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DB Scheme Funding – Consultation On New Funding And Investment Strategy Requirements – Investment Strategy


The government has launched a consultation on draft
regulations
setting out the detailed requirements for the new
funding and investment strategy that trustees of DB occupational
pension schemes will be required to set.

By way of background, the Pension Schemes Act 2021 introduces an
obligation for trustees of DB schemes to:

  • Determine, and from time to review, a strategy for ensuring
    that benefits under the scheme can be provided over the long term
    (a funding and investment strategy).

  • Prepare a written statement of that strategy.

Funding and investment strategy

The key principle underlying the new funding requirements is
that by the time a scheme reaches significant maturity, it should
have low dependency on the employer. “Low dependency”
means that the scheme has sufficient assets to provide for accrued
benefits and is not, under reasonably foreseeable circumstances,
expected to need further employer contributions. To achieve this,
trustees must determine a strategy for ensuring that by and after
the time the scheme reaches the relevant date:

  • Its assets are invested in accordance with a low dependency
    investment allocation.

  • It is fully funded on a low dependency funding basis.

A scheme’s maturity is essentially how far the scheme is
through its lifetime. The scheme’s maturity will be determined
by the scheme actuary using a (weighted average) “duration of
liabilities”. The point at which a scheme will be considered
to have reached “significant maturity” will be specified
in the Pensions Regulator’s new DB funding code of practice. It
is likely to be when the scheme reaches a duration of liabilities
of 12 years.

The “relevant date” will be set by the trustees and
cannot be later than the end of the scheme year in which the scheme
actuary estimates that the scheme will reach significant maturity.
The trustees must review, and if necessary revise, the relevant
date each time the funding and investment strategy is reviewed.

The strategy must specify:

  • The funding level the trustees intend the scheme to have
    achieved as at the relevant date.

  • The proportion of scheme assets the trustees intend to be
    allocated to different categories of investments on the relevant
    date.

  • The way in which the trustees intend benefits to be provided
    over the long term e.g. whether to “run on” with low
    dependency on the employer or to target a transfer of liabilities
    to a consolidator or insurer within an agreed timeframe.

  • If the scheme has not reached the relevant date, the expected
    maturity of the scheme at the relevant date.

In determining the scheme’s journey plan to the relevant
date, the level of investment and actuarial assumption risk that
the trustees can take must reflect the strength of the employer
covenant (assessed using the principles set out the draft
regulations) and how close the scheme is to the relevant date. In
other words, the stronger the employer covenant and/or the further
the scheme is from the relevant date, the more risk the trustees
can take. The trustees must also ensure that the scheme’s
investments have sufficient liquidity to meet expected cash flow
requirements and to allow for unexpected cash flow
requirements.

Trustees must determine their first funding and investment
strategy within 15 months of the effective date of the first
valuation after the draft regulations come into force. The strategy
must be reviewed, and if necessary revised:

  • Within 15 months of the effective date of each subsequent
    valuation.

  • As soon as reasonably practicable after any material change in
    the circumstances of the scheme or the employer.

The funding and investment strategy must be agreed with the
employer.

Statement of strategy

The written statement of the funding and investment strategy
will comprise two parts. Part 1 must set out the funding and
investment strategy itself. Part 2 must cover a range of
supplementary matters, including details about implementation of
the strategy and about the scheme’s maturity, level of
investment risk, liquidity, funding level, employer covenant and
actuarial assumptions.

The trustees must consult the employer on Part 2 of the strategy
and the employer can request that its comments are included in the
statement. The statement must be signed by the trustee chair. If
the scheme does not have a chair, one must be appointed.

The statement must be prepared as soon as reasonably practicable
after the funding and investment strategy is determined or revised.
In addition, Part 2 must be reviewed, and if necessary revised,
after any review of the strategy, whether or not the strategy is
revised.

A copy of the statement must be submitted to the Pensions
Regulator with a copy of the actuarial valuation to which it
relates.

Other changes to the funding regime

The Pension Schemes Act 2021 amends the funding regime to
require trustees to:

  • Calculate the scheme’s technical provisions in a way that
    is consistent with their funding and investment strategy.

  • Submit a copy of the scheme’s actuarial valuation to the
    Pensions Regulator as soon as reasonably practicable after
    receiving it. (Currently, only schemes in deficit on a technical
    provisions basis are required to do so.)

The draft regulations will make further changes to the funding
regime, including requiring the scheme actuary to include an
estimate of the following in the valuation:

  • The scheme’s maturity as at the effective date of the
    valuation and as at the relevant date.

  • The date on which the scheme is expected to reach (or reached)
    significant maturity.

  • The scheme’s funding level as at the effective date of the
    valuation, calculated on the low dependency funding basis used in
    the funding and investment strategy.

The draft regulations will also add a requirement for trustees,
when setting a recovery plan, to follow the principle that funding
deficits must be recovered as soon as the employer can reasonably
afford.

Open schemes

The draft regulations impose the same funding requirements for
all DB schemes, regardless of whether they are open or closed to
new members and/or benefit accrual. However, the government
acknowledges that during the passage of the Pension Schemes Act
2021 through Parliament, concerns were raised that open schemes may
be forced into inappropriate de-risking and that this could lead to
unnecessary additional costs, and an end to such schemes. The draft
regulations are therefore intended to work in a way that does not
prevent appropriate open schemes from investing in riskier
investments where there are potentially higher returns, as long as
the risks being taken can be supported and members’ benefits
are effectively protected.

For example, on each review of the funding and investment
strategy, open schemes will be able to move the relevant date into
the future, in which case they would not be required to undertake
investment de-risking, if this is considered appropriate in the
scheme’s circumstances. The government also expects the new DB
funding code of practice to set out further detail on how the
characteristics of an open scheme can be taken into account in the
projection of scheme maturity.

Next steps

The consultation closes on 17 October 2022. The draft
regulations indicate that they will come into force some time in
2023. The Pensions Regulator has stated that it expects the new DB
funding code of practice to become operational in September 2023.
It therefore seems sensible for schemes to plan on the basis that
the new requirements will come into force in late 2023.

Many schemes will already have some form of long-term funding
target and journey plan in place. Trustees of such schemes should
discuss with their advisers what changes might be required to those
targets and plans in order to comply with the new requirements and
at what point those changes should be made. Where schemes do not
have a long-term funding target or journey plan in place, trustees
should discuss with their advisers what actions they will need to
take to comply and when those actions should be taken.

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This
Mayer Brown
article provides information and comments on legal
issues and developments of interest. The foregoing is not a
comprehensive treatment of the subject matter covered and is not
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