Scheme funding takes another turn

A briefing outlining the new legislative objective set for the Pensions Regulator and the possible implications for trustees and employers.

7 November 2013

Since it was introduced at the end of 2005, the scheme funding regime for defined benefit pension schemes has been through a process incremental of evolution.  With a new legal objective for the Pensions Regulator now revealed, will this alter the approach of employers and trustees to scheme funding in practice or will it turn out to be business as usual?

Back in 2005, the emphasis was on the scheme specific nature of the new funding regime.  It was about funding arrangements agreed between the employer and trustees to reflect the circumstances specific to their scheme, thereby putting some distance between the new regime and the outgoing Minimum Funding Requirement (MFR), which was a general, one size fits all floor below which scheme funding should not fall.

Despite the early messages from the Pensions Regulator on the scheme specific nature of the replacement funding regime, in practice the Regulator was more interventionist in funding arrangements made between employers and trustees than was first envisaged and, before the Regulator was given the power in the Pensions Act 2008 to intervene in funding rates already agreed between employers and trustees, arguably more interventionist than the law strictly envisaged.

What drove this more interventionist approach from the Regulator?  The interaction between the Regulator's statutory objectives and worsening scheme deficits since 2005 clearly had a part to play.

By the Regulator's current objectives centring on protecting members and protecting claims being made on the PPF (see box), without any express requirement to consider the interests of other stakeholders (mostly notably the scheme employer), the Regulator has effectively been boxed into a corner in which protecting members and the PPF take precedence over the business interests of employers.

Current objectives of the Pensions Regulator:

• to protect members
• to protect/reduce claims on the PPF
• to maximise compliance with employers' auto-enrolment duties
• to promote good administration of schemes

New additional objective:

• to support scheme funding arrangements which are compatible with sustainable growth for the sponsoring employer

The new objective proposed for the Regulator (see box) seeks to address a perceived imbalance between the impact on the employer of deficit repair contributions and the explicit objective already in place to protect members and the PPF. Some commentators argue that the new objective is already an implicit part of the funding regime as the legislation already requires the Regulator when exercising its powers to have regard to the interests of parties who are directly affected.  In practice, though, having regard to the interests of competing parties is not the same thing as giving them equal priority, and when the Regulator exercises its powers, this currently remains against a backdrop of the explicit objectives to protect members and the PPF.

The proposal for the new objective goes some way to removing the doubt over precisely how the Regulator can and should act in balancing business and funding needs and is consistent with the funding regime evolving over time.  It is also consistent with the government’s wider policy objective of regulatory bodies having regard to economic growth in the exercise of their functions.

What will the new objective mean in practice?  The position should become clearer once the Regulator's new Code of Practice on Scheme Funding is published over the coming months, although as this is not expected until early 2014, this will not assist schemes dealing with valuations before then.  A possible hint of what is to come is in the form of the Regulators "more pragmatic approach" to scheme funding set out in this year's annual funding statement from the Regulator, in which a softer, more flexible approach is adopted.

The key aspects of this year’s Annual Statement from the Regulator are:

trustees can set different assumptions for the technical provisions and recovery plan compared to previous valuations,
contributions and recovery plan - as a starting point, trustees should consider whether the current level of contributions can be maintained; trustees can take into account what the employer can reasonably afford and “where there are significant affordability issues trustees may need to consider whether it is appropriate to agree lower contributions and this may also include a longer recovery plan”,
where the employer is considering prioritising investment in its business over what would otherwise be made as contributions to the scheme, then the trustees need to consider how this improves employer covenant,
trustees should use an integrated approach to covenant, investment and funding risk,
a move away from the Regulator setting triggers when assessing whether a particular scheme is at risk, to the use of broader risk factors which the Regulator will evolve.

In its Annual Statement for this year, the Regulator is already moving in the direction of greater flexibility for some employers when agreeing contributions and recovery plans, as envisaged by the new statutory objective.

On a broader level, given the material sums involved, it will be interesting to see how some employers will react to the new objective when it becomes law, whether seeing greater justification to challenge a decision of the Regulator which was not there before the new objective was in place or support for corporate restructurings involving pension schemes which previously had not been acceptable to the Regulator.