UK Government closes consultation on new DB funding rules – what’s next?

Last week, the Department for Work and Pensions (DWP) closed its consultation on the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 (the Draft Regulations). The DWP will now digest the consultation responses from stakeholders across the defined benefit (DB) pension scheme ecosystem.

In our last blog on this topic, we looked at some of the central features of the Draft Regulations. In this blog, we summarise some of the key issues that have been raised with the Draft Regulations and the industry response to them. 

(In)flexibility 

In the consultation document the DWP makes much of the “flexibility” of the Draft Regulations ensuring that the regime remains scheme-specific. Many of the journey-planning elements of the new regime could indeed be tailored to individual schemes. However, many in the industry believe that, once schemes reach the point of “significant maturity”, the funding requirements become overly prescriptive and insensitive to the actual circumstances of individual schemes.

Ultimately, a less flexible approach could disadvantage pension scheme beneficiaries and limit the sustainable growth of scheme employers, if even well-funded schemes unduly pivot to low-risk (and low-upside) investment portfolios to ensure they comply with the new regime.

Impact on employers’ sustainable growth

Employers may be particularly concerned about a new principle that funding deficits should be recovered “as soon as the employer can reasonably afford”.

Though the concept of “reasonable affordability” is already part of the practice of the Pensions Regulator (TPR), this currently has no statutory footing and must be balanced with its statutory objective (in the exercise of its funding powers) to have regard to the need to “minimise any adverse impact on the sustainable growth of an employer”. The absence of such a qualification in the Draft Regulations could cause significant confusion. We may see a significant uptick in trustees pushing for aggressive recovery plans to be implemented, even where this could seriously disrupt the sponsoring employers’ sustainable growth, as that is what the Draft Regulations seemingly require (unless sustainable growth is read into the “reasonableness” qualifier of affordability).    

Employer covenant

The Draft Regulations allow for contingent assets, such as guarantees, to be taken into account in assessing the employer covenant. However, this is only to the extent these assets “will” be sufficient to provide support when the trustee comes to enforce them.  

Given the range of uncertainties – employer and sector-specific risks, wider market conditions, legal enforcement issues – it could arguably never be said that a contingent asset “will” provide any level of support. So this requirement might unduly remove contingent assets from assessment of the employer covenant altogether (which is not the policy intent).

It is possible to read the Draft Regulations in a less restrictive way than this, but it would be helpful for them to be clarified so that the assessment of contingent assets can be on a secure legal footing.

Legal basis 

The Draft Regulations envisage that the legal definition of “significant maturity”, and the more detailed matters to be taken into account in assessing the “employer covenant”, will be provided by TPR in its forthcoming DB Funding Code of Practice. Commentators have raised concerns that this approach could be an unlawful delegation of power to make binding law from the DWP to TPR.

To address this issue, the DWP could define these specific matters in the Draft Regulations, but such an approach would likely make the concept even less scheme-specific, and exacerbate the criticisms outlined above around flexibility and the employer covenant. Alternatively, the DWP could move away from binding definitions, and instead articulate broader principles which could then be appropriately applied in practice by individual schemes, under the supervision of TPR through (non-binding) codes of practice and guidance.

What’s next?

The DWP will consider the consultation responses before releasing the final regulations. The DWP has indicated that they will come into force at some point in 2023. But this timing could be in doubt, given the significant recent market turmoil and political instability in the UK.

TPR has said it intended to announce its own consultation on its new DB Funding Code of Practice, which would sit alongside the Draft Regulations, by Autumn. However, given we are almost into November, this may also be in doubt.

The Draft Regulations clearly reflect a wider trend – accelerated by recent market conditions and improved funding levels - towards a focus on the DB pensions “endgame”. Scheme sponsors, and their trustees, would be wise to begin considering how the new scheme funding requirements will fit together with their endgame planning (e.g. any plans to secure scheme liabilities with an insurance company or consolidator vehicle in due course).

If you would like to discuss any issues relating to the new scheme funding regime, the Pension Schemes Act 2021, or the pensions “endgame” more generally, then please get in touch with your usual Freshfields contact or any of the authors.