Does a scheme need to comply with the new DB funding code?
When the scheme funding regime came into effect in April 2005, it shook up the whole world of actuarial valuations. For many pension schemes, this was the first time that employers and trustees had really discussed the actuarial process for the specific features of the scheme rather than just meeting the then statutory regime. This included arguing about assumptions and methodologies, and debating how any deficit would be paid which was then set out in the Statement of Funding Principles (“SFP”) which was meant to have a medium to long term horizon.
That change was part of a wholesale rewriting of the legislation around the funding of pension schemes in Part 3 of the Pensions Act 2004. This gave new legal obligations and powers to all the normal parties involved in a valuation but also to The Pensions Regulator (“TPR”) – a brand new regulatory body at the time.
You could argue that the changes in the proposed new DB Funding Code of Practice (“Code”) are just as radical. However, this time the law isn’t being entirely repealed and rewritten. In fact, the only change to funding in the Pension Schemes Act 2021 is to require schemes to put in place the new Statement of Funding and Investment Strategy which references the new long term funding objective. In a strict legal sense, there is no obligation to comply with the Code outside these limited changes.
Why does this matter?
Of course, everyone will pay attention to the new Code once it comes in, which is most likely to be in 2022. Trustees will take advice from their actuaries and start their new valuation. They will consider their SFP in the normal way, but as is required by the new Code, they will also have to decide whether to opt for “fast track” or a “bespoke”.
Who cares if the law doesn’t mention most of this? Trustees are unlikely to say, “hang on a minute, what does Part 3 of the Pensions Act 2004 say?”. However, lawyers always think about the worst-case scenario: what happens in the future if everything goes wrong? And this is where the distinction between the law and the Code comes in.
What if the unthinkable happens?
Imagine a pension scheme is funded using the fast track basis in the Code. Some years later, the unthinkable happens – the employer goes bust, the pension scheme is not fully funded and is expected to go into the PPF. Some members are angry about this, arguing that the trustees could have asked the employer for even higher contributions in the past and then they would have got their benefits in full, without any of the PPF restrictions. The members get together, hire a lawyer, and sue the trustees for breach of trust.
Now, trustees can’t be sued just because things have gone wrong. Trustees aren’t required to make assumptions that always turn out to be correct, or to never get things wrong. They are, however, required to administer the scheme as well as they can, focusing on providing the benefits under the scheme, and to follow their duties under the legislation.
In our example, the trustees want to show that they have followed these legal requirements so they can defend themselves properly against the angry members. However, if all the trustees have done is look at the Code and opt for the fast track, that won’t be much use as a defence. They need to show that they thought about their legal duties under Part 3 of the Pensions Act 2004 and considered how best to ensure benefits got paid and that fast track was consistent with those legal duties.
Trustees should look at the Code and pay attention to it so that they can work alongside TPR, but because this isn’t a legal requirement, they need to think about the law as well.
So, whatever the final form of the new Code of Practice says, trustees should continue to ask the questions they have asked before:
Have I complied with Part 3 of the Pensions Act 2004?
Have I done my best to protect members’ benefits?
To sum up…
We expect that there will be some push back on the Code, perhaps from employers who want to encourage funding that is outside the Code but consistent with the law. If they can show their valuation does work within the law, technically TPR can’t stop them. It may be that over the coming years some schemes will choose to take a position outside the Code and find themselves defending their approach in front of TPR’s Determinations Panel or the Upper Tribunal.
However, in the meantime, all trustees need to remember that the Code isn’t their only, or biggest, concern when it comes to funding.
Read Rosalind and Kate’s article in Hymans Robertson’s blog here.
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. Arc Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.