Following a consultation in the Winter, the Regulator has now published its final documents setting out how it will regulate scheme funding in the future, taking account of its new statutory objective “to minimise any adverse impact on the sustainable growth of an employer” and reflecting what they have learned since 2005. There is a package of documents, comprising a replacement Code of Practice no.3 and a Regulatory Strategy, both of which are high-level documents, and TPR’s DB funding policy. This last document is more detailed and will be supplemented by annual funding statements (as now) and further guidance. It replaces the 2006 statement (the one that introduced the 10-year trigger for recovery plans).
The Code was laid before Parliament on 10 June and will come into force “in the coming months”, for valuation dates which fall after that date.
Funding Risk Indicator
In this brave new world without triggers the main risk indicator will be an assessment of whether trustees have reached a Funding Risk Indicator (“FRI”) (referred to previously as the Balanced Funding Outcome). TPR will set the FRI as follows:
- it will calculate for each scheme the value of the scheme’s liabilities, using “an objective basis”;
- based on the employer’s covenant strength and the scheme’s maturity, it will adjust the liability value to produce a notional asset level at which TPR would consider it appropriate for no further contributions to be paid;
- it will then compare this notional asset value with the scheme’s actual assets and derive the contributions required to eliminate any deficit over “the medium term”;
- finally the scheme’s proposed deficit contributions will be compared with those derived under the third step above.
However, in response to criticism that the FRI could become another Minimum Funding Requirement, the Regulator has decided that it will not publish its FRI, at least in the short term. Rather it will be a tool used internally by the Regulator to help identify schemes where intervention is justified.
The Regulator has responded also to criticism of the length of the documents and managed to trim about 40 pages from the combined total, although the annual funding statement and a new “Essential Guide” are in addition to that. The Essential Guide is a 9-page document that sets out the main principles covered by the longer documents and may be found at http://www.thepensionsregulator.gov.uk/docs/essential-guide-db-code-trustees.pdf.
Key points
The key points in the Regulator’s new approach are:
- schemes will be segmented into four bands of different covenant strength – strong, tending to strong, tending to weak and weak;
- trustees and employers will need to collaborate – trustees should focus on the employer covenant and understand what “sustainable growth” means for their employer;
- not all risks have to be eliminated – but they do have to be managed;
- intervention will be more proportionate than hitherto, focussing on about 200 of the larger schemes each year;
- as reflected in the last couple of annual funding statements, trustees should take an integrated approach to investment, covenant assessment and funding, defining their desired outcomes and developing a strategy for achieving them, including contingency plans;
- the Code of Practice contains guidance on setting the discount rate and mortality assumptions.
2014 Annual Funding Statement
The annual funding statement is of relevance mainly to those carrying out valuations with effective dates between 22 September 2013 and 21 September 2014. The Regulator’s analysis suggests that these schemes will see a worse funding position than in their previous triennial valuation, though probably better than in their last annual update. It suggests also that the economic recovery may lead to many employers becoming able to afford an increase in contributions.