TPR’s new
funding code: could we be heading for the worst of both worlds?

Our viewpoint

TPR’s first consultation on principles of the new DB funding code of practice has now closed, and TPR will be considering the industry’s responses ahead of producing the draft code itself.

In July I co-authored an LCP on point paper that set out the background to this first consultation as well as our concerns arising from it, including the potential for unintended negative consequences for some scheme members, scheme sponsors and the PPF. 

The key concern we highlighted in that paper was the potential overreach of the Fast Track regulatory approach, and its use as a benchmark for Bespoke valuations. We argued that it is vital that sufficient flexibility remains in the funding regime to enable schemes to find the solution that is right for them.  

We also looked at other potential issues, including the appropriateness of the prudency in the Fast Track parameters and the risk that sponsors may view Fast Track as a maximum target. In other words, for those schemes where a more prudent target than Fast Track is appropriate and achievable, there is a risk that sponsors will be unwilling to fund beyond the level required to meet Fast Track benchmarks and thus those benchmarks might constrain what trustees are able to negotiate. 

It’s important to note that these are different issues and not mutually exclusive – one is about the level of the benchmark and one is about the flexibility that is allowed relative to that benchmark. In my view, in order to achieve the best overall regulatory outcomes, both need to be set at the right level, and the Regulator shouldn’t try to compensate for one with the other. For example, I think it would be unhelpful to compensate for inflexibility by weakening the Fast Track benchmark – this would just result in funding regime that is both too restrictive and too weak. However there is a risk this is exactly where we are heading.  

Looking first at the strength of the benchmark,  given the current economic climate it is highly possible that the initial Fast Track parameters will be weaker than originally envisaged in order to make the regime more “employer-friendly” – indeed TPR has hinted at this on more than one occasion (see for example comments from David Fairs in his May 2020 blog, and further comments in a July 2020 interview with Professional Pensions Live).   

And despite pressure from various industry bodies and stakeholders (including LCP), TPR has consistently said that it believes the principles underlying its first consultation remain appropriate, including that Fast Track should be the benchmark for Bespoke valuations. What is more there is even the possibility that this principle may end up becoming a legal requirement early next year depending on the drafting of the Regulations once the Pension Schemes Bill becomes law – we don’t yet know what the DWP have planned on this point. 

This means that the current expectation is that there will be less flexibility in the new regime, and it also seems likely that there will be a Fast Track benchmark that may be less prudent than the level that many schemes currently fund to. This risks a regulatory regime that is the worst of both worlds at least in the short term.  And in future years might the Regulator find it difficult politically to set an increasingly ‘more prudent” Fast Track basis? If so, we could end up with a steady weakening of funding approaches over time, which will increase the risks in our pension system and be difficult for the Regulator to recover from.   

So, what would be the alternative? Well this is of course the question that TPR will be grappling with, and it is not an easy one to answer.  

But in my view the best solution would be a Fast Track benchmark that is towards the more prudent end, reflecting an appropriate outcome for those schemes that wish to use this option, and one which doesn’t constrain trustees’ negotiating positions. But crucially alongside this Fast Track option there should be more flexibility for a Bespoke solution which moves away from the Fast Track benchmark based on scheme-specific circumstances, including the level at which you set your Long Term Objective and your journey to get there.  This seems to me to be a far better regulatory solution than an inflexible, less prudent Fast Track benchmark, and I hope TPR agrees once it has fully digested the industry’s responses to its first consultation. 

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