UK: All Change Please! TPR's New Approach To Scheme Funding

Last Updated: 24 February 2014
Article by Justin McGilloway

The Pensions Regulator ("TPR") recently undertook a consultation exercise on a revised code of practice and regulatory approach to funding defined benefit (DB) schemes.

The consultation period which closed on 7 February 2014, was driven by the evolution of DB scheme funding over the last eight years and TPR's proposed new statutory objective to "minimise any adverse impact on the sustainable growth of an employer."

The new Code of Practice – how trustees should approach funding

TPR's current code of practice on DB scheme funding was published in 2006 and has been supplemented by annual statements and other materials since inception. The new, revised code (which is currently in draft form) will bring TPR's published documents up to date, reflecting current practice and encouraging trustees and sponsors to work collaboratively to establish viable, long term funding plans. The document also encourages trustees to take an integrated approach to managing key scheme risks: namely funding, investment and the employer's ability to meet its obligations to the pension scheme.  "Balance" is the buzzword with a clear recognition that a strong sponsor is the ideal.  Helpfully, TPR is interpreting "sustainable growth" to include sponsors that may be investing to stand still, and not for profit/charitable  organisations.  We anticipate that the new code will be in force by July 2014 but it urges trustees and employers to consider the contents now.

The key principles (nine of them!)

The code of practice is focussed on principles and outcomes which are to be applied to schemes depending on the needs and circumstances of the scheme. TPR identifies key funding principles:

  • trustees and employers should work collaboratively in an open and transparent manner;
  • an integrated approach to risk management and setting triggers for action;
  • confidence that the employer covenant is strong enough to mitigate the adverse consequence of funding or investment risk;
  • trustee decisions should be consistent with the long term views of the employer strength;
  • trustees should act proportionately in carrying out their functions given their scheme's size, complexity and circumstances;
  • trustees should not compromise the needs of the scheme, unreasonably impact on the employer's sustainable growth or take excessive or unnecessary risks;
  • trustees should adopt good governance standards;
  • trustees should seek to ensure that the scheme is treated fairly, in a manner consistent with its equivalent creditor status; and
  • having agreed an appropriate funding target, trustees should aim for any funding target to be eliminated as quickly as the employer can reasonably afford.

The draft code also sets out how trustees should prepare for the valuation process, engage with employers, deal with conflicts and work with advisers. There are also sections on employer covenant, investment strategy and monitoring contributions.

The funding policy - how TPR will regulate

Much of TPR's new material is in its draft funding policy. This document sets out details on how TPR intends to develop its approach to overseeing the funding of schemes and protecting the Pension Protection Fund.

Show me the money!

There seems to be shift in focus of what really matters – cash is now king. Previous triggers for regulatory intervention, based on technical provisions and lengths of recovery plans are to be abandoned in favour of a Balanced Funding Outcome ("BFO"). The BFO is focussed on the agreed level of cash being paid by the sponsor taking into account the amount of the deficit and the strength of employer covenant. How the BFO develops as an appropriate measure is difficult to predict, especially when one considers the many sophisticated funding arrangements being utilised by schemes (e.g. contingent payments, asset backed funding arrangements and security etc...)

Segmenting the DB universe - covenant assessment

As noted above, a key driver of the BFO will be strength of covenant. TPR is therefore proposing to segment employers into four bands: strong; tending to strong; tending to weak and weak. Each band will have its own BFO and it will be interesting to see how covenant advisers in the market develop their offering in light of this new system.

Risk bars

TPR will operate "risk bars" (risk tolerance thresholds) when deciding in which schemes' funding arrangements it should intervene, taking into account such matters as the size of the scheme, TPR's resources and what it might be able to achieve for a particular scheme. TPR specifically acknowledges that it does not intend to intervene with the majority of smaller schemes but that it does expect the same level of behaviour from small schemes as it does of large schemes. Trustees of smaller schemes may therefore find themselves under greater pressure in their discussions with sponsors as both parties will have limited expectations of any regulatory involvement. In any event, when schemes submit actuarial valuations and recovery plans, they will receive a letter within three months of the later of the submission date and the statutory deadline, indicating whether or not TPR has any has any issues with their content.

Wedlake Bell's view...

On the whole, the 160 pages published by TPR contains a lot of positivity on a more integrated approach to DB scheme funding. Arguably many schemes have already been following some of these principles and the revised code simply reaffirms current practice. To other schemes, the acknowledgment of greater balance, flexibility and transparency is good news, as is the fact that TPR's statutory concerns are to extend to the need for sustainable growth amongst DB employers. However, the true meaning of "sustainable growth" will inevitably differ from industry to industry - there can never be a blanket approach to this concept as some industries will be stronger and face a brighter future than others.  The upshot is that professional covenant assessment will play an even more vital role, in fact we believe that it will become the norm over time, both as partt of the valuation process and regular monitoring between valuations.

The proof of the pudding is in the eating and time will tell how trustees, sponsors and their advisers interpret the new code and policy documents. TPR itself will undoubtedly be faced with more difficult issues as new themes and concepts emerge. To this end we understand that TPR does in fact intend to continue publishing its annual statements for DB schemes. These will reflect its experience and evolving approach over time. All in all it shows TPR's willingness to roll with the punches and stay light in on its feet. It also demonstrates that the world of DB pension regulation rarely (if ever) remains stagnant.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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