UK Government to consult on new DB funding rules

On 26 July, the Department of Work and Pensions (DWP) published its consultation on the long-awaited draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 (the Draft Regulations). The Draft Regulations are the latest component of a broader regulatory push towards ensuring that Defined Benefit (DB) pension schemes are focused on long-term journey planning.

Low dependency

The Draft Regulations introduce a new guiding principle for trustees: “low dependency” on the scheme employer. As discussed in our last blog on this topic, the Pension Schemes Act 2021 requires DB trustees to set a target funding level and draw up a Funding and Investment Strategy (FIS) for their scheme. The Draft Regulations require that both the target and the FIS will over time need to be determined on a low dependency basis, i.e. determined so that, by the time the scheme reaches “significant maturity”, it would not be expected that further employer contributions would be required to meet pension promises. Significant maturity will vary between schemes, being reached when the “duration of liabilities” of a scheme meets a threshold that the DWP anticipates will be set by the Pensions Regulator in its forthcoming DB Funding Code of Practice (likely around 12 years).

The low dependency principle marks a departure from “self-sufficiency” as the gauge of scheme health for mature schemes. It will underpin not only the financial destination set by scheme trustees but, crucially, the roadmap (the FIS) which they are required to create to guide the scheme to that point. The DWP estimates that 80% of DB schemes already have a long-term objective for their scheme, but even trustees for these schemes will have to ensure their approaches qualify under the new low dependency rules. From an employer perspective, the policy pivot towards achieving long-term low dependency may prompt a spike in short-term trustee demands for support, as the industry seeks to adjust to the new regulatory expectations.

FIS requirements and negotiation

The Draft Regulations also specify the level of detail a FIS must contain, and certain “matters and principles” that trustees must take into account when developing and revising the FIS, including the investment risk and liquidity of the scheme at the relevant stage of its journey plan. The strength of the employer covenant will also inform the FIS, with schemes that have greater recourse to employer support permitted more latitude in developing their FIS.

Interestingly, the DWP confirms that employers “will need to agree” the FIS with the trustee. This process may create some friction in the employer-trustee relationship not least by potentially giving employers a greater say over investment matters. Further, particularly in the short term, we may see trustees seek to drive up contributions to compensate for more conservative investment allocations, whilst employers resist them. It is significant that the Draft Regulations envisage the FIS as a living document: it must be reviewed (and if necessary revised) in circumstances including the conduct of any statutory valuation, or any “material change” in the circumstances of the scheme or the employer. The trustee-employer FIS negotiation is likely to become a familiar process, adding time and effort to running a DB pension scheme.

From an employer’s perspective, these new requirements may spark further interest in seeking to off-load the scheme altogether to an insurance company or superfund.

The consultation on the Draft Regulations will close on 17 October 2022. The Pensions Regulator is expected to announce its own consultation on its new DB Funding Code of Practice, this Autumn.