Consultation on New DB Funding Code: DB funding to get scheme specific(er)
On 3 March 2020, the Pensions Regulator released its consultation on the principles which are to underpin a new DB Funding Code (with a further consultation on the draft Code to follow in due course).
The consultation sets out the Regulator’s proposals to overhaul the scheme specific funding regime. The changes are proposed to address concerns that some sponsoring employers are exploiting the flexibility inherent in the current system to the detriment of schemes (for example by arguing that their covenant is sufficiently strong to justify a longer recovery plan but not strong enough to warrant or afford higher contributions) and trustees appear unwilling or unable to curb the behaviour. In short, the Regulator has concluded that funding plans are simply not scheme-specific enough.
To remedy this, the Regulator is advocating a twin track approach with ‘fast track’ or ‘bespoke’ options. The Regulator will consult on the detailed requirements which must be met in order to comply with the fast track option based on factors including scheme maturity and employer covenant strength. Where employers prefer (or require) more flexibility around funding plans, they may choose the bespoke option but this will attract greater scrutiny from the Regulator.
Schemes will also be required to have a long term funding objective of ‘low dependency’ ie to target a level of funding over a defined time period which results in only limited reliance being placed on the sponsor for additional funding. Many schemes have already adopted a secondary funding target of ‘self sufficiency’ (although it remains aspirational for many). The new regime would codify and formalise this best practice.
The critical change under the proposed system is that the burden of proof would be shifted ie it would be for employers and trustees to justify a departure from the ‘vanilla’ fast track option (based on scheme-specific factors) rather than for the Regulator to “prove” that a bespoke funding plan is not appropriate.
While the Regulator has said that it is not advocating fast track – as both methods are equally valid ways to ensure compliance – the ’comply or explain’ like model would suggest that it favours the fast track approach (as a way to ultimately ‘nudge’ schemes toward best practice).
Comment: If all goes to plan, many smaller (SME) employers may choose to ‘stay in lane’; preferring the lower cost and certainty which ’fast track’ promises over the additional scrutiny which bespoke will attract. For employers supporting larger schemes, who may place a premium on flexibility, fast track may not be a good fit – the sartorial equivalent of ‘off the peg’ when your preference is made-to-measure.
There is evidently a trade-off between greater security and affordability which the consultation does not really address. If the Regulator sets the bar too high, many schemes will conclude that fast track is unaffordable (becoming aspirational) and arrive at the bespoke option by default. If the bar is set too low, the goal of greater security will not be achieved.
The impact of COVID-19 meant that the conclusion of the consultation was delayed until 3 September 2020 meaning that the second consultation (on the detail) will also be delayed and any changes put back for now. However, in May 2020, David Fairs (executive director of regulatory policy, analysis and advice) confirmed that the Pensions Regulator has no intention of acceding to calls to rethink or abandon the principles outlined in the consultation in light of the prevailing economic climate. The Pension Protection Fund is also broadly supportive of the twin-track approach. Accordingly, the direction of travel is clear – sponsors are likely to find themselves with less ‘wriggle room’ when agreeing funding plans in future and will almost certainly need to factor in higher pension costs resulting from higher deficits and/or a faster pace of funding.