The landscape for funding UK Defined Benefit (DB) pension schemes changed significantly earlier this year, following a long-running review by the Government and the Pensions Regulator. The new regime introduces several new requirements that will impact both corporate sponsors and trustees of these schemes. Here, we look at the three key features of the new regime.
Further details on these changes and the Regulator’s code of practice are set out in our recent Trustee Agenda publication.
Agreeing a Long-Term Objective for the Scheme
A central element of the new regime is the requirement for trustees to formalise a plan to reach low dependency on the sponsor by the time the scheme is significantly mature. This long-term objective requires trustees to calculate liabilities on the assumption that, if the scheme is fully funded on that basis and the assets are invested in accordance with a “low dependency investment allocation”, no further employer contributions should be needed.
- Current Practices: Many schemes may already have long-term objectives. However, under the new regime, these objectives must now be explicitly set out.
- Strategic Focus: This new requirement places a stronger emphasis on the long-term strategic planning of both corporate sponsors and trustees and is expected to become a pivotal discussion point during valuation negotiations. This is likely to lead to increased consideration of whether insurance transactions are viable to secure a scheme’s liabilities.
Formal Assessments of the Employer’s Financial Ability
The new regime also formalises an assessment of the employer covenant supporting the scheme. For the first time, "employer covenant" is defined, with a prescribed framework for assessment.
- Covenant Strength: The framework requires trustees to gauge the employer’s financial strength and its capacity to support the scheme and the duration for which they can rely on this. In particular there will be an increased focus on the weight placed on contingent assets. This strength will influence the level of risk that can be taken in actuarial assumptions.
- Deficit Recovery: When a defined benefit scheme faces a funding deficit, the new rules stipulate that any recovery plan must aim to eliminate the deficit “as soon as the employer can reasonably afford.” In formulating such plans, trustees need to consider factors like the sustainable growth of the employer, the employer’s available cash, the reliability of employer cash flows, and reasonable alternative uses of funds by the employer. These more prescriptive requirements may lead to heightened negotiations around recovery plans.
The Regulator has recently published further detailed guidance on the approach it expects trustees to take when considering the strength of employers.
Enhanced Scheme Governance Requirements
The new regime imposes more robust governance requirements, impacting both sponsors and trustees.
- Sponsor Engagement: Employers will need to engage with trustees more comprehensively on funding matters.
- Trustee Compliance: Trustees will face increased compliance and regulatory obligations, with potential implications for governance costs.
- Additional Legal Documentation: Trustees will be required to prepare and review a statement of strategy for their scheme setting out certain prescribed matters.
- Cost Implications: Enhanced governance requirements are expected to raise the costs associated with managing these schemes. Additionally, higher contributions may be necessary to meet the new standards.
The new funding regime for UK DB pension schemes represents a shift in regulatory expectations and responsibilities for both corporate sponsors and trustees. By focusing on formalising long-term objectives, assessing employer financial support, and enhancing governance frameworks, the new regime seeks to further ensure sustainable funding and robust management of DB schemes.