DWP paves the way for DB funding code from September

The Pensions Regulator’s (TPR) new funding code for defined benefit (DB) pension schemes is set to come into effect in September after the government finalised its legislative framework.

Today (29 January), the Department for Work and Pensions (DWP) published its response to the consultation on proposed scheme funding and investment strategy regulations. These were in part designed to bring regulations up to date given the maturity of private-sector DB schemes, as well as help facilitate the goals of the Mansion House compact.

Paul Maynard, the pensions minister, said in his introduction to the regulations: “With the improved funding levels we have seen, it is particularly important that funding standards are crystal clear. These regulations demonstrate the clear scope for most schemes to take more investment risk, while keeping members’ benefits safe. That is why there are clearer metrics that set sensible limits.

“In this way we can encourage schemes to get their assets working hard for them, while ensuring that scheme members can be confident, they will get the benefits they were promised, and have worked hard for.”

Aligning government and regulator approaches

The government has made several changes to its regulations in order to align them with TPR’s new code, which was brought to parliament earlier this month. These changes, the DWP said, had helped to reassure respondents that there would not be any conflicts between the approaches of the government and the regulator.

The DWP stated: “The regime will strike the right balance between member security and employer affordability to provide the best possible retirement outcomes for scheme members, while supporting flexibility for sponsors and trustees on how legacy DB liabilities are managed.”

The final regulations have also introduced changes designed “embed more scheme specific flexibilities”, the DWP said.

These changes included clarifications to ensure the regulations do not “constrain actual investments”, and to support the consideration of the sponsoring employer’s sustainability in investment decisions.

The new regulations also make it clear that open DB schemes can factor in the effect of new entrants and future accrual in their journey planning exercises. They also give TPR the ability to request “less detailed information information in some cases, depending on the circumstances of the scheme” to reduce unnecessary administration.

‘Starting gun fired’

The pensions industry has been waiting for the revised DB funding code for nearly four years, with TPR’s initial proposal first published in March 2020. With this announcement, the code is now expected to apply to all scheme valuations dated after 22 September 2024.

Jon Forsyth, partner at LCP, said: “It’s great to see the starting gun for the new DB funding regime finally fired, and what is more it is pleasing to see that DWP has listened to the industry in a number of areas in making updates that we support, relative to the draft regulations we previously saw…

“Though not perfect, these regulations do address many of the concerns raised, and it’s particularly pleasing to see explicit clarifications for open schemes recognising their particular circumstances.”

Nigel Peaple, director of policy and advocacy at the Pensions and Lifetime Savings Association, echoed this sentiment and added that the legislation “also clarifies that DB schemes can take appropriate levels of investment risk where supportable by the employer covenant”.

“A reduction in burdens from streamlined processes for information requests, reducing administrative burdens based on individual scheme circumstances will also aid scheme trustees,” Peaple said. “These changes signify positive strides toward a more adaptable and efficient regulatory framework.”

Simon Kew, head of market engagement at Broadstone, said: “The increased focus on scheme-specific flexibility is to be welcomed given the risk of inflicting unnecessary cost and burden onto smaller schemes, in particular. Trustees and employers now have the clarity to set in place long-term plans for schemes that will benefit members while delivering a regime that will encourage productive finance and its potential benefits for the UK economy.”

Janet Brown, partner at Sackers, pointed out that much had changed in the industry between the original consultation from the DWP and today’s finalised version.

“In the intervening 18-month period between the original consultation on the draft regulations and the finalised version, the Mansion House proposals and 2023 Autumn Statement focused on how DB schemes could use their assets more flexibly,” she said.

“Seemingly at odds with the then draft DWP funding regulations and DB code, which were steering schemes to take on less risk as they mature, the final regulations have had to pirouette somewhat to accommodate wider government aims, as well as the ‘richness of the responses’.”

LCP’s Forsyth added that it was “hard not to think of the new DB funding regime as a solution to yesterday’s problem”, given vast improvements to DB funding positions and the renewed focus on “productive finance”.

“On this front it is pleasing that the final regulations are less restrictive in forcing schemes down a path towards low-risk investments in all circumstances,” he added, “but more is needed in terms of policy change if the UK is to make best use of the £1.5trn assets in DB pension schemes while ensuring pensioners are very well protected.”

Surplus requirement?

However, David Fairs, partner at LCP and former executive director of regulatory policy, analysis and advice at TPR, said there were still gaps in the regulations that could raise issues for schemes that generate surpluses through the new investment flexibilities.

“Given that the code is expected to ensure members receive their full benefit with a high level of probability, there is a real likelihood that some schemes will end up with trapped surplus,” Fairs said. “Ways of accessing surplus should now become a priority for government if it wants pension schemes to support its productive finance agenda.

“Until then, sponsors and trustees will need to creatively consider flexibility within the overall framework set out by the government and TPR to achieve the right balance between security and flexibility.”

The government has already moved to reduce the tax payable on DB surpluses from 35% to 25% with effect from April this year, and it also plans to consult on further changes to rules around the treatment of surpluses.

The regulations are subject to parliamentary approval.