16 November 2020
With Royal Assent of the Pension Schemes Act 2020 imminent, we now pretty much know what the legal framework will be that will support a new funding and investment regime for UK DB schemes.
But will this regime be a much tougher hurdle for many schemes, as was implied by the Pensions Regulator’s first consultation, or will it be watered down for some or all pension schemes in the light of a post Covid, post Brexit economic environment, and strong pushback from various quarters of the pension industry?
Here are 10 key questions about the new funding regime that we will be looking for the answers to, once we have the Pension Schemes Act 2020 and as we go through 2021:
- Will the implementation of the new regime be delayed in order to let the economy recover to some extent – eg will it first apply to valuation dates in 2022 (as currently planned) or might this be deferred to 2023 or even 2024?
- What will the PSA20 Funding Regulations say, and what powers will they give TPR to rigidly impose Fast Track funding parameters on schemes? The nature of these powers will be critical to the operation of the new regime, and we await draft regulations, hopefully in the coming few months.
- Will “Bespoke” actually be bespoke? For example, if a Bespoke funding and investment strategy represents materially more risk than Fast Track, for example is based on a Gilts plus 1% pa discount rate (with no further mitigation), but if the sponsoring employer can clearly support that risk (for example because they are a large, strong business), will that be acceptable to the Regulator? (Currently, this is not expected to be acceptable, but my view is that this doesn’t make sense.)
- How will trustees be expected to navigate their way through setting an investment strategy for a scheme, when the PSA20 requires them to now agree their long term investment strategy with the sponsor, but the law still requires them to be responsible for their immediate strategy and only consult with the sponsor? Will this lead to new conflicts between trustees and sponsors?
- Based on comments by the Pensions Minister Guy Opperman, we are anticipating that the law won’t differentiate between schemes that continue to admit new members and those that do not, but there may be a special set of rules within Regulatory guidance for such “open to new members” schemes. What form will these rules take, and will some open schemes be forced to close to new members or even to future accrual?
- How will the new regime be framed for the not-for-profit sector, and how will the appropriate balance between pension contributions and spending on the organisation’s key purposes be struck? This is an especially difficult balance given that higher spending on the key purpose can often be closely linked with more financing or charitable giving, and hence better covenant.
- Will there be a requirement to capitalise future expenses and PPF levies and include this liability within deficits, which could be very material addition to liabilities for 100s of smaller schemes? Might this mean many smaller schemes accelerate their path to buyout and we begin to see faster consolidation to insurers and superfunds?
- Will the Regulator’s Fast Track basis permit an allowance for the strength of the sponsor covenant to be made beyond 3 years (or at all, if the scheme is already mature)? If not, contributions to schemes are likely to prove higher than necessary in many cases, and this will create challenges for efficient use of corporate funds.
- How will TPR avoid a “rush to the bottom” with employers saying they will not agree a long term funding strategy more prudent than eg a discount rate of “gilts plus 0.5% pa”, even where their scheme is already funding on a more prudent basis?
- Finally and perhaps most importantly, what will be the cost of the new regime to UK plc (measured in additional contributions and the potential for inefficient de-risking), scheme members (the possibility of scheme closures, lower benefits), employees not in the DB scheme (reduced funds for DC contributions) and the PPF (if inappropriate risk management decisions lead to further business failures)? The Government Actuary’s Department are expected to assist the Regulator with more analysis of this in 2021, but the scope of their work is not yet clear.
The first Regulator consultation on the new funding regime in Summer 2020 gave us some very helpful pointers on the direction of travel, including pointing to some unnerving unintended consequences as we set out in our on-point paper. However, we will need answers to the above questions, and more, before we can be sure of the implications for many schemes. And in the meantime, given the ongoing uncertainty, it could be challenging for some trustees and sponsors to work out the best course of action in relation to their scheme. Hopefully some of these questions will begin to be answered early in 2021.