LCP calls for greater flexibility from TPR DB funding code

Proposed changes to the way defined benefit (DB) pension schemes are regulated could risk being “too rigid” and having a damaging impact on both scheme members and employers alike, Lane Clark and Peacock (LCP) has warned.

In response to The Pensions Regulator’s (TPR) ongoing consultation on the new DB funding code, which was extended in light of the pandemic, the firm highlighted concerns around the scope of the bespoke approach, arguing that this does not go far enough in recognising the diverse nature of schemes.

Furthermore, it stated that this approach “unhelpfully” still uses the fast track as a benchmark, even where schemes “clearly face unique issues” and where doing so could lead to worse member outcomes.

The regulator’s proposals are based on a dual track regulatory framework, allowing pension scheme trustees to choose between the fast-track approach, expected to be chosen by the majority, and a bespoke approach, for schemes where a standardised approach would not be appropriate.

LCP has now argued that this proposal would push schemes towards more conservative investment approaches, noting that whilst this may make sense in some cases, for others, it could increase the cost to the employer and simultaneously worsen the security of member benefits.

Within its response, the firm used an integrated risk management model to consider the risk of a company becoming insolvent, in addition to investment risk, to demonstrate the sub-optimal outcome that can arise if bespoke valuations are ‘rigidly’ benchmarked against fast track.

This showed that for some schemes, pushing too hard for extra employer contributions or requiring excessive caution on investment could undermine the financial security of the employer and weaken the security of member benefits overall.

The firm has now pushed for the regulator to consider using an integrated risk management approach for the Bespoke pathway, supported by modelling, emphasising the importance of considering the interaction between the scheme and the sponsor in an integrated way.

Alternatively, it suggested that the eight key principles already being consulted on by TPR be used themselves as a more flexible benchmark for bespoke valuations, in a principles-based approach to regulation.

However, It acknowledged that this might make it harder for TPR to benchmark schemes and justify use of its powers, and therefore could run the risk of “ending up back in a similar situation to where we are now”.

LCP partner, Jon Forsyth, commented: “The DB pension universe is incredibly diverse, and there is a real risk that these new requirements could force too many schemes into a one-size-fits-all mould.

“Whilst it is understandable that TPR wants to press trustees to reduce risk and employers to fill pension deficits as quickly as possible, our modelling suggests that if this is over-done then in some cases it could actually reduce member security.

“The idea of a ‘Bespoke’ funding regime is a good one in principle, but if it is too rigidly benchmarked against a standardised ‘Fast Track’ approach then it will not be flexible enough to reflect the diversity of DB schemes.

“It is important that anyone who has concerns about the proposals responds to the current consultation so that the final version of the new regime appropriately reflects the diversity of UK DB schemes.”

The firm also emphasised the importance of striking a balance between different stakeholders, especially considering the economic crisis and the need to ensure economic growth.

In particular, it noted that excessive pressure on employers to increase contributions could have an adverse effect on stakeholders, including members of a workplace DC arrangement.

Furthermore, considering the current context, the firm stated that some may question whether a shift towards greater protection for pensions is appropriate, warning that the proposals could run the risk of “overpaying for pensions” over the short and medium term, resulting in an inefficient use of capital for UK plc, potentially running to the “tens of billions of pounds”.

The report highlighted a number of other areas where the current proposals may not be a good fit for particular schemes, such as the expectation that investment returns are benchmarked against the return on gilts, rather than reflecting the actual investment mix of the scheme.

It also warned that the lack of a special framework for open schemes, which the government recently suffered a defeat over in the House of Lords, could also lead to increased pressure to close the schemes.

LCP also emphasised that it was supportive “of much of what is proposed in the consultation document”, as well as the overarching aim of improving pension funding standards and practices.

It also acknowledged that for many schemes, the new code of practice is likely to lead to more prudently-assessed funding deficits, additional de-risking of investment strategies and shorter recovery plans, which, in some cases will likely lead to improved member benefit security and less strain on the Pension Protection Fund (PPF).

In response to the LCP report, a TPR spokesperson stated: “We want to hear views from stakeholders on how we can set clearer expectations with regards to DB funding. Our proposed principles build on the importance of trustees setting a long-term objective and putting a realistic plan in place to get there.

“There is good evidence that schemes which have managed their risks well, and have built in sufficient resilience in their long-term funding strategy, are likely to have fared better as market conditions have worsened. Integrated risk management is needed now more than ever.

“After the consultation closes on 2 September, we will consider the responses, prevailing market conditions, where schemes currently are and undertake an impact assessment to inform the setting of the proposed Fast Track parameters. We will subsequently consult on the funding code itself.”

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