The Pensions Regulator’s new framework for defined benefit (DB) schemes is too rigid and fails to take into the unique issues faced by certain schemes, risking worse outcomes for members and employers.
In its report ‘Fast Track to problems?’, LCP highlights what it describes as ‘serious concerns’ about proposed changes to the way DB pension schemes are regulated.
In March 2020 TPR published a consultation on a new framework for regulating DB pensions. TPR sets out a dual track regulatory framework that provides pension scheme trustees a choice between two approaches to meet TPR’s new requirements on funding and investment.
The ‘Fast Track’ approach, which is expected to be chosen by a majority of schemes, uses standardised assumptions about investment returns and other factors, which could allow relatively swift TPR sign-off of pension scheme valuations.
A ‘Bespoke’ approach is available for trustees and sponsors who take the view that their scheme has distinctive characteristics which means that a standardised approach would not be appropriate.
It is expected that this new approach would be backed up by powers in the new Pension Schemes Bill which would enable TPR to impose an approach, centred around the Fast Track framework, if it was not happy with what the scheme was proposing.
LCP is concerned that the Bespoke approach does not go far enough in recognising the diverse nature of DB schemes, and still uses the ‘Fast Track’ approach as a benchmark even in cases where schemes face unique issues and where doing so could lead to worse outcomes for members.
LCP says a particular issue arises around TPR proposals which would push schemes towards more conservative, lower risk investment approaches. In some cases, this makes sense, it says, but in other cases this could increase the cost to employers whilst at the same time worsening the security of member benefits. The report uses an ‘integrated risk management’ model which takes account not just of investment risk but also of the risk of a company becoming insolvent. The model shows that in some cases pushing too hard for extra employer contributions or requiring excessive caution on investment could undermine the financial security of the employer and lessen the security of member benefits overall. TPR says that it agrees that ‘integrated risk management is more important today than ever’.
The report also highlights a number of areas where the proposed regulatory framework may not be a good fit for particular schemes. These include:
– The expectation that investment returns are benchmarked against the return on gilts (a ‘gilts plus’ approach), rather than reflecting the actual investment mix of the scheme;
– The lack of a special framework for open schemes – an issue on which the government suffered a recent defeat in the House of Lords – leading to increased pressure to close;
– The requirement to reduce reliance on the strength of the employer over an unrealistically short period;
– The risk that excessive pressure on employers to increase contributions could have an adverse effect on other stakeholders, including members of workplace DC arrangements which may be less well funded as a result;
LCP partner Jon Forsyth says: “The DB pension universe is incredibly diverse, and there is a real risk that these new requirements could force too many schemes into a one-size-fits-all mould. Whilst it is understandable that TPR wants to press trustees to reduce risk and employers to fill pension deficits as quickly as possible, our modelling suggests that if this is over-done then in some cases it could actually reduce member security. The idea of a ‘Bespoke’ funding regime is a good one in principle, but if it is too rigidly benchmarked against a standardised ‘Fast Track’ approach then it will not be flexible enough to reflect the diversity of DB schemes. It is important that anyone who has concerns about the proposals responds to the current consultation so that the final version of the new regime appropriately reflects the diversity of UK DB schemes.”
A spokesperson for TPR says: “We want to hear views from stakeholders on how we can set clearer expectations with regards to DB funding. Our proposed principles build on the importance of trustees setting a long-term objective and putting a realistic plan in place to get there.
“There is good evidence that schemes which have managed their risks well, and have built in sufficient resilience in their long-term funding strategy, are likely to have fared better as market conditions have worsened. Integrated risk management is needed now more than ever.”
“After the consultation closes on 2 September, we will consider the responses, prevailing market conditions, where schemes currently are and undertake an impact assessment to inform the setting of the proposed Fast Track parameters. We will subsequently consult on the funding code itself.”