The Pensions Regulator (TPR) has published a consultation on defined benefit (DB) pension regulation.
Its Defined benefit consultation: setting a balance approach sets out how TPR intends to balance its new objective to minimise the impact on employers’ sustainable growth with its existing DB funding objectives.
The new objective is contained in the Pensions Bill 2013, currently before Parliament.
The content of the consultation also reflects how TPR’s approach to DB funding has evolved over the past eight years in light of its experience, and that of the pensions sector, in managing the risks in DB schemes.
The consultation includes:
- A draft funding code of practice that provides practical guidance to help pension trustees meet the requirements of scheme funding legislation.
- A draft regulatory strategy setting out at a high level TPR’s risk-based approach to tackling issues in DB pension schemes.
- A draft funding policy describing in more detail TPR’s intended approach to regulating DB funding issues.
TPR intends to hold a series of events and meetings with key industry stakeholders and experts during the consultation period in order to gather their feedback on both broad principles and narrow technical issues.
The consultation period closes on 7 February. It is anticipated that the new code will be in force by July 2014 and will apply to schemes undertaking valuations from that time.
Stephen Soper (pictured), interim chief executive at TPR, said: “We welcome the transparency that our new objective on employer growth brings to the DB funding regime and we look forward to working with trustees, employers and the wider pension community to ensure that it is implemented in a balanced way.
“Investing in sustainable business growth is central to being able to provide a long-term future for any organisation and its pension plan. The best support for a DB pension is a strong employer and effective trustees working together to manage and balance the risks to their business and scheme.
“Our revised code of practice emphasises the importance of pension trustees and employers working collaboratively to establish viable, long-term funding plans.
“We place a strong focus on education and enablement to help schemes to achieve appropriate outcomes. The needs of employers and schemes can be reconciled in the vast majority of cases through good working relationships without the need for our involvement.”
We are pleased to see that The Pensions Regulator recognises that collaboration between employers and trustees is crucial in establishing viable, long-term funding plans for DB schemes. We also note the regulator’s focus on a more integrated approach outlined in the draft code. These are both areas that the NAPF has made clear required more flexibility.
The NAPF will respond in full to the consultation and will also arrange meetings between the regulator and a number of our members, to ensure that the principles-based approach of the code can be clearly applied and understood by different types of schemes, such as multi-employer and charity schemes.
The package for consultation from The Pensions Regulator is a welcome opportunity for all stakeholders involved with defined benefit schemes to consider scheme funding issues. The ACA will certainly approach the consultation process in a very positive way and we welcome TPR’s transparent approach to developing the new code of practice, regulatory strategy and approach to funding policy.
The regulator has a challenging role to balance its existing objectives with the new objective ‘to minimise any adverse impact on the sustainable growth of an employer’ and realistically this is likely to be an area where day to day experiences will be needed to see just how this can be achieved.
The Pensions Regulator’s consultation documents present a large amount of information, to the extent that no single topic can take centre stage. The new objective to minimise the impact of scheme funding on employers’ sustainable growth is very prominent, though, and views on its integration into the code are invited as the first of 19 specific questions in the consultation.
There is one sting in the tail of the new objective: an expectation that planned investments used to negotiate down scheme contributions, but which are not actually invested later, should be made available to the scheme. Employers must therefore be careful in claims made about their plans for capital investment.
This consultation process is a positive step. The regulator’s ‘guiding principle’ of integrated risk management, which focuses on the three key risk areas of employer covenant, investment and funding, is a welcome idea.
It is also good that the regulator is being more transparent by providing information on how it ranks employer covenants, with four broad risk categories – Strong, Tending to Strong, Tending to Weak and Weak – as well as outlining the funding behaviours it expects trustees and others to follow. For example, dividend leakage should be a trustee concern for those schemes with weaker covenants.
The consultation document also outlines a Balanced Funding Outcome (BFO) indicator for each scheme it regulates. The BFO is linked to the strength of the employer’s covenant, as well as the scheme’s maturity and it enables the regulator to determine notional deficit repair contributions, which can be compared to those in the scheme’s recovery plan. A large gap between the regulator’s BFO and actual deficit repair contributions is a key risk factor when considering the need for regulatory intervention.
The BFO methodology should bring more rigour and consistency to comparing risks across different scheme valuations within a tranche (year) and across tranches (successive years).
Risk management is a vital area for both trustees and employers, and one where improved modelling techniques enable us to help everyone to work together to agree common risk principles.
The draft code of practice on funding brings a welcome focus on collaborative working between the various parties. We believe that, regardless of scheme size, there are pragmatic steps that trustees can take to understand better the many different risks to the scheme. This understanding can lead to better outcomes for pension scheme members, trustees and employers.
Headlines about pension deficit payments holding down wage growth will reinforce the political appetite for companies to be given time to pay. However, policymakers have an eye on future headlines too and won’t want to stand accused of being too soft on employers that subsequently run into trouble. The materials published by the regulator reflect this usual balancing act.
While the regulator has been given a new objective to minimise any adverse impact on the sustainable growth of an employer, trustees have not. They are told only to avoid ‘unreasonably’ affecting the employer’s growth prospects while looking at how the scheme could benefit from the employer’s investment plans.
Just listing growth as one of the factors for trustees to consider when determining how quickly the deficit can be paid off does not point to a paradigm shift in the employer’s favour. Indeed, there are suggestions as to how trustees could toughen up their negotiation position. They are reminded that there may be ‘untapped affordability’ from the last valuation, that assurances given to banks can be modified, and that if other companies in the group benefit from the scheme sponsor, the trustees can ask for something in return. Trustees are also reminded that allowing for more investment outperformance in the recovery plan can unpick some of the prudence in the funding target. However, what the regulator says will matter less than how it acts when push comes to shove.
It was no secret that the regulator wanted to focus a lot more on how covenant, funding and investment risks are integrated and on contingency planning. This makes sense, but has limitations. Many schemes are on de-risking journeys that mean the investment strategy will not support as high a discount rate in future even if the covenant remains strong. What these trustees will be focusing on is whether the company is strong enough to finance the desired level and pace of de-risking.
Similarly, while it is a useful discipline to anticipate threats to a recovery plan, things are unlikely to go wrong – let alone be rectified – in precisely the way that trustees prepared for. If a decent slug of cash is on the table, trustees are unlikely to walk away on the basis that the employer won’t commit to specific courses of action in various hypothetical situations.
The regulator has given the industry a new piece of jargon with a three-letter acronym. The Balanced Funding Outcome, or BFO, puts cash going into the scheme over the next few years front and centre when it comes to deciding whether a funding plan needs querying, and the regulator seems to have softened its focus on funding targets [technical provisions] alone. Because the BFO does not take account of affordability, schemes with weaker covenants are likely to find themselves explaining to the regulator why the employer cannot afford to pay more.
The update consolidates TPR’s views from recent years and in particular responds to their new statutory objective ‘to minimise any adverse impact on the sustainable growth of an employer’. The buzzword for the documents is ‘balance’ – going to great lengths to stress the balance between the pension scheme’s needs and those of the employer. There is clear recognition of the value of a strong employer, and that valuation agreements should suit both parties and use the flexibility in the system where appropriate. Helpfully, TPR is interpreting ‘sustainable growth’ broadly to include employers that may be investing to stand still, and non-profit organisations.
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