Defined Benefit funding code of practice – What does it mean for employers?

13 August 2024

After what seemed like months of waiting… on Monday 29 July 2024, The Pensions Regulator (TPR) laid the Defined Benefit funding code of practice before parliament, where it will be required to sit for at least 40 days.

Happy summer everyone!

While much of the document will remain familiar to those of us who have followed the evolution of the funding code over the past five years, there is a strong sense of balance between old and new.

A quick reminder: it’s now 10 years since the last funding code. The newly updated code, alongside the Funding and Investment Strategy Regulations 2024, is intended to better suit a Defined Benefit (DB) landscape in which most schemes are now closed and maturing.

The central premise remains that when a DB scheme is very mature, it should be funded and invested in a way that doesn’t need any further support from the sponsoring employer.

Yes, there is still an acceptance that buying-out members’ benefits with an insurer may still be the long-term target for some schemes. As such, stakeholders will still be expected to take this objective into account when setting other elements of their scheme strategy. Alongside that, however, there is a recognition that run-on now has its place at the table, as does the DB ‘superfund’ or ‘consolidator’.

There is also a recognition that for open schemes, the journey will probably be different, and that the long-term objective may never align with a low-dependency target. Here, sense has prevailed, and open schemes now have more flexibility than early drafts of the code gave them.

On my reading at least, schemes will still need:

• A real grasp of the sponsor covenant, their cashflows and their prospects
• A statement of strategy – which TPR is very likely to scrutinise
• A funding and investment strategy which would require 100% funding on a low-dependency measure by a ‘relevant date’
• Technical provisions (i.e. the funding target) that are set consistently with the above
• A well-hedged investment strategy which is liquid and highly resilient to short-term adverse changes in markets at the “relevant date”.

And yet the new code, as drafted, gives stakeholders greater flexibility in agreeing their funding and investment framework.

Here we have less of a formulaic tick-box exercise and more of a principle-based (and dare I say it, common-sense) approach to considering the end game. For example:

• It’s now clearer that the low-dependency investment allocation (LDIA) is a notional one used to set funding assumptions. The LDIA is not intended to interfere with trustees’ investment duties; trustees (with good reasons) can invest at variance from the LDIA at significant maturity.
• There’s a distinction between how schemes are expected to invest their low-dependency investment allocation and what options they have with any surplus assets.
• There are some easements for smaller schemes (those with fewer than 200 members) and open schemes.

The increased flexibility compared with earlier drafts is evident throughout, and has been widely welcomed.

Do the new requirements come at a cost to employers?

Given the improved funding levels of the last few years, the DWP-estimated £7bn or so of shortfall contributions – to be redirected thanks to the ‘levelling down’ and ‘levelling up’ of schemes as a direct result of the revised framework – appears to be wide of the mark.

There is therefore no doubt that the contribution tap can be turned off for many schemes. For some schemes however, no matter how much you turn the tap, it may not be sufficient. With those schemes, some tough conversations lie ahead – perhaps emphasising the importance of reassessing those goals and having that all-important plan B.

Yet it is the initial implementation costs, identified by the DWP in its impact assessment (part 9) as £7,000 per scheme on average in the first year, that will concern the smallest schemes. And while an increase in average ongoing costs of around £1,100 per scheme may not seem like much, the reality is that every pound matters for those schemes.

I sense this is just the tip of the compliance iceberg, particularly when you consider what the statement of strategy might involve and the increased scrutiny for those c20% of schemes that may be going down the Bespoke compliance route.

What next for sponsors?

For sponsors with valuation dates of either 30 September or 31 December 2024, the challenge is clear. You’ll need to familiarise yourself with the code and collaborate with your trustees to achieve a balanced valuation and investment strategy outcome.

Remember, the new regime doesn’t require you to get it perfectly right on day one. Indeed, it’s taken the Regulator more than five years to get this far! This is intended to be an iterative approach, with the expectation that you will finesse your journey plan as you near your destination.

For small and open schemes, familiarise yourself with and make effective use of the easements. They exist for your benefit, and you may need all the help you can get.

The average costs of implementation could run to nearly £10,000 per scheme over three years, according to DWP estimates. Proportionality (a word TPR uses, together with ‘proportionate’, some 23 times in the code), is going to be key, alongside getting the best support you can for your money.

For all other sponsors, it may be best to avoid getting into the weeds right now. Instead, you should take the opportunity to reassess the high-level funding and investment strategies you have in place for your scheme(s).

The landscape continues to evolve, and with new superfund guidance and the long-awaited funding code being laid by parliament, this is likely to be a summer of change – certainly if July is anything to go by. The game may now look somewhat different from what we expected at the start of this process some five years ago. It’s therefore a good idea to begin by checking you have your goalposts in the right place.

There’s no doubt that challenges await as we all take stock and familiarise ourselves with the new requirements. The skill will lie in navigating them in a proportionate, considered and cost-effective way, particularly with schemes that remain some distance away from their relevant date.