On 2 September, our first consultation on defined benefit (DB) funding is closing. We want your input to help shape the foundations of how we regulate DB schemes for many years to come.
The way we regulate the funding of DB pensions is changing against an evolving landscape. It’s crucial that trustees take a long-term view to ensure savers receive the pension they have been promised as DB schemes mature.
Before the consultation closes, I wanted to take this opportunity to talk through some of the key proposals and how they should provide both open and closed schemes with the clarity and flexibility needed to protect member benefits. To do this, I am going to answer some commonly asked questions.
What is the twin-track approach to valuations?
The current funding framework is working largely as intended. Yet there is room for improvement, specifically around providing greater clarity on what we expect from trustees and employers.
Therefore, the first thing we’re looking to propose is a twin track approach to compliance – Bespoke and Fast Track. Under Fast Track we would be setting out clear guidelines around what we think is an appropriate scheme funding approach. This will be particularly helpful for small schemes with less access to advice.
The current regime means that all schemes effectively take a Bespoke approach and are assessed on a case by case basis. But, without explaining what ‘good looks like’, we are not making efficient use of our regulatory resources. This also means trustees, employers and advisers are left to operate in silos.
We have not yet set the parameters or metrics for Fast Track, however we hope a broad range of schemes will be able to use this route. Although it is a more prescriptive route to compliance, it will lessen the amount of explanation and documentation that trustees will need to give us.
How is TPR proposing to regulate the Bespoke option?
Bespoke is a scheme-specific approach and, as I’ve said, is similar to the current regime schemes are in now. However, our proposals intend to bring clarity for schemes and objectivity to assessing that valuations and recovery plans are compliant with legislation.
Bespoke will offer trustees flexibility if they cannot, or choose not, to meet Fast Track guidelines – although of course trustees will still be expected to follow our core set of principles. Trustees will also need to explain how or why their Bespoke arrangement deviates from Fast Track and how any additional risk has been managed.
But this does not mean that Bespoke is just Fast Track in a different guise. We are simply trying to ensure that trustees understand the risks in their approach, they have measured them and if appropriate put in mitigation.
Trustees of schemes in Bespoke may have a closer relationship with us if we want to ensure their valuation meets our compliance expectations. However, we envisage that many Bespoke arrangements will be relatively straightforward and may not require further engagement from us.
What does the DB code mean for open schemes?
We know it’s essential that we develop an approach that works well for open schemes.
Our proposals seek to secure a reasonable balance between protection of member benefits, fairness between schemes, and flexibility for schemes to fund and invest as they wish – especially where they have a strong covenant and a long-time horizon.
We know the best support for a DB pension scheme is a strong employer. So we’re keen to ensure the new funding framework doesn’t lead to unnecessary scheme closures by unduly increasing the cost of running the scheme. However, for funding purposes, it is important to distinguish between past (accrued) and future benefits.
I firmly believe that members’ accrued benefits should be protected to the same level in both open and closed schemes.
To do this, we propose that the funding strategy for accrued benefits for an open scheme should be set consistently with that of a closed scheme. It should use the same Fast Track technical provisions and recovery plan guidelines and taking scheme maturity and covenant strength into account.
And as always, employer covenant is important, as it is with closed schemes. The stronger a scheme’s sponsor, the more risk is supportable.
We expect many open schemes will be able to follow the Fast Track route. However, under the flexibility offered by Bespoke, trustees would be able to use a different approach if more appropriate for their open scheme. Under the Bespoke route, trustees have the opportunity to set out their approach taking into account the employer’s plans for keeping the scheme open and the future covenant strength and visibility.
We also want your input on options for calculating future service accrual under Fast Track. This could be based on different assumptions to technical provisions without compromising the security of accrued benefits.
What does this mean for an open scheme’s long-term objective (LTO)?
We propose that it should be the same as that of a closed scheme: low dependency funding by the time the scheme has become significantly mature.
However, open schemes tend to be less mature than closed schemes, so it will take them longer to become significantly mature and reach their long-term objective. Truly open schemes with a strong flow of new entrants might never mature. This means more flexibility over their funding and investment strategies in the meantime.
Imagine an open scheme – which I’ll call Scheme A. It doesn’t expect to mature at all because new entrants replace those who retire and leave, meaning the age profile of the scheme isn’t expected to change.
Scheme A finds itself in a ‘steady state’, as it’s not moving towards its LTO. For as long as it remains in this ’steady state’, the scheme keeps all the flexibility to fund and invest that immature schemes have.
If Scheme A were to close, then the process of maturing begins and the scheme would move towards its LTO.
However, this process would take many years and Scheme A would still have a lot of flexibility in setting funding and investment strategies. There would be no immediate need for a substantial change to these strategies (for instance substantially de-risking at a fast pace). But equally, if the scheme were to close, there would not be a cliff edge with a large deficit suddenly emerging.
We think this approach takes into consideration the different characteristics of both open and closed schemes balancing affordability and security.
Where to find our consultation
Hopefully now all your key questions have been answered and you have everything you need to respond to our first of two consultations on DB funding. We genuinely want your views on our proposals and the principles we think should stand behind all valuations.
We welcome challenge and criticism of the approach and views that we have set out, as this will help us develop a code that is robust, relevant and flexible enough for the real world. If you disagree with us, please write and explain why, we will listen and take all views into account when developing our second consultation.
Please remember to submit your response by 2 September. You can find everything you need on the website, including the recording of the DB funding consultation webinar that took place on 13 August.
By David Fairs, Executive Director of Regulatory Policy, Analysis and Advice