DB funding code is full of unintended consequences

Though encouraged by TPR’s principle-based approach to the code, as it suggested the regulator had heeded previous feedback, a number of concerns were voiced in response to the consultation that closed on March 24. 

Prescription and flexibility don’t mix

The Association of Consulting Actuaries said its main concern was the disconnect between the relatively prescriptive wording used in the draft Department for Work and Pensions regulations and the greater degree of flexibility indicated by TPR’s document. 

ACA chair Steven Taylor said that the association strongly supports the principles set out in the draft code, but that trustees and sponsors need certainty that they will be compliant by following the approaches outlined in the draft code. 

“Our preference is for the final regulations to be refined to more closely illustrate the flexibilities envisaged by TPR,” he said. 

It would be perverse to require ever higher employer contributions that lead to trapped surpluses, which may then not be refundable

Steven Taylor, ACA

“We have a strong preference for use of a less volatile measure of significant maturity, to help schemes plan ahead with certainty on when they must reach low dependency and would support a fixed basis for the calculation of duration.”  

The ACA response suggests the requirements for schemes that remain “genuinely open” will impose a significant amount of additional work – and potentially cost – for limited, if any, benefit. 

Its response calls for a “carve-out for such schemes”, as recent research it conducted showed that two-thirds of respondents for whom the rules would apply believed the proposed new regime would have a negative impact on schemes open to future accrual.

The trade body also said that proposals in the code may increase the prospect for trapped surpluses under some scheme rules.

“It would be perverse to require ever higher employer contributions that lead to trapped surpluses, which may then not be refundable,” Taylor added. 

“The funding regime must be sufficiently flexible to consider the likelihood of, and sensible mitigation for, ‘trapped surplus’ risks when agreeing journey plans, low dependency asset allocations, employer contributions and use of contingent assets.”

Covenants and unintended consequences

Others called for TPR to streamline the approaches by moving the detailed guidance on every funding assumption from the code into its fast-track parameters, and replacing it with a simple overarching requirement that the funding assumptions being adopted are appropriate.   

Iain McLellan, director at pensions advisory firm Isio, said: “The subjective nature of covenant reliability also has potential to cause unnecessary issues for trustees and covenant advisers in trying to come up with an accurate value to use. 

“By introducing a default covenant reliability period for trustees, the process of setting this value is simplified, while still allowing flexibility to adopt a different value where the default isn’t appropriate.”

Pensions advisory firm Cardano said it was “positive that covenant is placed at the heart of journey planning – this is not easy to implement in practice”.

The bespoke nature of schemes means that oversimplification, prescription or formulae “risks forcing trustees to take decisions that are not in the best interest of their members” with regards to rerisking, derisking and extending reliance on covenant without holistic consideration of the scheme-specific circumstances. 

For example, the maximum risk equation is “a helpful but simplistic illustration” but not flexible enough to be tailored to scheme-specific circumstances. It should therefore not represent a mandated or prescribed approach, Cardano said. 

“Smarter covenant advice, focused on scheme-specific risk management driving bespoke funding and investment solutions, would avoid the risks of a prescriptive, one-size-fits-all formulaic approach, such as poor decision-making, unnecessary costs and potential trustee/sponsor relationship strain,” it added. 

Not enough time for consultation

XPS Pensions Group said TPR should ensure the industry is fully consulted on the DB funding code, even if it means delaying to 2024. 

Heidi Webster, head of scheme funding at XPS, said the October 1 2023 implementation date for the new regime does not provide sufficient time for the industry to be fully consulted on any changes to DWP’s draft funding regulations. 

“Given the long-term nature of the new funding regime, we feel TPR – and DWP – should take appropriate time to ensure the industry is fully consulted. Even if this means delaying implementation to later in 2023 or early 2024,” she said. 

On the whole, Webster felt the changes set out in the code would create a best practice environment for more schemes, improve collaboration between trustees and employers, and ultimately improve member outcomes, yet she shared further reservations about the draft. 

“Having to define the new covenant timeframes – visibility, reliability and longevity – may result in unproductive disagreement between trustees and employers, covenant reliability being a key driver of risk taking on the journey and recovery plan length,” she said.

Webster also raised concerns about the lack of guidance for schemes close to or already beyond their deadline for reaching low dependency. 

“For these schemes, we feel realistic and reasonable measures should be available to bridge any remaining funding gap and to transition assets to a low-risk allocation,” she added.