Funding and Investment Regulations: five reactions

Following the Department for Work and Pensions (DWP) response to its 2022 consultation on the draft Funding and Investment Regulations in January 2024, Mark Tinsley shares five initial thoughts on the key changes made to the 2022 draft and implications for UK defined benefit schemes.

1. Striking a better balance

The 2022 draft was created to address flexibilities in the current funding regime that were being abused by a minority of schemes. The DWP took a more prescriptive approach in an attempt to make the funding standards clearer, but many felt the initial draft went too far, unnecessarily harming the majority of well-run schemes.

The amendments and clarifications announced this week strike a much better balance. While it is reasonable to wonder why it has taken so long to reach this position, ultimately, the pensions landscape is in a much better position now that the DWP has taken the time to listen to concerns that we and others in the industry raised.

2. Squaring the Mansion House circle

The biggest changes made to the draft regulations concerned scheme investments, where a series of significant amendments and clarifications were made. With these changes, the DWP state that even mature schemes can invest in a “wide range of assets beyond government and corporate bonds” and that open schemes in particular will continue to be able to invest a material proportion of assets in “high-growth” strategies where appropriate. The amendments also make it clearer that the power for trustees to set the investment strategy has not changed.

The changes also significantly reduce the tension that seemed to exist between the regulations and the Government’s more recent Manson House reform proposals, which amongst other things aim to encourage DB schemes to invest more in “productive assets” and to delay de-risking, potentially even running-on beyond buyout. Indeed, while there was plenty of industry feedback on the investment aspects of the draft regulations, it is possible that a change in Government focus as much as anything was instrumental in softening the requirements. 

Whatever the reason, the changes are welcome, and mean that the DWP can fully focus on developing the Mansion House reforms – hopefully, lessons have been learnt from #1 above and the DWP take the time to get the details right the first time.

3. A day without end

The concept of “significant maturity” - the point by which schemes need to be fully funded on a low dependency basis and planning to be invested in a low dependency asset allocation - is key to the regulations. 

The regulations confirm that significant maturity will be measured using a scheme’s “duration”. Due to the technical way that duration is calculated, there were concerns that significant maturity would be a moving target for schemes, particularly during times of market turmoil. To address these concerns, the DWP have fixed the economic conditions to be used for the duration calculations, choosing a date of 31 March 2023 for this purpose.
 

31 March 2023 market conditions

Pension actuaries will soon be used to the chart above

However, in trying to solve one problem, the DWP have potentially introduced a different set of issues. Specifically, there are technical issues associated with applying past market conditions to future valuations. While this is mainly stuff that will agitate actuaries, the DWP did not need to complicate matters in this way.

Instead, if DWP wanted to fix market conditions, a much simpler approach would have been to use single assumptions (for example, say gilt yield equal 4% p.a.). Better yet, the DWP could have left this kind of technical detail to The Pensions Regulator (TPR) to specify in the Code, which would have the additional advantage of flexibility should changes be needed in the future.

As it is, 31 March 2023 will now become something of a DB scheme Groundhog Day - a date where nothing ever changes, and tomorrow never comes.

4. Hope for a reduced compliance burden

The funding landscape has changed almost unrecognisably in the time that it has taken to finalise the new legislation. Many schemes who were potentially in the regulatory crosshairs will now be in much healthier positions due to recent rises in interest rates.

The compliance burden of the new funding regime therefore remains a concern, given that there is now a very small, and reducing, number of poorly funded schemes. However, a newly inserted clause in the regulations offers some hope. 

Specifically, the final regulations allow TPR to exercise discretion in respect of the amount of information that schemes will need to provide in their Statement of Strategy. Let’s hope that TPR makes good use of this power by significantly reducing the amount of information that well-funded and immature schemes (including many open schemes) will need to prepare and submit. 

5. Major Code changes unlikely

When TPR published its draft Funding Code in December 2022, several legal observers highlighted some potential inconsistencies in the guidance and the draft regulations, particularly where TPR appeared to be taking a pragmatic and liberal approach to interpreting the requirements.

To the extent that there were inconsistencies, TPR emerges victorious, with the final version of the regulations appearing to be more closely aligned with the draft Code, reducing the likelihood of significant changes being made to the latter. This is good news, especially for those schemes that have already taken steps to incorporate the guidance of the draft Code into their funding and investment strategies.

Nonetheless, uncertainty remains while the final version of the Code is unpublished, including in the crucial areas of knowing what duration is to be used for defining significant maturity and how employer covenant should be factored into investment decision making beyond this point. As such, DB schemes will be looking to TPR to finalise the Code as soon as possible. 

Further information

If you would like to discuss how these regulations may impact on your scheme, please get in touch with your usual Barnett Waddingham consultant.