It has been a long time coming but yesterday morning, the draft Pensions Regulator’s Defined Benefit (DB) Funding Code (the “Code”) was laid before Parliament. It seemed an appropriate juncture, in a slight lull between all the various announcements regarding pensions post-Election (what with the small matters of the Pensions Bill announced during the King’s Speech and the new government announcing the kick-off of its pension s review with the first phase looking at investment) and just before the new Chancellor’s announcement regarding the Autumn budget yesterday afternoon. 

The new Code will replace the existing Code (which dates back to 2014) and must be laid for a period of 40 days commencing on the date of laying (i.e. yesterday). 

Background

Initial work in relation to the new Code first kicked off in 2018. Between then and now there has been quite a few significant events which have changed the pensions landscape (the ongoing impact of Brexit, the Covid pandemic and still-rippling effects of that on the economy and cost of living crisis, several changes in UK prime ministers and pensions ministers, 2022 gilts crisis, the ongoings war in Ukraine and Israel/Gaza and the announcement last year of the Mansion House reforms). 

We find ourselves in a very different world now compared to back then. with funding levels having improved significantly and most DB pension schemes now enjoying large surpluses and facing the not unpleasant challenge of tackling ways in which to address those surpluses. 

Bearing all this in mind, it was essential that the Code reflected the changed landscape and allowed for flexibilities in approach to accommodate DB schemes’ funding positions and also the new government’s drive for increasing investment in the UK economy and partially using DB scheme assets to assist with that.  And, of course, that the Code dovetails in with the requirements of the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 (the “Regulations”), which were introduced in April this year. 

Key changes

The Pensions Regulator (TPR) has said that they extensively engaged with external stakeholders to finalise the Code and explain the changes being made and that, as a result, stakeholders were largely encouraging of the updated Code.

TPR notes that the new Code “… reflects the Regulations and industry feedback to TPR’s consultation on the draft Code” and “… strikes the right balance between security and flexibility for scheme specific funding and investment approaches in the interests of members and employers”.

Key changes made to the previous version of the Code are as follows:-

Low dependency investment allocation (LDIA) – The Code now makes clear there is no requirement to invest in line with the LDIA, but there is an expectation that, for most schemes, investing in the best interest of members at and after the relevant date will mean investing in line with the trustees’ chosen LDIA. TPR makes clear there is significant flexibility to take investment risk when complying with the low dependency principle, and there are no restrictions in the draft Code on trustees’ ability to invest in line with their fiduciary duties. 

The draft Code has also been updated to reflect that the Regulations define the LDIA as providing a highly resilient funding level to short-term changes in market conditions.

Significant maturity – The Code delegates the power to TPR to specify the duration of liabilities in years, or different dates, at which schemes reach significant maturity. This metric has now been reduced to a duration of 10 years for schemes with DB benefits and 8 years for schemes with cash balance benefits. This reflects a revision to the Regulations in the calculation of duration,.

Open schemes - Reflecting consultation responses and engagement with open schemes on the draft Code, TPR has extended the flexibility on the length of future accrual and new members that trustees can take account of when determining future maturity. The draft Code has a new specific section outlining expectations for open schemes.

Employer covenant assessment – The draft Code has been updated to bring it in line with the Regulations and also to provide greater clarity on how to assess the employer covenant reliability and longevity periods. Within the Code, TPR sets out its expectations on how long these periods should be for a typical scheme and acknowledges that some employers may be able to demonstrate a longer period is appropriate for them.

Assessing maximum risk over the journey plan – Reflecting concerns raised in the consultation responses, TPR has amended the Code to replace the previous formulaic test to determine the maximum level of risk supported by employer covenant, by a principle-based approach to assess that the level of risk being run in the journey plan is supportable. This provides trustees with flexibility to recognise the different ways in which schemes can assess risk as well as the different types of support that can be available.

Recovery plans and reasonable affordability – The Code re-iterates that trustees must follow the overriding principle that steps must be taken to recover deficits as soon as the employer can reasonably afford and, when assessing that, it must take account of certain matters including the impact of the recovery plan on the sustainable growth of the employer. The Code sets out that trustees should assess affordability on a year-by-year basis.

When will it take effect from?

Given that there is still a legislative scrutiny process to go through, the Code’s entering into force is unlikely to be before 22 September 2024, the date on which the Regulations kick in for actuarial valuations with an effective date on or after that date. 

This means that it is possible that there will be some DB schemes with valuation dates immediately after 22 September, which will have to commence the valuation process under the ambit of the old Code, with the new Code then coming into force mid-valuation.  

TPR has acknowledged that there will be a gap between when the requirements of the Regulations commencing and the Code coming into force, but has noted that schemes with valuation dates in this period can use the new Code as the base for their approach. TPR has said it will be communicating with those affected schemes and will take a "reasonable regulatory approach to them”.

Comment

The general consensus now within the industry, is that the time taken in finalisation of the Code was perhaps no bad thing, given the significant changes in the pensions scheme landscape and funding positions over the last few years, which the continued delays have allowed the updated Code to accommodate.  

The Code has so far been uniformly welcomed by the industry and TPR has been praised for its “balanced approach” and for showing “greater flexibility” in many areas of the Code (e.g. in relation to open schemes and the testing of the high resilience of the LDIA). Some concerns have been expressed about the costs of compliance with the requirements, particularly for small schemes and that TPR has extended the compliance requirements (via its repeated use of the word “should” in the Code when setting out what trustees need to do) of the DB funding regime further than that set out in the Regulations. 

Going back to a comment above, there is also a question mark over whether the Code allows for an approach to be taken by DB schemes which is conducive to the new Government’s drive to boost productive UK investment, despite the many new flexibilities now folded into the Code. 

Finally, the analogy of jigsaw pieces has been used time and time again in relation to the new DB funding framework. Continuing that theme, we should not forget that there are still one or two final pieces of the jigsaw which are still awaited - the updated employer covenant guidance and the final format of the Statement of Strategy, following a consultation on the latter earlier this year.

 

Co-written by Clive Pugh and Mairi Carlin