Summary
The Pension Schemes Act 2021 requires defined benefit (DB) pension schemes to have a funding and investment strategy, for the purpose of ensuring that scheme benefits can be paid over the long term. They will also be required to report progress against their targets, including the main risks and mitigations, to the Pensions Regulator (“TPR”) in a statement of strategy. The draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 (the draft Regulations) set out the detail of these new arrangements and will be supported by a new code of practice from TPR.
The Secretary of State for Work and Pensions will have a duty to review the provisions, at least every 5 years.
Funding and investment strategy
The draft Regulations provide that a key principle the trustees or managers must follow when determining or revising their scheme’s funding and investment strategy is to be in, at least, a state of low dependency on their sponsoring employer by the time they are “significantly mature”. Maturity is to be measured using the duration of the scheme’s liabilities (on a low-dependency basis); TPR will specify in its code the duration corresponding to “significantly mature” (expected to be 12 years).
A state of low dependency on the sponsoring employer means that:
- the assets are invested in accordance with a low-dependency investment allocation and
- the scheme is fully funded on a low-dependency funding basis.
A low-dependency investment allocation means that the assets of the scheme are invested in such a way that:
- the cash flow from the investments is broadly matched with the payment of pensions and other benefits under the scheme and
- the scheme’s funding position is highly resilient to short-term adverse changes in market conditions.
The draft regulations prescribe how the strength of the employer covenant should be taken into account. The assessment of the covenant:
- should take account of the level of support that can be provided by any contingent assets,
- should be in the context of the size of the funding shortfall on the low-dependency basis or on the solvency basis (the latter to be considered in relation to the probability of the employer suffering an insolvency event).
Trustees will be required to set, and then review at each valuation, the “relevant date”, being their target date for achieving low dependency. The relevant date must not be later than the end of the scheme year during which the duration of the liabilities is expected to reach significant maturity (as defined in TPR’s code of practice). DWP envisages that trustees will first determine the date of significant maturity, on actuarial advice, then choose a relevant date. The trustees will then determine a low-dependency asset allocation they intend the scheme to have achieved by that date and a low-dependency funding basis consistent with that asset allocation.
The level of investment and funding risk that can be taken before the relevant date should take account of the strength of the covenant and the period remaining until the relevant date, less risk being appropriate where the covenant is weaker and/or the remaining period is shorter. These provisions should assist open schemes to justify more investment risk. Schemes should have sufficient liquid assets to meet expected benefit payments when they fall due, together with an allowance for unforeseen benefit payments such as transfer values.
The funding and investment strategy produced under the regulations will have to include:
- the way in which pensions and other benefits under the scheme will be provided over the long term (eg buyout, running on),
- the expected maturity of the scheme at the relevant date and
- the high-level asset allocation the trustees expect to hold at the relevant date.
The strategy must be reviewed in conjunction with each actuarial valuation or on a material change in:
- the value of the assets relative to the value of the scheme’s liabilities,
- the maturity of the scheme or
- the strength of the employer covenant.
Statement of Strategy
The Pension Schemes Act 2021 requires trustees to prepare a written statement of strategy, setting out the scheme’s funding and investment strategy (as described above) in Part 1 and “supplementary matters” in Part 2. Examples of the supplementary matters include:
- an assessment of whether the funding and investment strategy is being successfully implemented, or any remedial action the trustees intend to take to get the strategy back on course, and
- the key risks and mitigations for implementation and the trustees’ reflections on any key decisions and lessons learned,
- the actuary’s estimate of the scheme’s current maturity and how it is expected to change over time,
- the current asset allocation and level of investment risk and how they are expected to change over time,
- the current funding level of the scheme and the assumptions used to calculate the low-dependency funding position and
- an assessment of the strength of the employer covenant, how it has changed since the last assessment and how long it is reasonable to rely on the covenant.
Part 2 of the statement must be reviewed and, if necessary, revised after each review of the strategy.
Chair of trustees
If a trustee body do not already have a chair, they will have to appoint one. The chair is required to sign off the statement of strategy. The statement will then have to be submitted to TPR, along with the actuarial valuation.
Actuarial valuations
Under the new regulations (which will amend the 2005 Scheme Funding Regulations) technical provisions will have to be calculated consistently with the trustees’ funding and investment strategy. The actuarial valuation report will have to include:
- the actuary’s estimate of the scheme’s maturity at both the effective valuation date and the relevant date,
- when the scheme is expected to reach significant maturity and
- the actuary’s estimate of the funding level, on the trustees’ low dependency funding basis as at the effective valuation date.
The draft regulations amend the 2005 Scheme Funding Regulations to require the trustees, when determining whether a recovery plan is appropriate, to follow the principle that funding deficits should be recovered as soon as the sponsoring employer can reasonably afford. DWP also wishes to consider whether this new factor should have primacy over the existing matters and whether the existing factors (asset and liability structure, risk profile, liquidity requirements and age profile of members) are still relevant to recovery plans.