Following on from our overview of the Pensions Regulator’s second consultation on the draft DB funding code of practice, over the coming weeks we will take a more in-depth look at some of the legal issues arising from the draft and how it interacts with the draft Regulations. First up, we look at the role of the employer in agreeing the scheme’s funding and investment strategy.

By way of reminder, under Schedule 10 of the Pension Schemes Act 2021 (PSA21), section 229 of the Pensions Act 2004 (PA04) is to be amended so that in addition to the methods and assumptions to be used in calculating the scheme's technical provisions, the statement of funding principles, recovery plan and schedule of contributions, the employer’s agreement will be required to the scheme's funding and investment strategy (FIS). The existing modifications in the Occupational Pension Schemes (Scheme Funding) Regulations 2005 remain, so that in those limited situations where trustees have sole power to determine the rate of employer contributions and no-one other than the trustees can reduce or suspend those contributions, the trustees need only consult the employer on the FIS. However, if trustees must currently obtain the employer’s agreement to their triennial valuation, they will need employer agreement to the FIS.

As the PSA21 progressed through Parliament, concerns were raised that this would fetter trustees’ powers of investment and would contradict section 35 of the Pensions Act 1995 which provides that trustees should not be required to obtain employer consent when selecting and making investments. So, how are those concerns addressed under the new regime?

The statement of strategy

The statement of strategy will be divided into two parts. Part 1 is the FIS that must be agreed by the employer whereas the Trustee need only consult the employer on the supplementary matters to be set out in Part 2. So, what must go in each part?

Part 1

Part 1 must specify:

• the funding level the trustees intend the scheme to have achieved as at the end of the scheme year in which the scheme is expected to reach significant maturity (known as the “relevant date”); and
• the investments the trustees intend the scheme to hold on the relevant date.

The draft Regulations provide further detail and state that Part 1 must:

• set out the way in which the trustees intend pensions and benefits under the scheme to be provided over the long term (e.g. bought out with an insurance company, paid as and when they fall due, transferred to DB consolidator);
• where a scheme has not reached significant maturity at the time the statement of strategy is prepared, the expected maturity of the scheme at the relevant date;
• the proportion of scheme assets intended to be allocated to different categories of investments on the relevant date – so essentially setting out the employer and trustee’s objectives as to what the scheme’s investments will look like when it reaches relevant maturity.

Part 2

Part 2 must set out:

• the extent to which, in the opinion of the trustees, the FIS in Part 1 is being successfully implemented and, where it is not, the steps they propose to take to remedy the position (including details as to timing);
• the main risks faced by the scheme in implementing the FIS in Part 1 and how the trustees or managers intend to mitigate or manage them;
• reflections of the trustees on any significant decisions taken by them in the past that are relevant to the FIS (including any lessons learned that have affected other decisions or may do so in the future);
•  “the granular detail” of a scheme’s journey plan including matters such as:
  • the current level of risk in relation to the investment of the assets of the scheme,
  • the level of risk the trustees intend to take in relation to the investment of the assets of the scheme as it moves along its journey plan,
  • the proportion of assets intended to be allocated to different categories of investments as the scheme moves along its journey plan; and
  • the discount rate or rates and other assumptions used in calculating the scheme's technical provisions in the actuarial valuation to which the FIS relates, and how the trustees expect the discount rate(s) to change over time;
  • their assessment of the strength of the employer covenant and how long it is reasonable to rely on this assessment.

Trustees must explain the evidence on which they have based their assessment of these matters. The statement must include confirmation that consultation with the employer has taken place and include any comments that the employer has asked to be included. 

A copy of the statement of strategy (as amended) must be sent to TPR with each triennial valuation. However, if a statement of strategy is revised between triennial valuations it does not need to be sent to TPR.

Regulation 18 of the draft Regulations requires the statement of strategy to be submitted in a form set out by TPR. However, the DB Funding Code consultation documents launched before Christmas do not currently include TPR’s proposals on the format of the document – instead it is engaging with industry to discuss how best to obtain that information from schemes in a way that minimises any additional burden and administrative costs. It remains to be seen whether a template will be produced but we do know that TPR intends that the information will be submitted electronically.

What if an employer won’t agree the FIS?

Given the forward looking, aspirational nature of the information to be set out in Part 1 of the statement of strategy, it does not appear that the new requirements will fetter the Trustees’ discretion over day to day investment decisions. Nevertheless, what if the Trustees and the employer have very different views as to how benefits should be provided by the scheme over the longer term? For example, the market movements seen last autumn has meant that many DB schemes are even closer to the funding levels required to de-risk or fully buy-out their pension obligations than previously planned for. What if the Trustees want to take advantage of those market movements and buy-out but the employer remains intent on running on the scheme (which is consistent with the agreed and documented FIS)? There is some commentary on this in the draft Code. It states:

“Our expectation is that investment decisions by trustees (and fund managers to whom decision making has been delegated) will generally be consistent with the strategies set out in the funding and investment strategy….We expect trustees to review their investments at more frequent intervals than [as part of the triennial valuation], so investment decisions in practice may differ from the funding and investment strategy over the short term. For example, opportunities in the markets might arise that would enable the trustees to accelerate their plans for de-risking and take advantage of advantageous market opportunities such as increased bond yields.

Other circumstances where investment decisions may not mirror the funding and investment strategy are:

•  A sponsoring employer refuses to agree to changes to the investment strategy set out in the funding and investment strategy, despite the trustees considering it appropriate. Employer agreement is required for the funding and investment strategy, but not for the investment elements in the statement of strategy (where consultation with the employer is required) However, the power to take actual investment decisions lies with the trustees (subject to the scope of their powers in the scheme’s trust deed and rules). While we would expect trustees and employers to work collaboratively in agreeing the funding and investment strategy, where agreement cannot be reached this does not inhibit the trustees in exercising their investment powers; or
• The scheme may have a material surplus (on a low dependency funding basis) after their relevant date. While trustees are still required to set their low dependency investment allocation and low dependency funding basis according to the relevant requirements, they may wish to invest differently in practice. For example, investing an increased amount in growth assets in order to meet their long-term objective (for example, to buy out with an insurer) sooner.

Although the examples set out above show that there might be good reasons in the short term to move away from the investment strategy in the funding and investment strategy, as stated above, our general expectation is that investment decisions by trustees (and fund managers to whom decision making has been delegated) will be consistent with the strategies set out in the funding and investment strategy”.

This certainly does give us lawyers comfort that trustees’ independence and primacy in day to day investment decisions will be maintained. Nevertheless, we anticipate that the new requirement to agree a FIS will lead to some in depth discussions between sponsoring employers and trustees on some of our schemes.

This blog was written by Catrin Young with assistance from Emily Fox.