An updated DB funding code was published over the summer, applying to valuations with an effective date on or after 22 September 2024. It updates the code to reflect legislative changes in 2021 and related regulations earlier this year.

However, there are no real surprises. For “normal” valuations, the code largely clarifies existing regulatory expectations, with an understanding that it should lead to a reduced regulatory burden for the vast majority of schemes that are well funded and/or partially/wholly bought in. There is significantly more detail around the long-term planning requirements, but many schemes will have already started such discussions to some extent.

This code has been a long time coming – a green paper around changes to scheme funding was first issued way back in February 2017 after a series of high-profile corporate failures in 2016, and since then there have been numerous consultations.

Ongoing valuations

A lot of what is in the code is intended to embed existing good practice into the existing framework for technical provisions valuations. The Regulator has been very clear for many years that it regards integrated risk management – covenant assessment informing decisions about the level of risk that can be taken in investment strategy and the degree of prudence in valuations – as key. The code explicitly draws out flexibilities that it says were already embedded in the current regime.

While there is some additional guidance on regulatory expectations about covenant assessment, there is little in the code which represents a radical change to the approach expected in relation to ongoing valuations.

This is largely evolution, not revolution.

However, an express distinction is being drawn between “fast track” and “bespoke” regulatory assessment of future valuations. Where a scheme meets specific funding criteria, it will fall under the fast-track approach, resulting in limited regulatory scrutiny and a lower evidential burden. The Regulator believes 62% of schemes already meet the criteria and another 19% could meet them with no extra cost. So, for the vast majority of schemes that are well funded and/or partially or wholly bought in, the code should lead to a reduced regulatory burden.

Long-term strategy

There is significant detail around the new long term strategy requirements, including how to calculate the “relevant date” (by which full long-term funding should be achieved).

The code explicitly recognises that there are a range of different ways to aim to secure benefits over the long-term including insurer buy-out, consolidator transfer or running on indefinitely, and that the long-term objective may change over time.

The code also helpfully emphasises that the long-term investment strategy is an objective rather than a principle which must be followed in actual investment decisions and does not apply to surplus funding.

However, the code is clear that the statement of strategy setting this out will need to include greater detail where the approach is complex, or a higher level of risk continues to be taken.

What next?

There is evidently more to come, but the position is now a lot clearer.

The code emphasises generally the importance of collaboration between trustees and sponsors, encouraging early engagement and provision of information the trustees reasonably decide they need in relation to covenant.

Trustees and sponsors should consider promptly with the actuary whether a scheme falls within, or can be brought within, the fast-track criteria at an early stage and agree the level of information the trustees need. It is clear that the Regulator expects to see that views on covenant are backed by evidence.

For schemes with an ongoing deficit that need further meaningful contributions under a recovery plan, the code suggests recovery plans for ongoing deficits should not normally exceed the period over which there is reasonable certainty over sponsor cash flows in the short to medium term; generally, it thinks this will be three to six years (consistent with the way sponsors commonly plan).

The code recognises that legislation says that it is appropriate to consider a recovery plan’s impact on the sponsor’s sustainable growth, but where trustees agree to available cash being used for investment rather than scheme funding, trustees will need to have “clear and persuasive evidence” about how this will produce benefits to both the scheme and sponsor(s),and ensure that they understand the risks and benefits to both sponsor(s) and scheme. Where there is uncertainty, there is a clear expectation that a suitable supporting contingent asset covering the expected deficit at the end of the reliability period is put in place. So, for some trustees and sponsors, agreeing the recovery plan in future may be more challenging.

Many schemes already have some form of long-term journey plan – sometimes explicit and detailed, some more as a broad direction of travel. While the long-term strategy can be flexed over time, in practice it is likely that changes will need justification.

Some sponsors will be concerned that locking in something other than run off could be unduly limiting, so agreeing the formal long-term strategy could be a more challenging discussion, and one which should be started sooner rather than later. As a first step, the actuary should be asked to think about what a scheme’s “relevant” date might be on different approaches.

Key takeaway

Given the code’s emphasis on collaboration and early engagement, trustees and sponsors should consider starting discussions about the long-term strategy now.