Govt faces growing calls to 'rethink' draft DB funding rules

Calls for the government to reconsider the draft defined benefit (DB) funding and investment regulations have grown, with industry organisations arguing that greater flexibility is needed, particularly in light of recent market volatility.

Industry experts have continued to raise concerns over the "unnecessarily restrictive" in response to the government's recent consultation, warning that the regulations may not be fit for purpose, and could push 200 employers to the brink of insolvency.

The recent market volatility has perhaps heightened concerns, with Isio head of research and development, Iain McLellan, noting that the framework would have “failed the ‘stress test’ of the past two weeks”.

“The proposed DB funding and investment rules would act to tighten the straitjacket on trustee flexibility, however, the draft regulatory framework would have failed the ‘stress test’ of the last two weeks, so perhaps the Department for Work and Pensions (DWP) should go back to the drawing board to provide the flexibility for strategies to be genuinely scheme-specific,” he stated.

Indeed, The Pensions Regulator (TPR) also confirmed that changes would be needed following the recent market volatility, confirming that it was reviewing the use of duration as a measure of maturity in the DB funding code following recent market volatility.

However, XPS head of valuations and journey planning, Heidi Webster, raised broader concerns that the draft regulations are currently too prescriptive, suggesting that a more principles-based approach should be adopted.

She continued: “For some schemes it will increase costs unnecessarily and may leave other schemes to congregate towards a low dependency funding discount rate of gilts +0.5 per cent with no clear path for reaching stronger funding positions if they choose to close out risk, leaving material shortfalls in cover if employers fail.

"We estimate that the current shortfall between new targets and the insurance cost is roughly £200-£300bn."

In particular, Webster said that limiting the level of risk taking and potentially restricting the form of contingent assets after significant maturity "unnecessarily limits" the range of options available to secure pensions for members and could trap schemes in longer-term dependency on sponsors.

"The regulations also unnecessarily add in a new funding rule requiring schemes to be funded as soon as the employer can reasonably afford," she added.

"Without any qualification on how to assess this, it may place unnecessary financial pressure on some sponsors and risk large cash calls."

Cardano also shared industry concerns regarding the potential unintended consequences of the draft regulations in its response to the consultation, agreeing that these consequences need to be addressed.

In particular, Cardano raised concerns that the regulations could formalise an "overly-simplistic and restrictive" definition of covenant, dissuade investment in sustainable growth or push employers into stress or distress through unaffordable contributions.

Additionally, it warned that the regulations could see schemes reducing prudence or extending covenant reliance, and focussing on low-dependency at significant maturity as the “end point”.

Cardano also suggested that many of these unintended consequences could be addressed by the regulations focusing on principles, with TPR responsible for setting out the practical detail and application.

However, it acknowledged that providing too much detail in the draft regulations and providing not enough is a "challenging balance", especially given the draft Funding Code of Practice has yet to be published by TPR.

Industry experts also previously highlighted difficulties in commenting on the regulations without sight of the code itself, after TPR delayed its second consultation on the code to allow time to learn from the DWP's consultation.

Despite these challenges, Cardano argued that the draft regulations are headed in the right direction in helping trustees and employers in planning their scheme funding over the longer-term.

Cardano Advisory managing director, Emily Goodridge, stated: “There has been widespread concern in the industry about the draft regulations linked to some of their potential unintended consequences.

"We agree that these unintended consequences need to be addressed but, overall, we are supportive of the intention to improve risk management through covenant-driven investment and funding strategies and a long-term objective of reducing reliance on covenant.

“However, looking beyond the unintended consequences, this is a really good opportunity for schemes and sponsors to engage on managing pension risks, particularly as part of an ongoing valuation process or a strategic reset following the recent turmoil in the gilts markets.

“We look forward to the upcoming consultations on the DB Funding Code of Practice, which we hope will provide the appropriate level of detail to flesh out the principles within the regulations, and the guidance for assessing and monitoring the employer covenant.”

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