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Final DB funding regulations published

Final DB funding regulations published

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Volume 2024 | Issue 02

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The DWP has published the government response to the consultation on its draft regulations requiring DB schemes to set a long-term funding strategy.

The final regulations, which have been laid before Parliament, are expected to come into force on 6 April 2024 and will apply to actuarial valuations with effective dates from 22 September 2024.

The Pensions Regulator’s revised DB funding code of practice is now awaited (and also expected to come into force from 22 September).

Background

One of the few areas covered by the Pension Schemes Act 2021 still to be fully brought into effect is the requirement for trustees of defined benefit (DB) schemes to maintain a funding and investment strategy, designed to ensure that benefits can be provided by the scheme over the long term.  A statement on the strategy (the statement of strategy) will need to be signed off by the chair of trustees and sent to The Pensions Regulator.

The DWP consulted on draft regulations about these requirements during 2022, and it has now published the response to the consultation which confirms a number of changes to the draft regulations, mainly in terms of clarifications, rather than any wholesale changes to what was originally proposed.

The DWP’s consultation

As a reminder, the DWP’s consultation proposed the following measures:

  • the funding and investment strategy must, as a minimum, follow the principle that by the time the scheme is significantly mature there is low dependency on the sponsoring employer with high resilience to funding and investment risks;
  • the maximum levels of funding and investment risks that the scheme can take before significant maturity is dependent on the financial ability of the employer and contingent assets to support the scheme. Subject to that, they are also dependent on the maturity of the scheme;
  • the funding and investment strategy must be determined or reviewed and, if necessary, revised alongside each valuation (usually every three years) and after any material change in the circumstances of the pension scheme or of the employer;
  • a requirement to prepare a statement of strategy. The statement must include a section setting out further information on the scheme’s long-term plans including the current strategic asset allocation, how trustees intend the strategic asset allocation to change as their scheme moves along its journey plan, and the level of risk attached to these investments; and
  • amendments to the current DB funding regulations, which add a new requirement for trustees, in determining whether a recovery plan is appropriate. Trustees must follow the new affordability principle that funding deficits must be recovered as soon as the employer can reasonably afford.

The funding and investment strategy

The regulations confirm that the funding and investment strategy must specify:

  • How the trustees intend pensions and other benefits will be provided under the scheme over the long term.
  • The scheme’s funding level as at the effective date of the actuarial valuation to which the strategy relates, as set out in that valuation.
  • For schemes that have not reached the date on which the scheme is expected to reach significant maturity (referred to as the ‘relevant date’):
    • the expected maturity of the scheme at the relevant date,
    • the assumptions used in specifying the funding level that the trustees intend the scheme to have achieved at the relevant date, and
    • how those assumptions are different to the assumptions used in calculating the scheme’s technical provisions in the relevant valuation.
  • In the case of a scheme that has reached the relevant date, the assumptions used in the actuary’s estimate of the scheme’s funding level as at the effective date of the relevant valuation.
  • The discount rate(s) and other assumptions used in calculating the scheme’s technical provisions.
  • How the trustees expect the discount rate(s) to change over time.
  • (In respect of the requirement to specify the investments the trustees intend the scheme to hold on the relevant date) the proportion of scheme assets the trustees intend to allocate to different categories of investments.

The statement of strategy

The statement of strategy is intended to improve trustee engagement in their long-term plans and how they are managing risks. It is also meant to ensure better understanding and accountability between trustees and The Pensions Regulator, to enable more effective regulation by the Regulator.

The statement is comprised of two parts: the funding and investment strategy (as described earlier) in Part 1 and supplementary matters in Part 2.

Supplementary matters in the statement of strategy

Actuarial valuation and recovery plan

  • A summary of the information contained in the relevant valuation that the funding and investment strategy relates to.
  • A summary of the information in the recovery plan (if one has been prepared or revised in relation to the relevant valuation).

Maturity

  • The actuary’s estimate of the maturity of the scheme as at the effective date of the relevant valuation, as set out in that valuation.
  • Where, in determining the future maturity of the scheme, the trustees have taken into consideration whether new members may be admitted to the scheme and the future accrual of benefits:
    • a calculation of the duration of liabilities and future accrual based on the assumptions used; and
    • the number of years of future accrual that have been allowed for when estimating the date of significant maturity.
  • For a scheme which has not reached the relevant date, how the maturity of the scheme is expected to change over time.

Investment risk

  • The level of risk in relation to the intended investment of the assets of the scheme relating to the actuarial valuation to which the funding and investment strategy relates.
  • For a scheme which has not reached the relevant date:
    • the level of risk the trustees intend to take when investing scheme assets as it moves along its journey plan, and
    • how the trustees intend to comply with the objective that, from the relevant date, the assets to which the minimum funding level relates, are invested in accordance with a low dependency investment allocation.
  • For a scheme which has reached the relevant date, how the level of risk, in the intended investment of scheme assets relating to the actuarial valuation to which the funding and investment strategy relates, complies with the objective that, from the relevant date, the assets to which the minimum funding level relates, are invested in accordance with a low dependency investment allocation.

Liquidity

How the investment of scheme assets complies with the principle that they must be invested in investments with sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements.

Employer covenant

  • An assessment of the strength of the employer covenant.
  • How long it is reasonable to rely on this assessment.

General

  • The extent to which the funding and investment strategy is, or remains, appropriate.
  • Confirmation that the trustees have consulted the employer in relation to the scheme in the preparation or revision of this part of the statement.
  • Any comments that the employer has asked to be included in this part of the statement.

Determining, reviewing and revising the funding and investment strategy

The first funding and investment strategy

The first funding and investment strategy for a scheme must be determined within the period of 15 months of the effective date of the first actuarial valuation obtained by the trustees on or after 22 September 2024.

Review and revision

The strategy must be reviewed and, if applicable, revised, within 15 months of the effective date of each subsequent actuarial valuation, and as soon as reasonably practicable after any material change in the circumstances of the scheme, or of the employer.

Material changes in the circumstances of the scheme include, but are not limited to, a material change in the value of the scheme’s assets relative to the value of its liabilities, or a material change in the maturity of the scheme

A material change in the circumstances of the employer includes, but is not limited to, a material change in the strength of the employer covenant.

Requirement for a chair of trustees

A chair of the trustee board will be required to sign-off the statement of strategy, and where the board does not currently have a chair, they must appoint one. This is meant to encourage best practice and allow for accountability of the trustee board and the decisions they make in respect of their funding and investment strategy.

A chair of the trustees must be a trustee who is either an individual or a professional trustee body. (Where a company which is not a professional trustee body is a trustee, a director of that company, or a professional trustee body which is a director of that company will be the chair.)

Sending the statement of strategy to The Pensions Regulator

Unless the Regulator has used its powers to give directions in relation to the calculation of technical provisions, trustees must send the statement as soon as is reasonably practicable after the funding and investment strategy has been prepared or revised.

It must be submitted in a form confirmed by the Regulator. A consultation is expected on this shortly.

Comment

The finalisation of the regulations is welcomed, especially the fact the DWP is focused on clarifying, rather than materially changing, its expectations of trustees and employers. This is still only half the story, however, as we still await the final version of the Regulator’s revised DB funding code and the consultation on the form of the statement of strategy.