We have new DB funding regulations  but the revised regulations are still a brake on the productive finance agenda.

The Department for Work and Pensions has published revised defined benefit funding regulations today, and has responded to the consultation it launched in July 2022.

The intention is right, the Pensions Minister tells us in his foreword

we have made changes to make the Regulations explicitly more accommodating of appropriate risk taking where it is supportable, and to increase the scope for scheme specific flexibility. This will support trustees in reacting to changing circumstances and investing appropriately in the best interests of their members…

These Regulations demonstrate the clear scope for most schemes to take more investment risk, while keeping members’ benefits safe.

My reading of the regulations and the consultation suggests that while the Government has good intentions , these DB funding regulations are substantially wrong and continue to send  DB trustees  down the wrong road.

Graham McLean

Graham McLean, head of pension scheme funding at WTW, is not impressed either:

“The Government says it has revised the regulations to better support the productive finance agenda. While some of the tweaks may help this, the suggestion that schemes will have freedom over investment is more implicit than it needed to be, and it is hard to see anything in the final regulations which fulfils the promise to ‘make it explicit that there is headroom for more productive investment’¹.

To use the vernacular, the Regulations are a big girl’s blouse

“In particular, the regulations still indicate that, once a scheme is significantly mature, its funding basis must assume an investment allocation which makes the value of assets relative to liabilities not only resilient to market movements but ‘highly resilient’ to them².

This sounds even more of the same, pensions locked into non-productive assets with little scope to invest in long-term financing for the UK

“It is arguably now clearer that this need not apply to surplus assets, and the Government is underlining that actual investments could be different from those assumed. But trustees might still question whether the ‘highly resilient’ test allows them to assume for funding purposes that 20-30% of their portfolio is in growth assets, as the Regulator has said might be possible³.

In practice, this means very little extra scope for more long term investment and probably a contraction in the scheme’s ability to invest for the future rather than match current liabilities.

“When the Government consulted on the draft regulations, it asked for views on whether to permit significantly mature schemes to take more risk supported by the employer pledging contingent assets. Since no changes to the regulations are made in this regard, for funding purposes it will not be possible to take these into account. This will act as a further brake on schemes investing in pursuit of surpluses that can be used to benefit both members and the sponsoring employer.

It is hard to see this as anything but an opportunity missed

“Where schemes are less mature, risk appetite may be reduced by the requirement for trustees to focus on what they can be ‘reasonably certain’ of when assessing the employer covenant⁴.

The death of the covenant assessment has perhaps been premature

“Judging the overall effect of these changes will require careful thought and interpretation, but the opportunity to write something clearer and more explicit has been missed.”

I hope that Graham McLean is wrong , but fear that he and WTW are rigth

Eliminating deficits as quickly as the employer can reasonably afford

WTW continue in the same vein when examining the new rules around deficit recovery

Until 2014, the Regulator’s Code of Practice said trustees should aim for any shortfall between the value of a scheme’s assets and its technical provisions should be cleared as quickly as the employer could reasonably afford. This was deleted when Parliament told the Regulator to ‘minimise any adverse impact on the sustainable growth of an employer’.

It is now being brought back, with the wording strengthened. The requirement has also been hard-coded into regulations and is described by DWP as having ‘primacy’ over other factors, presumably to avoid any challenge to whether a Regulator enforcing this approach was following its objectives. (my bold)

This could have been a bigger deal if funding levels were not as healthy as they are but should still strengthen some trustees’ negotiating hands.  Though trustees will have to take account of the impact on the sustainable growth of the sponsor, it seems the deficit recovery plan continues to be a challenge to a corporate growth strategy.

Schemes that are already significantly mature

Graham Mclean concludes

“Where a scheme is already significantly mature when they undertake their first valuation under the new regulations, the Regulator might expect technical provisions to match the low dependency target immediately – sometimes requiring deficit recovery plans that would not be required under the current regime.

This means more money pouring into pension schemes quicker and less money available to sponsoring companies to become more productive and assistive to economic growth

How many schemes this affects depends on how the Regulator defines ‘significantly mature’ when it publishes its revised Code of Practice in the Spring.”

Some solace may be in TPR’s detail but these regulations are setting the wrong direction of travel

References

1. Paragraph 51 of the Government’s November 2023 response to its Options for Defined Benefit Schemes call for evidence
2. Regulation 5
3. From the Regulator’s December 2022 consultation
4. Regulation 7(4)