The introduction of a twin-track approach to regulating defined benefit scheme funding could stifle the creativity needed to navigate the current financial crisis, experts have warned.
Recent statements by the Pensions Regulator about the ‘fast-track’ arm of its proposals have been unable to appease some industry players, as the deadline for responses to its consultation comes to a close on September 2.
‘Fast-track’ would see schemes demonstrate that they are on track to be fully funded against a prudent discount rate, by a point of “significant maturity”, in exchange for a lighter regulatory burden. Schemes opting for a bespoke approach would have to justify their divergence from this standard.
The regulator announced its plans for a split approach to DB funding in early March, just weeks before the spread of the novel coronavirus dramatically altered the economic background in the UK.
The legislation is clear that scheme-specific funding should be possible, and tight measurement against fast-track removes this flexibility
Matthew Arends, Aon
It has since introduced temporary measures designed to ease the strain on the UK’s sponsor covenants, while extending the deadline for stakeholders to respond to its planned approach.
In August, TPR further announced that a second consultation on the details of the regime would not be published until spring next year.
Meanwhile, in a Pensions Expert podcast, executive director for regulatory policy, analysis and advice, David Fairs, stressed that the parameters of the fast-track compliance method would adapt to the situation in which employers find themselves.
Consultants unconvinced
However, the reassurances have not been sufficient to ease the concerns of some leading pensions companies.
Leading consultancy Aon voiced objections about fast-track, with partner and head of UK retirement policy Matthew Arends saying its use as a comparator with bespoke proposals, and as a default that the regulator could force on non-compliant schemes, amount to “mission creep”.
“Fast-track is a great idea as a simplified compliance option for those schemes that want to use it,” said Mr Arends, who also warned that some levelling down could occur among employers that are currently above the standard – some 55 per cent of schemes with tranche 14 valuations, according to Aon analysis.
“The problem arises in trying to use fast-track to measure bespoke compliance – it is the wrong tool for the job given how diverse DB pension schemes are and how diverse their sponsoring employers are (no more so than under the current circumstances),” he continued. “The legislation is clear that scheme-specific funding should be possible, and tight measurement against fast-track removes this flexibility.”
Meanwhile Lynda Whitney, a partner at Aon, said she was concerned about the decreasing focus on covenant strength, rather than maturity, as the driver of schemes’ funding and investment strategy.
“Given that failure of covenant is ultimately the only risk that will result in members entering the Pension Protection Fund and receiving less than full benefits, any reduction in the importance of covenant is a concern – and especially when we are approaching a time of extreme economic uncertainty,” she said. Ms Whitney encouraged greater detail on how alternative funding could be used to shore up scheme benefits.
“Getting schemes to be less reliant on covenant in the long term is a noble aim, but the approach of assuming all covenants could evaporate quite quickly has unintended consequences on the journey, potentially increasing the contributions required,” she warned when pressed on the trade-off between cash contributions and more flexibility.
Mercer, another of the UK’s largest pension consultancies, struck a similar note of warning, signalling the potential for the gilt-based parameters of fast-track to drive bespoke schemes away from increasingly efficient cash flow-driven investment strategies.
Charles Cowling, the company's chief actuary, said: “Importantly, with a cash flow-matching strategy, we can use dynamic discount rates aligned to yields on CDI strategies for valuing pension liabilities. This means that our pension liability valuations will mirror changes in the value of the investments, which is entirely sensible when holding CDI assets through to redemption, and are largely unconcerned by market values in the interim.”
The ghost of MFR
Rosalind Connor, a partner at Arc Pensions Law, said the regulator’s duty to protect sustainable employer growth should prevent fast-track from having an unnecessarily adverse effect on all employers. But she added that its prescription could prove incompatible with the diversity of sponsoring businesses in the UK.
"If well done, I don’t see any problem with the twin-track approach. The risk is that, if not very carefully communicated and managed, it encourages trustees to assume that the 'fast track' is right for their scheme whether or not it is,” she said.
TPR to make changes to DB funding ‘fast-track’
Podcast: The Pensions Regulator will make changes to the fast-track approach proposed in its defined benefit funding consultation due to the impact of Covid-19, revealed its executive director of regulatory policy, analysis and advice David Fairs.
“I think the industry all agrees that a return to prescription that we had with the minimum funding requirement is not a good idea, and the risk is that a presumption that fast-track is the way to go may very well lead to prescription again.”
