The Pensions Regulator (“the Regulator”) has recently implemented a revised version of Code of Practice 3 (“the Code”) for funding defined benefit pension schemes.
The Code has been updated to take account of the Regulators new statutory objective to minimise impact on the sustainable growth of the employer. The code recognises that a strong, ongoing employer alongside an appropriate funding plan is the best support for a well-governed scheme.
The revised Code is less prescriptive and more principles based and as such leaves scope for interpretation. There is no longer a ‘one size fits all’ approach where schemes will avoid the scrutiny of the Regulator provided they do not hit certain ‘triggers’. Each funding plan will be and should be unique to that scheme, and the circumstances of the sponsoring employer.
The Regulator recently held a series of sessions providing an overview of the changes implemented by the new Code and working through a practical real-life example to show how the principles should be applied in practice. The sessions were well attended and attendees originated from a variety of backgrounds including independent Trustees, member nominated Trustees, sponsoring employers and pension professionals.
Presenters on the day also originated from a variety of backgrounds including covenant assessment, actuarial and law, providing a holistic view of the Code from a variety of perspectives.
The sessions began with an introduction to the new changes, focusing on the need for Trustees to fully understand the level of risk inherent in scheme funding plans from the level of prudence contained in the technical provisions basis, to the level of risk in the investment strategy and the strength of the employer covenant. Risk should be assessed as a whole across all strands of a funding plan and if Trustees believe that they are exposed to a significant level of risk then they should mitigate this risk accordingly.
Delegates worked through a case study based on a scheme in the process of completing an actuarial valuation, a range of investment strategies had been proposed, and as such, a range of recovery plans had been proposed with varying investment return assumptions. The sponsoring employer was considering further investment in the business to support growth and had suggested paying lower contributions to the Scheme initially to support this growth strategy.
The new Code promotes employer investment and understands that a strong employer is the best support for a scheme, however this flexibility should not be used as a tool to defer contributions and Trustees should have a robust due diligence process in place to ensure any deferment of contributions is the best option for the scheme.
In the example given, the Regulator made the following points:
– Trustees should understand the expected returns from any investment in the business and should understand and document how these returns are to be split between the competing demands of the employer in future, including the pension scheme;
– Trustees should have in place robust contingency plans should any investment not provide the returns expected, this may involve contingent assets or increases in employer contributions based on certain events;
– Trustees should understand and quantify the risk they are exposed to should this investment not materialise. A decision should be made as to whether or not the employer is strong enough to absorb this risk and if not, mitigation should be put in place.
The Regulator will ask for evidence of the analysis Trustees have carried out in setting funding plans to ensure the level of risk exposure is acceptable.
Trustees should ensure they have a robust governance process in place to document any decisions taken, should the Regulator call for evidence.
In summary, Trustees should understand the strength of the employer covenant and ensure the level of risk exposure in the funding plan is consistent with this. Trustees should document all analysis and decisions made, and where there are uncertain risks, ensure there is a robust monitoring structure in place to take action should experience not turn out as expected.
The revised Code of Practice can be found at the following address:
For a summary of the Code of Practice 3 for funding defined benefit pension schemes read our recent blog highlighting the key changes.
Technology plays a key role when implementing a robust monitoring structure, watch our new defined benefit scheme management video for more information on how you can do this.