A new funding
regime – what does this mean for trustees of DB schemes?

Our viewpoint

On 3 March 2020, the Pensions Regulator published its long-awaited consultation on the principles it proposes to adopt in regulating DB pension scheme funding and investment strategies (see our News Alert for our initial summary and analysis).

This is an important step towards the new regulatory regime which will by the end of 2021 include a new Code of Practice setting parameters around how schemes should be funded and invested and in the Regulator’s words, “provide further clarity on what good looks like”. 

Once in place, many trustees will see this as good news - some will be able to use it to negotiate a stronger position, perhaps more contributions or reduced investment risk or additional covenant protections. Those who satisfy the Regulator’s new “Fast Track” funding regime will be able to submit their valuations, comfortable that they are unlikely to have much Regulator scrutiny. A number will be able to meet Fast Track already - for example our LCP Sonar data shows nearly three-quarters of schemes already have a long-term discount rate of gilts + 0.5% pa or less (so tend towards the Regulator’s possible low-reliance level) although of course there are other principles to comply with too. Whatever your position, the principles behind the regulatory changes appear to make good sense - all schemes are encouraged to have a clear end-game in mind and a journey plan to get them there, managing funding and investment risks along the way, and all set in the context of the strength of the sponsor’s covenant. This is very much the theme of our Chart your own course report. 

But of course, the devil will be in the detail and others may find that the new regime constrains them - for example those already satisfying Fast Track may find it harder to negotiate a better position or even find themselves under pressure to weaken their hand, where there are margins. And there may be more work to be done to manage your scheme - it certainly raises the bar for some sponsors, not least putting the pension scheme firmly in the picture in a number of corporate decisions. 

Whilst Bespoke “permits trustees to design funding arrangements that are unique to and appropriate for their scheme... we do not consider that it should be an ‘opt-out’ from the new regime”  trustees and sponsors of schemes aiming for Bespoke will find the burden is firmly on them to justify to the Regulator their departure from Fast Track on each of the specific Fast Track requirements. There are some helpful examples in the consultation of what that justification could look like - including providing additional support such as a contingent asset or parent guarantee or providing something better than Fast Track overall. The Regulator also notes that there may be some struggling sponsors who cannot support Fast Track - and again looks for this evidence. 

To think through what the new regime means for you, we recommend trustees:

Think through where your scheme’s funding and investment strategies are likely to sit relative to the Regulator’s new “Fast Track” funding regime.

  1. LCP have developed our Fast Track Forecast based on the information in the consultation. You can find out more about this here. We can use this to advise you on the potential implications for your scheme. Many trustees will wish to share this with their sponsors, including the potential implications for sponsor dividends.
  2. Where you do not regularly take independent covenant advice, revisit this decision. Covenant is a central component in determining the Fast Track parameters and key to funding and investment decisions. The new regime is expected to strengthen the requirements around trustees seeking independent covenant advice, and you can read more about this here.
  3. To meet the new Fast Track regime you may need to reduce the investment risk in your scheme, seek advice on how this might be done and consult with the sponsor. You can read more about this here.
  4. Consider whether “Fast Track” or “Bespoke” under the new regime is most appropriate for you and begin to discuss this with your sponsor. There will be a number of factors you’ll wish to consider including:
    1. how your current position stacks up against Fast Track and what reasons you would have to justify using a Bespoke approach instead;
    2. the affordability of sponsor contributions to get to a substantially de-risked position over the coming years; and
    3. the sponsor’s views on the possibility of future trapped surplus, and any alternative funding arrangements they wish to explore to mitigate the risk of this, for example escrow arrangements.
  5. Consider your preferences for the long-term funding and investment strategy for your scheme (your scheme’s destination “low reliance” funding target under the new regime and the journey plan to get there) and discuss this with your sponsor.

And if you haven’t had contact with the Regulator before, changes in their regulatory approach mean that this is becoming more likely in 2020, with perhaps one in six schemes now expected to have some regulatory contact as they work through their triennial actuarial valuation. 

So, wherever you are in your valuation cycle, we recommend you engage soon with the direction of travel of the new regime and start to think about the implications. In many cases, the new regime will lead to better managed pension risks, with improved likelihoods of pension benefits being paid in full, but for some this may come at a cost of reduced sponsor dividends and other business constraints.

We expect for all schemes the best outcomes will be achieved by trustees working closely with the sponsor to agree funding and investment strategies that are acceptable to both parties. 

Pension Schemes Act

Pension Schemes Act

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