR is running its consultation on the new DB funding code in two parts. After this first consultation on the principles, a second consultation on the specific details and parameters will follow next year. In the meantime, watch out for further industry discussion of these issues as TPR develops its thinking further.

For more details on the above, read our response to the consultation in full. Want to see how your scheme compares against each of the proposed Fast Track tests? Give our Fast Track tool a try now!

1.Our annual Trustee Barometer surveys 100 trustees of private defined benefit pension schemes with AUM >£50m. The survey is carried out by a third party and all responses are confidential.