New DB funding regulations signal a 'farewell' to technical provisions

Technical provisions will no longer be the primary funding measure that trustees need to be concerned with, industry experts have said, with new regulations placing a greater focus on low dependency, and embedding the role of employer covenant for the first time.

The government launched a consultation on draft defined benefit (DB) funding regulations earlier this week, which will require DB schemes to have long-term plans set out in a funding and investment strategy, and to submit these plans to The Pensions Regulator (TPR).

Industry experts have welcomed the consultation as a major milestone, with Ross Trustees trustee director, Pavan Bhardwaj, also pointing out that the regulations will “effectively usher out technical provisions as the primary funding measure which trustees need to be concerned with, and instead shift the emphasis to low dependency or better”.

He stated: “While the long-term objectives were previously an aspiration, it now becomes a mandated and more narrowly defined target against which funding and investment strategy is to be set.

“As a result, de-risking schemes has effectively become mandatory, and so removes some flexibility for trustees and sponsors, though does provides greater protection for members. In some cases too, deficit contributions will need to be brought forward to align with scheme maturity.

“Many schemes with professional trustees in place have already moved past technical provisions and have been set their funding and strategic targets with reference to a long-term objective.

“These regulations, if adopted in full, will formalise this approach and force other schemes into compliance. A professional trustee can help these schemes to navigate the new funding code, when published, and work with advisers to ensure funding and investment strategy are suitable.”

Adding to this, Abrdn pensions senior solutions director, Brian Denyer, suggested that the changes could particularly impact smaller schemes, which may need to spend a higher proportion of their budgets on developing their funding and investment strategies.

"Indeed, DWP’s impact assessment that was published alongside the draft funding regulations identified that smaller schemes typically lag behind larger schemes when it comes to setting a journey plan to a low dependency target, and went on to expressly state that “the proposed changes are expected to have a disproportionate impact on small schemes”," he explained.

RSM partner and head of covenant assessment services, Guy Mander, also pointed out that, alongside providing further detail on key concepts such as low dependency, the regulations have embedded the concept of employer covenant in legislation for the first time.

This has been welcomed by industry experts, with PwC partner in employer covenant and restructuring, Katie Lightstone, for instance, arguing that, since the 2004 Pensions Act, covenant has been an “essential element of understanding the appropriate funding and investment risk” and, “often even more importantly”, in transaction or restructuring situations where the support for the scheme is changing.

“These changes come at an interesting juncture for many trustees and corporates who are seeing better than expected funding positions but also complex challenges to their covenant strength with significant uncertainty in the short to medium term,” she stated.

“The draft regulations signal a change to the assessment of covenant and steer trustees to do this by reference to the deficit on a low dependency basis which could see more prudent overall outcomes.

“Corporates may face more of a challenge to evidence the ability of their covenant to support scheme risk. Both trustees and sponsors alike will need to react to these changes when assessing covenant strength and considering an appropriate level of funding and investment risk.”

However, Cardano Advisory managing director, Alex Hutton-Mills, argued that whilst the regulations put covenant on a formal footing as the foundation of all DB pension strategies, the focus on a low dependency funding position could bring a "step change" in how liabilities are measured.

“The risk for sponsors is that higher funding targets (and trustee prudence) further complicate decisions on the use of the “marginal pound” at a time when management will be focussing on investment and liquidity decisions to ride out the current macroeconomic turbulence," he continued.

"Robust and specialist challenge of trustee covenant assessments will become essential, with wider adoption of creative solutions to protect schemes whilst preventing overfunding.”

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