Out-Law News 3 min. read

Pensions Regulator pledges "more transparent" approach to DB funding requirements as it sets out new code of practice

The Pensions Regulator is encouraging trustees of defined benefit (DB) pension schemes to ensure that recovery plans are "reasonably affordable" for companies while continuing to meet the needs of the scheme, as part of its new approach to the regulation of DB funding.

It is consulting until 7 February 2014 on changes to its regulatory strategy on DB, which take into account the regulator's new statutory objective to minimise the impact of DB scheme funding on employers' sustainable growth. It has also published a new funding policy and code of practice for consultation. The documents call for better communication on funding between trustees and employers and a "more integrated" approach to managing funding risks by trustees.

Pensions expert Helen Hanbidge of Pinsent Masons, the law firm behind Out-Law.com, said that the updates reflected an increasing drive by the regulator to be more transparent about its approach to scheme funding. However, she warned that allowing employers and trustees increased flexibility could lead to more disputes between the Pensions Regulator and schemes.

"The Pensions Regulator has been moving towards this principles-based approach for a while now, but there are new elements in this consultation," she said. "There's a change of emphasis in the code of practice away from the statutory valuation requirements, meaning that the focus is more explicitly - and more usefully - on the complex and tricky balancing act involved in DB scheme funding. It highlights the wide range of strategic issues which trustees need to weigh up in practice: governance, integrated risk management, employer covenant and investment strategy considerations, to name but a few."

"But the flip side of this is that the new draft code and DB funding policy are long, and at times long-winded. It will take time for trustees and their advisers to get to grips with all the nuances of the regulator's approach. In allowing flexibility, the regulator opens up scope for disagreement – for example, trustees and employers may feel they can manage risk in a way which does not satisfy the regulator," she said.

The Pensions Regulator currently has five statutory objectives. These focus on the protection of members, their benefits and the interests of the Pension Protection Fund (PPF), which compensates pension scheme members in the event of employer insolvency. The new objective is included in the Pensions Bill, which is currently before Parliament; and will require the regulator to consider for the first time the long-term affordability to sponsoring employers of plans to pay back a scheme deficit.

Under its new approach, the Pensions Regulator expects trustees to take an "integrated" approach to manage the risks that influence a DB scheme's chances of being able to pay its benefits in full: funding, investment and the 'employer covenant', or the employer's ability to meets its obligations to the scheme.

As announced in its May funding statement, rather than using discrete triggers such as recovery plan lengths and discount rates to trigger intervention, the Pensions Regulator will instead allow trustees to manage these three risks together. Those that do so, accompanied by good scheme governance, will be unlikely to experience regulatory intervention. The regulator's more "proactive, targeted and segmented" approach to regulation will likely result in fewer investigations than in the past, but those investigations are expected to be more complex and in-depth, according to the regulator.

DB schemes will be divided into segments by the Pensions Regulator, according to whether the scheme covenant is strong, weak or in between. Different indicators will then be applied to show the regulator what a balanced funding outcome (BFO) might be for schemes in a particular segment, allowing it to assess the level of risk associated with the scheme and decide whether to intervene. These indicators will be reviewed annually in consultation with the industry.

"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," said Stephen Soper, interim chief executive of the Pensions Regulator.

"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," he said.

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