The new defined benefit funding code could land employers with a bill of £34bn, according to the regulator’s own estimates.
Pension consultants LCP points out that these “official figures” are contained in documents published by The Pension Regulator as part of its ongoing consultation process.
LCP says that prior to the publication of the TPR code consultation in December there had been no official estimate of the impact of these new rules. In July 2022 the Department of Work & Pensions declined to provide such estimates in its own consultation document, on the basis that the impact of the new regime would depend on TPR’s code.
In table 20 and Appendix 5 of the TPR consultation “Fast Track and our regulatory approach” it states the cost to firms of these new rules could be up to £34bn. LCP say that although this figure was published in December it was a part of a “lengthy” consultation document and has been largely overlooked.
TPR has calculated this potential bill on the basis that all DB pension schemes currently funded below the proposed level will ‘level up’ to the prescribed level.
LCP points out that there are a number of reason why this figures is likely to be an upper estimate of the potential cost. It says that these figures are based on market conditions as at March 2021, and scheme funding will have generally improved since that date. In addition some schemes may seek to adopt a ‘bespoke’ funding package, for example because their sponsor offers strong financial support or pledges so-called ‘contingent assets’ to stand behind the pension scheme, providing greater security and reducing the need for an immediate injection of cash.
However, LCP says that even if the final figure turns out to be lower than this, there can be little doubt that for some employers these new rules will represent a significant new or additional burden.
It adds that for some firms it may be impossible to meet the new rules whilst remaining solvent – and this might mean cuts to member benefits as a result. Even for those firms who can meet these new obligations, the legal requirement to clear deficits ‘as soon as reasonably affordable’ could curtail other business activities in some cases such as paying dividends, improving wages of the current workforce or investing in the business.
The Department of Work & Pension is strengthening DB regulation, following recent scandals that have seen the under-funding of these schemes at Carillion and BHS. This is proposed new framework is now in its final stages, following the passage of the Pension Schemes Act 2021, with the new rules are expected to come into force in October 2023.
LCP points out that a central feature of the new rules is that pension schemes will have to be funded on a ‘low dependency’ basis by the time they are ‘significantly mature’. The consultancy firm says that while exact definitions of both of these terms are still to be finalised, the assumption is that once schemes are mainly made up of pensioners they should be taking little investment risk, and not be calling on their sponsoring employer for additional funding.
In addition, the proposed new law says that trustees should expect employers to pay down any deficits “as soon as reasonably affordable”.
A key challenge for firms who sponsor pension schemes is that their scheme may not currently be funded at this level and they may not currently be planning to be funded at this level by the time they are mature.
Given that the DWP regulations give no indication of a transitional period, employers could find themselves receiving demands from schemes for large sums, collectively running into tens of billions of pounds.
LCP partner Michelle Wright, says: “The Government needs to be open about the potential impact of these new funding rules. The legal requirement to improve funding for schemes will apply at the first regular “valuation” of the scheme as soon as the new law is passed, which for some could be later this year.
“Employers could face demands from pension schemes collectively running into tens of billions of pounds over the following five years or so.
“Whilst everyone wants to see company pension schemes properly funded, this needs to be done in a proportionate way, rather than imposing rigid new rules overnight. In many ways, these new proposals are responding to the funding problems of years ago, when today’s world of pension scheme funding looks completely different.
“There is still time for the Government to think again and give schemes and their employers time to adjust to the new funding regime. Without this, some businesses could find they simply cannot afford what they are being asked for and could be at risk of insolvency, which is an outcome in no-one’s interest.”