Defined Benefit Scheme Funding: New Code Of Practice Issued By The Pensions Regulator

The Pensions Regulator has issued its new Code of Practice on Funding Defined Benefits, which replaces the existing Code published in 2005 shortly after the Pensions Act 2004 came into force. In addition to the Code itself, the Regulator has issued an Essential Guide and its Regulatory and Enforcement Policy for defined benefit funding. The Essential Guide is a short document providing an overview of the Code; but the Regulator has stressed that it is not a substitute for reading the entire Code – and that they expect all trustees to do so....

Some key points from the New Code

Trustees and sponsoring employers of defined benefit schemes should note the following:

• The Code encourages trustees and employers to work collaboratively and that trustees should adopt a holistic approach to assessing the funding, employer covenant and investment risks that they face
• Trustees should act in a proportionate manner. This means taking into account factors such as the size of the scheme in absolute terms and relative to the size of the sponsoring employer; the likelihood of employer covenant, funding or investment risks occurring and their impact if they do; the cost and benefit of any proposed approach. So, for example, in depth employer covenant analysis may not be required if the scheme is very small in comparison with a strong employer
• The Regulatory and Enforcement Policy divides covenants into four segments: strong, tending to strong, tending to weak and weak; although the Regulator recognises that this is a spectrum and three have no "cliff edges" between these classifications. We believe trustees and covenant assessors will move towards using these descriptions and the categorisation of these covenant segments in the Policy will be helpful to trustees in considering the covenant
• Trustees need to assess the employer covenant and how it may change in the future. The issuing of the Code has been driven in part by the new statutory objective for the Pensions Regulator of minimising any adverse impact on the sustainable growth of an employer when exercising its powers in relation to scheme funding under the Pensions Act 2004. This is reflected in trustees being encouraged to understand the plans the employer has for the future and the competing demands for the employer's resources. The Code acknowledges that "sustainable growth" will mean different things in different circumstances and encourages trustees to understand, in the context of the employer's circumstances, what would constitute success for the business
• The Code stops short of saying that trustees must obtain an independent analysis of the employer covenant (which would have been inconsistent with the proportionality principle). However, if trustees undertake covenant analysis themselves, they should document why they consider themselves sufficiently equipped, independent and experienced to undertake the work
• Trustees need to assess the likelihood of investment risks occurring and the ability of the employer to repair any deficit if they do arise. This means continued monitoring of the covenant. In addition, the more investment risk that the trustees are prepared to take, the greater the trustees' focus should be on the employer covenant available to support that risk
• Trustees should not compromise funding assumptions to result in lower employer contributions. This has been a consistent message from the Regulator since the Pensions Act 2004 first came into force
• Trustees need to consider the overall structure of any recovery plan – of which its length is only one aspect of that structure. Trustees are encouraged to recognise the flexibility available to ensure that recovery plans are appropriately tailored to the scheme and the employer's circumstances (including the employer's plans for sustainable growth). The "10 year limit" – which was only ever a trigger point for further Regulator consideration of a recovery plan – is firmly confined to history
• Between valuations, trustees should be alert to changes which might affect the investment and funding assumptions set at the last valuation. However, trustees should carefully consider whether bringing forward a valuation, if circumstances have deteriorated, is an effective use of their resources

The Code is subject to formal Parliamentary approval, which means it will not come into force until July, but it is not expected that there will be any further changes.

Links to the documents on the Pensions Regulator's website:

The Essential Guide to the DB Code

Code of Practice No 3 on the Funding of DB Schemes

DB Funding Enforcement and Regulatory Policy

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.