The response to our draft DB funding code of practice consultation that explained our approach to the new defined benefit (DB) funding code of practice.
Published: 29 July 2024
Introduction
Overview
We held our second consultation on our first draft defined benefit (DB) funding code of practice from 16 December 2022 to 23 March 2023. This was published as part of a comprehensive consultation package, which also included a consultation on our proposed approach to Fast Track.
Here we set out the feedback received on the draft code we consulted on. We outline how we approached the final draft DB funding code laid in parliament on 18 July 2024 to address these responses. We have also aligned it with the final Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 (the regulations)1.
The final draft code embeds existing good practice into a clear funding standard. It builds on the existing framework and supports trustees to plan and manage the long-term funding of their scheme.
We are confident that the final draft code takes a balanced approach. It supports both member security in retirement, and flexibility for scheme-specific funding and investment approaches in the interests of members and employers.
We have provided further flexibility for trustees to recognise their scheme specific circumstances when taking funding and investment risk. This is particularly true at low dependency and along the journey plan. The final draft code does not impose restrictions on the investments trustees choose to invest in.
The final draft code also recognises the unique characteristics of open schemes. We have provided greater flexibility for trustees to take account future accrual and new members for a longer period when determining the future maturity of the scheme. This reduces the liabilities of open schemes compared to an equivalent closed scheme. We have also included a new open schemes module signposting our code guidance and expectations for open schemes.
Thank you to everyone who has dedicated many hours to this code over the years.
Together we have embedded good practice and developed a code that will support trustees to effectively plan and manage the long-term funding of their scheme going forward. Long-term planning and risk management are key. They are fundamental principles for good scheme management, no matter the backdrop.
The developing funding regime gives us the tools to be more effective in our regulatory activity to protect member benefits, enhance the pensions system, and support innovation. Embedding existing good practice into a clear funding standard will raise the minimum level of compliance for those who misuse the flexibilities in the system to be in line with the majority. We will also have a clear funding standard to regulate against and the information we need to effectively identify and respond to emerging risks in a targeted way.
We welcome discussion and innovative thinking across industry and our new government on how to improve pension outcomes and security in retirement. This code and the new funding regime provide important building blocks. They will help deliver on future policy initiatives and innovation in the DB pensions space in savers’ best interests. Setting a scheme-specific journey plan that takes supportable risk on the way to low dependency (not ‘no’ dependency), over time, schemes are likely to be in a better position to take advantage of new, emerging ideas. These will aim to improve outcomes for savers and provide greater opportunities for trustees and employers.
We look forward to continuing these discussions with you.
1 We refer to the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 as 'the regulations' or 'the final regulations' and the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 as 'the draft regulations' through the remainder of this document. References to specific regulations relate to the final regulations unless otherwise specified.
This document
First, we reiterate why this package of work was introduced, what it aims to achieve, and provide an update on how the different elements work together.
We then set out how we have approached finalising the DB funding code, including our extensive engagement programme and consultations. We touch on the key issues that have informed the development of our thinking and summarise the key changes made to the final draft code.
The document then covers in more detail the key issues raised in each section of the first draft code and how we have addressed these.
We have included a brief summary of responses and respondents in the appendix.
Background
The final draft code has now been laid in parliament. It is a key milestone in delivering the significant package of work to improve the security and sustainability of DB pensions.
In 2016, we saw some high-profile DB schemes collapse. This was against a backdrop of increased scheme funding deficits and a maturing landscape that faced new risks. These were associated with becoming more mature and having to pay out more of their funds as pension benefits to members.
A white paper set out to determine whether the flexible and scheme-specific funding regime was broken. It concluded in 2018 that the UK had a robust system that exhibited good practice. It was also largely working as intended, with most members expected to get their benefits in full.
Many trustees were already exhibiting good market practice. However, member outcomes were adversely affected by short-term thinking, and a lack of accountability and transparency over how risks are managed. It was important that trustees identified and managed these risks over the long term.
A minority misused the flexibilities in the system. This was due to a lack of clarity on what was needed from trustees to comply with requirements. This made taking enforcement action difficult and inefficient when needed. It was particularly difficult for trustees to understand what was required to comply with key legislative principles. This included the requirements that technical provisions be calculated ‘prudently’ and recovery plans set ‘appropriately’.
New legislative measures were introduced, building on the pre-existing regime from Part 3 of the Pensions Act 2004 to embed existing good practice into a clear funding standard that would:
- encourage greater long-term planning and risk management
- drive more trustee accountability and transparency
- support more effective and efficient DB funding regulation
The legislation was to be complemented by a revised DB funding code of practice, associated guidance, and a new statement of strategy to be submitted to us.
The key question was how to provide clarity to support trustees in planning the long-term funding of their scheme and drive more effective regulation of DB funding. We also needed to maintain the flexibility for schemes to reflect their scheme-specific circumstances in their approaches to funding and investment. Rather than reshape the existing system, we are embedding existing good practice into a clear funding standard.
The funding package
In this section, we summarise the different elements of the funding package. More detail on the legal requirements is set out in the legislation and the Department for Work and Pensions’ (DWP) consultation response. More detail on the final draft code is set out later in this document.
New legislative requirements
The Pension Schemes Act 2021 and the regulations are now in force. The new requirements will apply to scheme valuations with effective dates on or after 22 September 2024.
In summary, under the new requirements, trustees will be required to determine a funding and investment strategy. A plan for how they will deliver benefits over the long term. The funding and investment strategy will set out how the trustees plan to transition from the current funding position to low-dependency funding by the time the scheme is significantly mature.
Along the journey plan to low dependency, risk must be supportable by the employer covenant and the maturity of the scheme. Once trustees have determined or revised the funding and investment strategy, they must produce a statement of strategy outlining their approach to funding and risk management.
These new long-term planning requirements build on the existing need for trustees to carry out an actuarial valuation at least every three years. This is to show the most recent funding position of the scheme. If a scheme is in deficit on a technical provisions (TPs) basis at the effective date of the valuation, trustees must put in place a recovery plan (RP) to restore the scheme to full funding on the TPs basis.
Trustees must follow the overriding principles that steps must be taken to recover deficits as soon as the employer can reasonably afford. This must take into account, among other things, the impact on the sustainable growth of the employer.
The DB funding code
Under section 90 of the Pensions Act 2004, we are required to issue a code of practice on scheme funding. We have revised our code to reflect the legislative requirements.
We had expected the final draft code to be laid in parliament in June 2024 and to be in force on 22 September 2024 when new requirements would start to apply. However, this timetable was delayed due to the 2024 General Election.
The final draft code has now been laid in parliament.
There will be a regulatory gap between when the new legislative requirements start to apply and when the code is in force. The effective date of some of the first scheme valuations to fall under the new regime will be in this period. Schemes with effective valuation dates that fall in this period must comply with the new requirements set out in legislation.
The final draft code that has been laid in parliament provides practical and useful guidance on how trustees can comply with these requirements. Codes of practice are not statements of the law and there is not usually a direct penalty for failing to comply with them.
However, the regulations also delegate the power to define the point of significant maturity, measured using duration of liabilities, to the DB funding code.
In the final draft code that has been laid in parliament, we set out that a scheme reaches significant maturity on the date it reaches duration of liabilities of 10 years. For cash balance schemes, this is duration 8 years. We also include a proxy that can only be used by small schemes, as defined in the code, using the Fast Track approach.
We recognise trustees, employers and their advisers need certainty as they plan and make decisions regarding the funding of their scheme. The code that has been laid in parliament is a clear indication of what we intend the final code to be. Trustees, employers and advisers can use this final draft code to inform their approach. If the code is to change as a result of the parliamentary process, we will take this into account when assessing valuations.
We will be a proportionate regulator. We will communicate with schemes that have effective valuation dates in this period to give the support needed to limit disruption. However, we expect that for many schemes any disruption will be minimal.
Statement of strategy and our regulatory approach
In March 2024, we consulted on our proposed approach to the statement of strategy. There was broad support for our approach, introducing templates to ensure clarity, ease burden and provide consistency. However concerns were raised in relation to proportionality and burden and ensuring the approach works for all schemes in the landscape.
We are carefully considering responses and engaging closely with industry as we finalise our approach. We expect to publish the final statement of strategy and consultation response in the autumn.
We will communicate our approach to regulating DB schemes in due course.
We will be publishing the statement of strategy in a separate document to the code. This will retain flexibility to adjust our approach to the information we collect in the future. The statement of strategy aims to be a useful tool for trustees and us. It supports trustees’ long-term planning and risk management.
The statement of strategy also ensures we have the information we need to regulate effectively. It is key that we achieve these aims without unduly increasing burden on trustees.
We will publish a document setting out our approach to regulating DB schemes in due course. This will include more detail on our twin track approach and the regulatory filters we will use when assessing valuations to find which schemes’ statement of strategy we may want to look at in more depth or trustees we want to engage with to understand the funding approach in more detail.
A scheme that is flagged by our assessment filters is not necessarily in breach of the legislation. We expect many schemes’ statements of strategy to demonstrate how their approach is compliant and risks are being managed.
Additional guidance, including covenant guidance
We will publish our consultation on the updated covenant guidance in due course. This will focus on the main areas that trustees must consider when assessing the employer covenant under the code.
These areas include employer cash flows, prospects, contingent asset support, and the reliability and covenant longevity periods. We will also provide guidance on maximum affordable contributions and affordability for recovery plan purposes.
We will also review our existing DB funding and investment-related guidance. This review will consider whether any additional guidance is required to support trustees as they approach the long-term funding of their scheme. We will approach this in line with new government policy.
Consultation responses
Thank you to everyone who responded to our consultation and provided feedback directly to us through our continued engagement programme. This feedback has been critical to ensuring the final draft code is robust and fit for purpose for the broad range of schemes that make up the DB pensions landscape, both now and in the future.
A full list of respondents is available in Appendix B. Most of these responded to both our first draft DB funding code and Fast Track consultations, although not everyone responded to every question.
Our approach to the final code
We have prepared the final draft code to reflect the final regulations. We address key issues raised in responses to our consultation on the first draft code and our extensive engagement programme.
In this section, we summarise the key themes we have been considering when producing the final draft code. Key changes are listed under each section of the DB funding code. Here, it goes into detail on the key issues raised in the consultation and how we have addressed them. You can read a summary of the responses to our consultation questions in Appendix A: Summary of responses.
How we have engaged and consulted with government partners and industry
We have engaged closely with government partners and the wider industry to ensure the developing code delivers on the policy intent and works for real schemes. We have met with key industry figures, representative bodies, trustees representing DB schemes, employers and adviser firms. We have discussed our proposals in depth, carefully considered feedback and evolved our thinking to address concerns.
We first consulted on the developing funding regime in 2020. We sought views on our proposed regulatory approach, the principles that should underpin all valuations, and ideas on how these principles could be applied in practice.
The DWP published its consultation on the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 (the draft regulations) in the summer of 2022. We then consulted on the first draft code itself, before the regulations2 were finalised. This gave industry a clear view of how we saw the different elements of the regime working together and provided an opportunity to respond to this approach.
Many commentators were reassured by the first draft code’s flexible interpretation of the draft regulations. This was noted by the DWP in the government response to consultation. We worked closely with the DWP to share insight and learnings collected across both consultations.
We then continued our engagement to ensure the final legislative framework introduced a clear funding standard. It also had to maintain the flexibility of the scheme-specific regime, and carefully balance the security of member benefits with impacts for schemes and employers.
2 Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024
Key changes to the draft regulations
The DWP’s key areas of focus when finalising the regulations were to be explicit on the flexibilities that were already embedded within the regime. These areas included providing stability in long-term planning, recognising open scheme characteristics, and addressing concerns that the new regime would result in a disproportionate governance burden.
The DWP published its consultation response to the draft Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023 in January 2024, which sets out key changes to the draft regulations. These changes included the following areas of focus.
- Scheme maturity – introducing more stability in long-term planning by prescribing a fixed date for economic assumptions used to calculate maturity and significant maturity.
- Open schemes – introducing an allowance for new members and future accrual of benefits when determining the future maturity of the scheme, based on the employer covenant.
- Low dependency investment allocation (LDIA) – removing the broadly matched principle to ensure clarity on the level of flexibility provided in the LDIA.
- Funding and investment strategy and actual investments – clarifying that the LDIA is an objective for the funding and investment strategy rather than a principle that must be followed in the actual investment decisions. The objective is not a requirement and does not apply to surplus funding.
- Recovery plan – including a requirement for trustees to consider the impact of the recovery plan on the employer’s sustainable growth. The DWP confirmed the intention of the regulations was to provide reasonable affordability primacy over other matters when determining an appropriate recovery plan.
- Statement of strategy flexibility – ensuring TPR has discretion to ask for different levels of detail in Part 2 depending on schemes’ circumstances.
These key changes to the draft regulations have been reflected in the final draft code.
Key issues raised in the consultation
The first draft DB funding code was broadly well received and was welcomed for its flexible interpretation of the draft regulations. However, key themes emerged in the responses that helped develop our thinking and approach further.
The key themes included:
- stability in long-term planning
- how the notional investment allocation impacts actual decisions
- replacing prescription with a principles-based approach, including:
- flexibility for scheme-specific approaches to assessing ‘highly resilient’
- sufficient flexibility for scheme-specific approaches to risk taking along the journey plan
- appropriate flexibility for open schemes to reflect their unique characteristics and introduce a specific section in the code for open schemes
- further guidance on how to assess the key areas of covenant
- clarity on proportionality and what is expected of schemes in different circumstances
Ensuring stability in long-term planning
Responses to the DWP’s consultation on the draft regulations and our consultation on the first draft code raised concerns about the sensitivity to market movements of the proposed approach for determining scheme maturity. Respondents were concerned about the difficulties this sensitivity to market movements would create for long-term planning. The regulations addressed this issue by prescribing a fixed date on which assumptions to calculate future maturity must be based.
In the final draft code, we have reviewed the definition of significant maturity. The point of significant maturity is duration 10 years for DB schemes, and duration 8 years for schemes with cash balance benefits.
This review reflects a significant shift in market conditions since 31 March 2021 and the change in regulations as described above. It aims to keep the calendar date of significant maturity broadly consistent with what we proposed in our draft consultation. We also provide a proxy for smaller schemes (as defined in the code) using Fast Track.
How the notional investment allocation impacts actual decisions
Respondents raised concerns that the regulations should be updated to remove ambiguity over whether trustees are required to invest in line with the investments set out in the funding and investment strategy.
The final draft code is clear that investment decisions in relation to the scheme’s actual investment allocation are not constrained by the notional investment allocation. This applies both at low dependency and along the journey plan. The notional investment allocation is used to derive and support actuarial assumptions for funding purposes.
In most instances, we expect trustees to align their actual investment strategy with the funding and investment strategy. However, this regime does not interfere with trustees’ existing duties in relation to the actual investments of scheme assets.
Replacing prescription with a principles-based approach
Assessing ‘highly resilient’
The low dependency investment allocation module has been updated to reflect the amendments to the draft regulations, simplifying the definition of an LDIA to focus on being highly resilient to short-term adverse changes in market conditions.
In our proposed approach to assessing whether schemes are ‘highly resilient’, many noted the one-in-six stress test was not a standard approach. There were also some suggestions that 4.5% as a benchmark for the test was not a threshold that adequately reflected low dependency on the employer.
We have revised the final draft code to remove prescription as to how trustees should test the high resilience of their LDIA to provide the flexibility for trustees to carry out a suitable test for their scheme, provided they can be satisfied that it demonstrates low dependency on the employer.
There is flexibility embedded in the new funding regime for trustees to adopt scheme-specific investment strategies and invest in productive assets, both at low dependency and along the journey plan where appropriate and supportable. There are no specific restrictions on the assets trustees choose to invest in.
Scheme specific approaches to risk-taking along the journey plan
We consulted on a proposed test for trustees to determine the maximum level of risk that could be supported by the employer covenant.
While the principle was viewed as reasonable, concerns were raised over introducing a formulaic test to assess maximum risk. Issues raised included that the principle relied on subjective elements with little guidance in the first draft code on how to assess them.
Respondents also mentioned the principle didn’t apply to all scheme-specific situations and presented practical issues. Strictly applying the formula to schemes near the limit of affordability, with big deficits, or both, could create a ‘feedback loop’ whereby the test could never be satisfied. Another potential outcome was creating perverse incentives to reduce deficit repair contributions (DRCs) to demonstrate risk is supportable within the remaining affordability.
We have replaced this formulaic test with a principle-based approach, which recognises the different ways trustees assess risk, and the support for this risk. Trustees will need to demonstrate that the covenant can support the risk being run during the reliability period.
Trustees will also need to consider the impact of a downside event (at least one in six) over the reliability period to understand the potential end deficit following a stress event. They should compare this with the maximum affordability contributions and contingent asset support available over the same period. We also set out principles for risk-taking after the reliability period.
We plan to set out an updated test we will apply as an initial trigger for a regulatory risk assessment. This approach should provide greater clarity to trustees on what might be appropriate, without unduly constraining them.
Recognising open schemes’ unique characteristics
The code has been developed to recognise the unique characteristics of open schemes. However, we recognise there is a wide range of schemes that may classify themselves as open.
The regulations now allow for schemes to take account of future accrual and new members when determining the future maturity of the scheme, with the assumptions subject to the employer covenant. The final draft code that has been laid reflects this change. It aligns with the approach in the draft code we consulted on, which set out that this allowance could be used in funding.
However, following feedback, greater flexibility has been provided for the assumptions trustees can make for future accrual and new members. These changes reduce the liabilities of open schemes, compared to an equivalent closed scheme.
The final draft code provides greater differentiation between the way trustees intend to provide benefits (the long-term objective) and the requirement for trustees to set a journey plan to reach low dependency by significant maturity in the funding and investment strategy. These may not align for all open schemes, so trustees will be able to recognise that the scheme plans to remain open formally in the statement of strategy.
The final draft code also includes a new section that collates the guidance in the code for open schemes and provides easy signposting to support trustees.
Further clarity on how to assess the employer covenant
In addition to calling for greater alignment with the regulations, respondents challenged the subjective nature of the reliability and covenant longevity periods as key underpins for supportable risk. Respondents also requested greater guidance on how to address these in the code. Concerns were also raised on how to take a proportionate approach to assessing the employer covenant under the first draft code.
The final draft code has been updated to align with the final regulations and to provide greater clarity on how to assess the reliability and covenant longevity periods. We also set out our expectations on how long these periods should be for a typical scheme. In addition, we acknowledge that some employers may be able to demonstrate a longer period.
Proportionality
Proportionality remains a key theme throughout the code. We have made our expectations for trustees clearer. The final draft code sets out guidance on proportionality, including:
- setting the low dependency investment allocation and funding basis – the level of detail and analysis is expected to increase with the maturity of the scheme
- assessing the employer covenant and supportable risk – the level of detail required to assess the employer covenant depends on the size of the scheme relative to the covenant support, the scheme’s funding position, the level of funding and investment risk and scheme maturity
- statement of strategy – where trustees are asked to provide explanations or commentary, the greater the level and complexity of risk being taken, we expect a greater level of detail and explanation
The issues raised in consultation are set out in more detail in Appendix A: summary of responses to our draft DB funding code consultation. Key issues and how we have addressed them are set out in the next section.
Key changes by section of the DB funding code
The funding regime
An outline of the funding regime
The final regulations were amended to introduce greater clarity and address concerns raised by respondents.
Response
The funding regime module has been updated to reflect the final regulations. We set out the high-level requirements and provide detail and explanation where needed to set the context for the rest of the code.
We have included the important elements of the two key requirements: to plan for the long-term funding of the scheme and to carry out valuations showing the current funding position. As part of our description of the valuation, we have included a summary of the requirements of the recovery plan, which was not included in the first draft code.
Role and responsibilities
The appendices in the first draft code have been removed to align with the general code of practice. This also addresses uncertainty over the status of appendices in a code and whether this held evidential weight.
Response
The material previously featured in the appendices has been incorporated into the main body of the code including a new main section containing a summary of legislative requirements.
Low dependency investment allocation
LDIA as a notional investment allocation
The final regulations make it clear that trustees’ investment decisions, in relation to their scheme’s actual investment allocation, are not constrained by the requirements of the regulations.
Response
In recognition of this greater clarity, we have revised the final draft code to highlight the difference between ‘actual’ and ‘notional’ investment allocations. The latter refers to investment allocations that are used to derive and support actuarial assumptions for funding purposes.
The code makes it clear that the LDIA is a notional investment allocation from which a low dependency funding basis can be derived and supported. The code sets an expectation that for most schemes, investing in the best interest of members at and after the relevant date will mean investing in line with the trustees’ chosen LDIA. However, we recognise this will not be the case for all schemes.
When considering how much detail is needed to define their LDIA, and how complex the analysis should be to satisfy the principles set out in the code, trustees should be mindful that the LDIA is intended to be a notional investment allocation. Trustees should therefore be proportionate in their approach. Trustees can consider how far their scheme is from the relevant date when setting out the detail of their future investments.
We expect that the detail trustees need to define their chosen LDIA, and the complexity of the analysis carried out to select it, will reduce the further the scheme is from its relevant date.
Change to the definition of LDIA in the regulations
At the time of our 2022 consultation, the draft regulations’ definition of an LDIA required assets to be invested so that the cash flow from the investments was broadly matched with the payment of pensions and other benefits under the scheme. This provision was removed from the final regulations.
Response
The policy intent underlying the LDIA did not change. The final draft code now makes it clear that an LDIA must mitigate the risks associated with a significantly mature scheme relying on disinvestments to meet benefit outflow – specifically the risk of crystallising material funding level losses such that the deficit cannot be recovered without further employer contributions. This is also known as an asset spiral.
Trustees do not have to generate cash flows as the sole means of mitigating this risk. They can also rely on disinvestments from suitably liquid and low volatility assets.
Revised definition of ‘matching assets’ for the purposes of the LDIA
Concerns were raised in the consultation responses that defining ‘matching assets’ solely as cash flow generative assets, was potentially restrictive. Respondents asked that schemes’ ability to meet cash outflows from sales of liquid assets be recognised.
Response
We revised the final draft code to broaden the definition of matching assets. This change recognises consultation feedback as well as the removal of the ‘broadly matched’ principle from the regulations while retaining the same policy intent.
Cash flow generation remains a valid definition of matching assets in the context of mitigating the risk of an asset spiral. However, for the purposes of defining an LDIA, suitably liquid assets can also be recognised as matching assets, provided they are expected to experience low price volatility in both stressed and unstressed environments. The code now makes clear trustees’ flexibility in choosing the appropriate mix of matching assets for their scheme.
Flexibility in testing high resilience of the LDIA
Many consultation respondents noted the proposed one-in-six stress test was not a standard approach. They asked for further technical clarifications to ensure a consistent approach across industry. Some respondents mentioned that 4.5% was not a threshold that adequately reflected low dependency on the employer.
Response
We revised the final draft code to remove prescription as to how trustees should test the high resilience of their LDIA. Instead, trustees are expected to carry out a suitable test for their scheme, as long as they can be satisfied that it demonstrates low dependency on the employer.
Retaining a hedging target of 90% for the purposes of the LDIA
The consensus amongst respondents was that this target was unnecessarily prescriptive and high, in the context of the draft regulations and first draft code. At the time this included the ‘broadly matched’ principle and a prescriptive approach to stress testing ‘highly resilient’ (see above). Some concerns were raised on the difficulties of implementation, especially for small schemes.
Response
The final draft code retains the expectation that an LDIA targets interest rate and inflation hedges of at least 90% of the scheme’s low dependency liabilities. Given the removal of other prescriptive requirements, such as ‘broadly matched’ and specific stress testing of ‘highly resilient’, we believe that retaining this notional hedging level target will provide clarity around our expectations of the degree of funding level resilience that should be targeted in an LDIA.
Implementation concerns are also mitigated by the LDIA’s role as a notional investment allocation, allowing actual investment decisions to diverge from it.
Low dependency funding basis
'Most reasonably foreseeable circumstances’
Many respondents made comments in relation to the requirement that to meet the low dependency test, no further employer contributions would be required under ‘most reasonably foreseeable circumstances’. Some respondents noted this is not something that features in legislation and requested further explanation or examples. Others commented that the word ‘foreseeable’ potentially sets the bar very high and is quite different to saying ‘prudent’ or ‘expected.’
Response
We have added some wording to clarify with certainty that trustees are not required to eliminate the need for further employer contributions. They should be satisfied that the likelihood of requiring further contributions is small and, to the extent contributions are required, that they are small relative to the size of the scheme.
Discount rate approach
Some respondents said if appropriate for the scheme’s circumstances, trustees should be able to use other approaches to set the low dependency discount rate beyond the two main ones set out in the first draft code. Alternative approaches mentioned included a dual discount rate (with different rates pre- and post-retirement) and different additions to a risk-free rate for pensioners and deferred pensioners.
Response
We added some wording in paragraph 11 to confirm that trustees can take a different approach to setting the discount rate if it meets the legislative requirements. This enables trustees to choose, when appropriate, one of the other approaches suggested by respondents. This flexibility is now more explicit – we did not consider it necessary to list further specific approaches in the final draft code.
Yield curve approach for financial assumptions
Some respondents said it is not always necessary to use a yield curve approach, and this approach could be disproportionate for smaller schemes. In addition, some requested clarification that a ‘yield curve approach’ could be interpreted as allowing a single equivalent rate derived from yield curves using actual or proxy cash flows.
Response
We clarified that if trustees consider it appropriate, they may use a single equivalent discount rate derived from the full curve. We also explained why the use of the yield curve in deriving assumptions is more appropriate for larger schemes, which are more able to rely on projected cash flows.
Advice from scheme actuary
Some respondents suggested we include an expectation that trustees obtain advice from their scheme actuary when considering their low dependency funding basis. This is on the basis that trustees are required to take advice when setting their assumptions to calculate TPs, and that TPs are supposed to be consistent with the low dependency funding basis after the relevant date.
Response
We are now explicit that we expect trustees to take advice from their scheme actuary on the actuarial assumptions for the low dependency basis.
Dynamic discount rate
A number of respondents queried when it was appropriate to use a dynamic discount rate and how it should be calculated based on the yields available on the scheme’s assets.
Response
Our policy intent was that a dynamic discount rate is appropriate when the scheme’s actual investments are held in cash flow generative matching assets. The rate should also be based on the observed yield on those assets held. Our policy on this is unchanged, but we have added new wording to clarify our original intent. In addition, we have removed the reference to adjusting for downgrades when setting the rate.
Relevant date and significant maturity
Concerns over sensitivity of significant maturity to market conditions
The regulations define that the maturity of the scheme is assessed using the duration measure. The point a scheme becomes significantly mature is delegated to the code, and in our first draft code this was set to be at the point when the scheme had a duration of 12 years.
The duration measure is sensitive to changes in market conditions and the industry had raised concerns about this sensitivity. In particular, they were concerned that changes in market movements meant the date of significant maturity would change sometimes by many years between valuations. As this will be the critical metric in determining the relevant date (the point the scheme must reach low dependency), respondents raised the concern that the proposed regulatory approach would lead to difficulties in planning.
Response
We took the opportunity in the code consultation to discuss different ways this volatility could be addressed. Many respondents preferred the use of fixed assumptions (option 1 of 3), an approach that largely fixes the assumptions has been reflected in the final regulations.
We have revised the final draft code to reflect these final regulations.
Assumptions for duration calculations
The regulations state that economic assumptions must be set using the same methodology as used in the scheme’s low dependency funding basis, but set ‘with reference to the economic conditions at 31 March 2023.’ We recognise that this phrase could be interpreted in different ways.
Response
Following further engagement on this topic, we have set out our expectation in the final draft code for how economic assumptions should be derived. The consensus from our engagement was that we should set out our expectation to limit debates on methodology in this area. This could increase the burden for schemes – particularly on small schemes.
We expect the economic assumptions at each valuation will be set based on the economic conditions that applied at 31 March 2023, as if that were the valuation date. This approach will be required for schemes using the Fast Track submission route.
We do recognise that other approaches are possible and may be used in bespoke submissions. For instance, an alternative method suggested by many, was to use what the economic assumptions would be projected to be at the valuation date based on the economic conditions at 31 March 2023.
For example, under this approach, if the valuation was carried out on 31 March 2026 using a yield curve methodology, then the economic assumptions would be derived using the yield curve from 31 March 2023. However, the first three years of the yield curve would be ignored and the assumptions would be based on the 31 March 2023 yield curve from year 3 onwards only.
Overall, the difference between the two methodologies is likely to be small. The recent article by XPS entitled ‘New funding and investment strategy regulations: Keeping an eye on the details to ensure successful outcomes’ states this and recognises changes to other assumptions in the low dependency funding basis.
For example, the assumed take up of cash commutation is likely to have a larger effect on the calculation. Equally, changes caused by scheme experience or by a future review of regulations and point of significant maturity could have a more pronounced effect on the projected date of significant maturity.
Given the above, we chose our preferred approach as being simple and in line with the policy intention. This was to use fixed assumptions. Specifying a date in the regulations was a pragmatic choice to ensure assumptions that were needed now and in the future could be derived by the trustees and scheme actuary.
The final draft code reflects the final regulations which require non-economic assumptions to be the same as the ones used in the scheme’s low dependency funding basis. We recognise, for example, the choice of assumed commutation factors, and that there is not a general rule for whether they may be classed as economic or non-economic assumptions. Their categorisation will depend on how they are derived.
Point of significant maturity
Given the change to the definition of duration, we have revised the point of significant maturity. In the first draft code, we used a duration of 12 years, and this had been broadly agreed by industry as giving an appropriate timeframe to significant maturity for schemes.
Our analysis for the first draft code was carried out using economic conditions on 31 March 2021. As now required by regulations, we have determined the revised point of significant maturity using the economic conditions on 31 March 2023.
All other things being equal, we have considered what point of significant maturity would broadly give the same time period to significant maturity for all schemes. This does not mean this objective will be met for each individual scheme, but that it will be achieved on average across the universe of pension schemes.
Based on this analysis, we have selected a duration of 10 years for the point of significant maturity. We shared our proposed methodology in informal engagement and received broad agreement that it was a sensible approach. We understand that a duration of 10 years is within the range now expected by actuarial consultancies.
As part of the consultation, we asked if the approach to the point of significant maturity for Fast Track submissions should differ from that specified in the code. This is with Fast Track submissions required to use a higher number for duration for all schemes and therefore an earlier date for significant maturity. Most respondents were against this, and we have not adopted it.
Point of significant maturity for different types of schemes
The regulations are explicit that TPR has the power to set a different duration for significant maturity for different types of schemes. Following feedback, we have used flexibility to specify a different point of significant maturity for schemes with cash balance benefits.
Cash balance schemes, which provide a lump sum on retirement, have different characteristics to other DB schemes. These provide a pension for the lifetime of the members. These earlier payments of post-retirement benefits mean that cash balance schemes will have a lower duration than other types of schemes, even when arguably they are at a similar level of maturity.
Response
To allow for this, we have specified a duration of eight years for cash balance schemes compared to 10 years for other types of DB schemes.
We recognise that many schemes offer a combination of cash balance benefits and other benefits instead of providing only cash balance benefits. To reflect this, those schemes can use a weighted average of the different durations specified for significant maturity. The weighting to apply will be the liabilities relating to each type of benefit, with those liabilities calculated on the basis used to determine duration.
Treatment of smaller schemes
Respondents agreed with our strategy of taking a simplified approach for the calculation of projected duration for smaller schemes. We have therefore included the proxy used for smaller schemes in Fast Track in the final draft code.
This proxy is used for projecting the date of significant maturity, which is required by regulations. However, this requirement could be burdensome for smaller schemes who did not ordinarily produce cash flows as part of their valuation.
The introduction of this Fast Track proxy was well received and its inclusion in the code clarifies that schemes adopting it are following regulations. The Fast Track proxy has been recalculated reflecting the revised point of significant maturity.
Under our initial proposals, this proxy was previously available for smaller schemes who have fewer than 100 members submitting their valuation using the Fast Track route. We had some feedback regarding the use of this definition of smaller schemes and took the opportunity to ask further questions about this in our statement of strategy consultation. The feedback from this consultation included requests to make the definition broader to include more schemes.
Response
We have therefore changed the definition for schemes eligible for the Fast Track proxy, from schemes with fewer than 100 members to schemes with 200 members or fewer at the valuation date. Responding to feedback, we have changed the definition of members, which was previously aligned to legislation, to exclude:
- members who are eligible for lump sum death benefit only
- for hybrid scheme members with defined contribution (DC) benefits only
- fully insured annuitants where they are not included in the calculation of the TPs liabilities
This approach retains the simplicity of a definition based on membership numbers. Additionally, by extending both the definition as well as the number allowed, it now covers approximately half of all schemes. Further detail on this issue will be covered in the response to our statement of strategy consultation.
Allowance for new entrants and future accrual in projected maturity
The final regulations make a significant change in that, when projecting scheme maturity, open schemes can make an assumption for new entrants and future accrual. The assumption must be reasonable and based on the employer covenant.
This is an important addition to the regulations because an allowance for new entrants and future accrual means open schemes could assume they reach the point of significant maturity later than a closed scheme, and that they can plan to take risk for longer. When that is reflected in higher expected investment returns over the period to the relevant date and in the discount rates used to calculate technical provisions, it leads to lower liabilities for an open scheme than an equivalent closed scheme.
The final regulations reflect the approach we were already taking in the first draft code for the purposes of setting the TPs. We had made clear that the assumptions for new entrants and future accrual should be set with reference to covenant.
This approach was welcomed by most respondents. However, there were some who fundamentally disagreed with this treatment and would have preferred an exemption for open schemes that were not maturing from these requirements.
Response
We have refined our approach based on the feedback we have received (see below). We have also moved our expectations in respect of these assumptions for projecting scheme maturity from what was previously Chapter 9 (on technical provisions) to our new relevant date and technical provisions module.
Determining assumptions for new entrants and future accrual
Our initial expectations for determining the assumptions for new entrants and future accrual set out in the first draft code could be summarised as follows.
- The length of allowance for future accrual and new entrants must be no longer than the period cash flows can be reliably forecast (the reliability period).
- Trustees should consider to what extent it is reasonable to assume accrual continues.
- Allowance for new entrants should be evidence-based and prudent.
We asked for views on this approach in the consultation. In particular, we asked if the length of allowance for future accrual/new entrants should be restricted to the reliability period. The response was evenly balanced between those who agreed and those who did not. The latter wanted more flexibility and thought that covenant longevity was a better metric to use.
Response
Based on this feedback, we have made the requirements in the final draft code more flexible. We have kept the second and third principles outlined in the list above broadly the same. However, we have added more flexibility to the first with our expectation now that schemes can exceed the reliability period.
We still believe that the reliability period is a key metric. However, we recognise that for most schemes, that period is limited by the ability to forecast cash flows with reasonable certainty rather than any other reason. For schemes where the reliability period is limited by forecasting, we think it can be appropriate to exceed this period.
However, once you look beyond the reliability period, there is less certainty that new entrants will continue to join and that future accrual will continue to be offered. There will therefore be more risk in relation to that assumption and in the overall funding strategy.
We expect trustees to bear that risk in mind when setting this assumption. As a result, we only expect this assumption to exceed the period of covenant reliability for a limited time. The length of that period reflecting the uncertainty of the cash flows after this period and the additional risk of assuming future accrual and new entrants.
In any event, we would not expect trustees to assume that the period exceeds the length of covenant longevity. We do not think it is appropriate to assume there will be new entrants, future accrual, or both after the point where it is possible to forecast that the employer will still be operating.
In general, we would expect in most cases a scheme to cease accrual and allowing new entrants before an employer ceases operating. We would expect trustees to assume a shorter period than covenant longevity.
Therefore, we now set out our expectations that the assumption for length of allowance for future accrual and new entrants can be between the period of covenant reliability and the period of covenant longevity. It can, of course, be shorter than this.
This additional flexibility in our expectations can mean lower technical provisions for schemes who choose a lengthier period when allowing for new entrants and future accrual, compared to the provisions in our first draft code.
Allowance for buy-in benefits
Some respondents asked us to be more explicit about the treatment of insured benefits, where the assets and liabilities remain part of the scheme buy ins, and whether payments arising from these should be included in the calculation of duration, assets and liabilities.
Response
Our expectation is that such payments should be included, so we have added wording in the final draft code to make this clear. This is because a buy in remains an asset of the scheme and should be treated consistently.
Employer covenant
Alignment between code and regulations
Respondents asked for the wording in the code around some key covenant concepts to be aligned to the final regulations.
Response
The changes made to Regulation 7 of the regulations were mainly to ensure they reflected the desired policy intent and better aligned with the approach we took with the first draft code. The changes include the following.
- Incorporating the likelihood of an insolvency event occurring as a factor to consider when assessing the other matters that are likely to affect the employer’s future ability to support the scheme (defined as the employer’s prospects within the code).
- Introducing the requirement for trustees to consider how long they can be reasonably certain that they can rely on their assessment of cash and prospects, and that the employer will be able to continue to support the scheme, therefore providing a legal hook to the code’s definitions of the reliability period and covenant longevity respectively.
To ensure consistency with the regulations, we have also:
- made clear that an assessment of the financial ability of the employer to support the scheme should be in relation to its legal obligations to the scheme
- updated the definition of contingent assets so trustees should reasonably expect the contingent asset to be legally binding and of sufficient value
Multi-employer schemes
There was a concern that the draft regulations may not be appropriate for multi-employer schemes, as it could be interpreted as requiring trustees to perform a full covenant assessment for each employer to the scheme.
Response
Although the final regulations were not revised to provide a special provision for multi-employer schemes, we have updated the final draft code to explicitly recognise that a full assessment of each employer’s covenant may not be necessary for multi-employer schemes to achieve compliance with the objective of the legislation.
Assessing reliability and longevity
Respondents raised concerns regarding the subjective nature of assessing an employer’s reliability period and the scheme’s covenant longevity and requested further guidance.
Response
We have updated the final draft code to provide further detail on the areas that we expect trustees to consider when assessing these periods, and set out our expectations around what a ‘typical’ employer’s reliability period and scheme’s covenant longevity period is likely to be.
This is aimed to be a helpful guide for trustees. However, we acknowledge that these periods may be longer (or shorter) depending on specific employer circumstances. We recognise the importance for trustees to take a proportionate approach to their assessment of these periods and have provided further clarity on what trustees should consider when determining if a lighter or more detailed assessment is required.
For example, a higher-level assessment of the reliability period may be sufficient where the scheme has a shorter recovery plan and is running lower levels of risk relative to the level of covenant support. A more detailed assessment may be needed where reliance is placed on a period longer than the typical reliability or covenant longevity period.
Finally, in response to requests for further clarity on how covenant longevity factors into trustees’ decision-making, we have been more explicit within the journey planning module about the role it plays when considering risk-taking, post the reliability period. As referenced earlier, the code also makes it clear that where a scheme is open, the assumptions used for future accrual and new entrants must not exceed covenant longevity, and we would usually expect it to be less than this.
Contingent funding mechanisms
We were asked in our stakeholder engagement to provide greater clarity on contingent funding mechanisms.
Response
Given the important role contingent funding mechanisms can play in supporting risk-taking, these mechanisms have now been included within the definition of contingent assets. Further guidance has been provided within the employer covenant module on how trustees should attribute value to these mechanisms.
Visibility over employer forecasts
Respondents noted that the period over which trustees have visibility over employer forecasts did not directly feed into trustees’ decision-making around recovery plans or risk taking within the first draft code. They therefore questioned whether it should be defined in the code as a specific period for assessment.
Response
The final draft code has been updated to require trustees to assess only the reliability period and covenant longevity. Visibility over employer forecasts remains important. However, this is considered a starting block to assessing employer cash flows and determining an appropriate reliability period.
Covenant guidance
A significant proportion of respondents noted that it would be helpful to see the covenant guidance to better understand how the principles outlined in the code are expected to be applied in practice.
Response
We have increased the level of detail within the final draft code to provide greater clarity. Information on our covenant guidance consultation can be found in the introduction.
Proportionality
Most respondents raised concerns regarding proportionality when assessing the employer covenant under the first draft code. This included both the level of work required from trustees to make their assessment and the potential increase in costs where trustees use external covenant advisers.
The main areas of concern were in relation to determining the reliability period, covenant longevity and assessing employer prospects. Respondents also highlighted concerns that the code was not clear that reliance upon the employer covenant does not end when a scheme is fully funded on a low dependency basis.
Response
Proportionality remains a key theme throughout the final draft code. This is particularly true in the covenant and journey planning modules, where we set out clear expectations on what trustees should consider when determining the appropriate level of detail required when assessing covenant.
This includes the size of the scheme relative to the covenant support, the level of investment and funding risk and the maturity of the scheme. Also, where possible, we have provided further clarity around specific areas where a proportionate approach should be taken.
For example, we have included our expectation on the ranges for both the reliability period and covenant longevity. This should assist trustees in determining when a greater level of work will be required to justify the period used. For example, where a longer period is deemed appropriate, more work to fully evidence and justify this will be required.
We have updated the code to clarify that schemes that are fully funded on a low dependency basis remain exposed to covenant risk if funding levels deteriorate or there is an unexpected employer insolvency event. In this scenario, trustees should continue to monitor covenant, albeit in a light touch and more proportionate manner, to identify any material risks that could lead to the scheme not providing promised benefits to members.
Journey planning
The investment journey plan as a planned evolution of the notional investment allocation
The final regulations embed the funding elements of the journey plan in the funding and investment strategy. Separately, the trustees are expected to set out the level of risk they intend to take in relation to the investment of the assets of the scheme as it moves along its journey plan. Clarification was needed to explain how these two elements relate to one another.
Response
We’ve revised the final draft code to clarify that the journey plan consists of both funding and investment elements. While only the funding element is strictly part of the FIS, the investment element, which details the evolution of the notional investment allocation over the period to the relevant date, is necessary to derive and support suitable actuarial assumptions.
As the level of risk taken in deriving actuarial assumptions cannot be meaningfully isolated from the investment risk assumed in deriving them, the code sets out that trustees will need to consider the aggregate funding and investment risks when considering risk along the journey plan.
We expect that the actual investment allocation of a scheme will be consistent with the notional allocation set out in the investment journey plan. However, the code makes it clear that the trustees are not obliged to evolve the actual investment allocation in line with the investment journey plan, where they believe it is in the best interest of members to diverge from it.
Assessing maximum supportable risk
In our first draft code, we set out a detailed framework for how trustees should assess the maximum risk their schemes could support during the reliability period. We also provided a formula that trustees should use for this. Many respondents supported the principles but there was significant opposition and concern around the complexity of the approach outlined in the consultation.
Some concerns included that:
- a prescriptive, formulaic approach is not required by the regulations
- there is lots of subjectivity in the different elements of the formula which could lead to lengthy negotiations
- the formula could be very complex to calculate in practice and disproportionate for smaller schemes
- it was unclear how it would work for multi-employer schemes
We also recognise that strictly applying the formula to schemes in deficit whose employer has limited affordability could create a ‘feedback loop’. This would mean the test could never be satisfied, could create perverse incentives to reduce DRCs to demonstrate that risk was supportable within the remaining affordability, or both.
Response
We have considered the feedback from the consultation and moved away from a formulaic approach. Instead, we have provided principles for assessing supportable risk over the reliability period that trustees can refer to.
This includes the testing we expect trustees to do to satisfy themselves that the scheme has access to sufficient employer cash flows and contingent asset support over the reliability period to recover the existing deficit (if any) and any further deficit that could arise from a scheme-related stress.
At the same time, we will include a formula in our regulatory approach document, based on these principles, that we will use as a regulatory trigger for further investigation, engagement with trustees, or both.
The formula is likely to be based on what we consulted on in the first draft code but we have sought to address some of the issues raised by respondents and have developed it further. We recognise that this is a somewhat simplistic indicator, but it will help inform us whether further engagement with the scheme may be needed. It should also give trustees some clarity on how we will view supportable risk when looking at valuations submitted to us.
Principles for de-risking after the reliability period
There was some support for the principles underlying our proposals on de-risking after the reliability period but there were many concerns raised over the complexity of the proposals and the difficulty of understanding some of the provisions. There was also unanimous support for keeping scheme-specific flexibility in the journey plan shape and the way we had set out our expectations was seen as inflexible in places.
Response
We have re-written our expectations on journey planning after the reliability period to make it clear which factors trustees should take into account when considering how much risk to take. We also clarified that different journey plan shapes set out in the code are just examples of the sort of shapes that schemes could adopt, with no prescription to use a particular shape. At the same time, we have provided additional guidance on journey plans for open schemes and journey plans for limited affordability schemes.
Statement of strategy
Lack of detail on the statement of strategy in the code
Responses to our consultation noted that the statement of strategy section of the first draft code did not provide any further guidance or expectations than the draft regulations. It was suggested that a template or checklist could be produced to provide clear guidance.
Response
It is important that the statement of strategy retains the flexibility to adjust the information it requests from schemes to ensure we can evolve our approach over time to reflect the developing landscape. This would not be possible if the detail of the statement of strategy was included in the code.
We have updated the code to reflect the final regulation requirements, including that we have the discretion to ask for different levels of information from different types of schemes.
We have consulted on the proposed statement of strategy templates and are carefully considering responses as we finalise our approach.
Technical provisions
Consistency of technical provisions and the funding and investment strategy
In our consultation, we asked if respondents agreed with our expectations for describing the consistency between TPs and the funding and investment strategy.
Response
While the response was broadly positive, we received useful drafting suggestions which we have incorporated, noting there were some changes to the final regulations in this area compared to when respondents made their suggestions.
These changes include introducing more consistency in the wording of paragraphs 11 and 12. They also meant making it clear that paragraph 12 sets out our expectations rather than regulatory requirements. We have also removed the phrase 'actuarially consistent' and replaced with 'consistent' following feedback.
Cost of future accrual
The section on future service sets out the high-level principles we expect trustees to take when deciding on the cost of future accrual. A significant majority of respondents were in favour of our approach, which concentrates on principles.
Response
We have made some drafting changes to make clear that these principles are set with reference to determining the cost of future accrual, which was our intention. We did not intend for these to refer to whether future accrual should continue, which some respondents interpreted this section to mean.
Recovery plans
Reasonable affordability
Overall, respondents appeared positive about our general messaging on reasonable affordability within the first draft code. However, multiple respondents raised concerns that the wording in the draft regulations was not aligned with this more flexible approach, leaving the code open to legal challenge.
Many respondents also questioned whether reasonable affordability should have primacy or be given equal weighting to the other matters trustees must take account of in preparing or revising a recovery plan under Regulation 8(2) of the Occupational Pension Schemes (Scheme Funding) Regulations 2005.
Response
The DWP sought to address these concerns in the final regulations and through its consultation response. Here, they highlighted that it was their intention that reasonable affordability should take primacy over the other matters.
While the wording in Regulation 20(4)(a) of the regulations has been updated, we do not consider these changes to have a material impact on the key messages set out within the recovery plan module, as this was already the approach adopted in the first draft code.
We continue to consider that trustees must follow the overriding principle that steps must be taken to recover deficits as soon as the employer can reasonably afford. Any revisions to our wording have therefore been to provide greater clarity on our expectations.
For example, future reasonable affordability should be assessed at least on a year-by-year basis, with steps taken to reduce the deficit set in line with this assessment.
Trapped surplus
Some respondents raised concerns that this approach could lead to a trapped surplus.
Response
While the final regulations and final draft code don’t deal with this explicitly, the DWP has signalled that this will be considered as part of its ongoing consultation on surplus management.
Sustainable growth
Although the first draft code looked to provide more flexibility for investing in sustainable growth compared to other alternative forms of cash, concerns were still raised about prioritising the scheme over the sustainable growth of the employer. This could have a detrimental impact on the overall support available from the employer covenant over the scheme’s journey plan.
Respondents also requested more guidance on how to assess the benefits of investing in sustainable growth in a proportionate manner.
Response
In line with changes to Regulation 20(4)(b) of the regulations, we have added ‘the impact of the recovery plan on the sustainable growth of the employer’ as an additional matter that trustees must consider when preparing or revising a recovery plan.
To address the concerns above and to reflect the importance of sustainable growth as a key matter to consider when setting an appropriate recovery plan, we have elevated this to be the first principle that trustees should consider when assessing reasonable affordability.
Under this principle, we set out clear expectations around the areas trustees should consider when assessing the reasonableness of investing in sustainable growth. We also cover the information that employers should be providing to aid with this assessment.
We recognise that any assessment should be proportionate to the amount of available cash being utilised in the investment. This also applies to the extent that this elongates the recovery plan beyond the reliability period.
Where investment in sustainable growth results in the recovery plan exceeding the reliability period, we expect trustees to understand with reasonable certainty, the benefits of this investment to the scheme and employer. Where this is not possible, a suitable contingent asset could be put in place to support the extension of the recovery plan beyond the reliability period, if available.
Other areas such as funding level, maturity and the level of risk being run are additional key factors when assessing the reasonableness of investing in sustainable growth. These also apply in determining the level of work required to assess the benefits of this investment.
Other matters
Respondents raised concerns over a lack of clarity as to how reasonable affordability and ‘other matters’ interact with each other when setting an appropriate recovery plan.
Response
The final draft code now includes wording to clarify that the other matters for consideration have been considered when setting the general principles and expectations within the recovery plans module. Therefore, through application of these principles and expectations, all matters will have been satisfactorily considered.
Alternative uses of cash
A number of respondents commented that there could be a broader range of alternative uses of cash than those set out in the first draft code.
Response
We have amended the final draft code to acknowledge that other alternative uses of cash could be acceptable if the trustees can fully evidence and justify why these are reasonable. Trustees also need to be able to outline why these should be preferred to repaying the scheme’s deficit. The code outlines the expectation that trustees should apply the same overriding principles when assessing other alternative uses of cash.
Post-valuation experience
There was overwhelming agreement that the option of allowing for post-valuation experience (PVE) is important and should be acceptable. We set out a number of considerations in the first draft code which were felt to be reasonable, except where we said that trustees needed to be prudent on the amount of PVE they take into account. Respondents considered this could be misinterpreted as suggesting that only negative PVE should be considered.
Response
We have clarified that, as PVE items are volatile, they could easily reverse before the next valuation. Because of this, trustees should consider only taking into account a proportion of the PVE experience.
Investment outperformance
There was overwhelming support for the approach we set out around making an allowance for investment outperformance in recovery plans, and most respondents indicated a preference for the current principles-based approach.
However, there were calls for clarification on some of the detail. Some respondents were concerned that the first draft code implied that investment outperformance could only be supported by the employer’s cash flows and contingent funding mechanisms, rather than other suitable contingent assets, which was not our intention.
Response
We have updated the drafting considering the feedback including clarifying the following items in the final draft code.
- We have updated the wording in the code to confirm that investment outperformance should only be allowed for to the extent it is supported by the employer covenant (which includes employer cash flows and all forms of contingent asset support) and is consistent with the principles of taking supportable risk over the journey plan, as discussed in more detail in the module on journey planning.
- Investment outperformance after significant maturity should be in line with a low dependency investment allocation and therefore expected to be small and kept to a minimum.
- We generally expect recovery plan lengths to be shorter than or in line with the reliability period and would not therefore expect any allowance for investment outperformance beyond this period unless supported by the employer covenant (except in ‘employer stress scenarios’).
Investment and risk management considerations
Deviations of actual investment decisions from the notional investment allocations
Given the inclusion of the notional investment allocation and its evolution along the investment journey plan as a concept, clarification was needed around our expectations for how this would guide actual investment decisions.
Response
We revised the final draft code to acknowledge explicitly that no element of the funding and investment strategy or the journey plan interferes with existing trustee powers of investment, as set out in the scheme’s governing documents.
Trustees remain obliged to invest in the best interest of members. Our expectation is that, for most schemes, this will entail the actual investment allocation being the same as or similar to the notional investment allocation. However, this will not always be the case.
Short-term employer stress
Most respondents appeared to agree with expectations for how to deal with employer stress. However, some requested further clarification on how to deal with schemes where the employer has a high probability of insolvency, while others asked for further guidance on how we will be interacting with schemes with stressed employers.
Response
We have revised the final draft code to clearly distinguish between our expectations for schemes who are experiencing short-term employer stress versus schemes whose circumstances prevent them from complying with the principles for assessing supportable risk.
For those dealing with employer stress, we have looked to clarify that our expectations only relate to situations where employer stress is expected to be short term and there is a reasonable expectation that the employer will rebound in the near future.
Where the deterioration in covenant support is expected to be longer term or more permanent and could lead to insolvency, we have clarified that the current investment allocation and journey plan should be revised to reflect this position. We expect that steps are taken to help ensure that the scheme’s existing funding position is protected.
For further clarification on how we expect trustees to monitor and respond to employer distress, please see our guidance on protecting schemes from sponsoring employer distress. Given the circumstances relating to an employer distress event are often unique, we will need to consider these on a case-by-case basis.
Inability to support risk
As above, most respondents agreed with our approach to dealing with those schemes that may be unable to meet all the principles for assessing supportable risk. Some requested further clarification on whether unsupportable risk can be accounted for through the scheme’s TPs.
Other respondents suggested softening the requirements for trustees to consider stopping future accrual of future service benefits and winding up the scheme, given trustees may not have the power to do this.
Response
In this section, we have provided further clarification on what we mean by a scheme that cannot comply with the principles for assessing supportable risk as set out in the journey plan section and reach full funding by significant maturity.
In these circumstances, we expect trustees to reflect only supportable risk (limited as it may be) in the scheme’s notional investment allocation along the journey plan, consistent with the supportability principles set out in the journey planning section of the final draft code.
Consequently, trustees should place low reliance on the employer covenant when setting TPs, with limited risk-taking based on the scheme’s maturity. Where unsupportable risk is deemed appropriate to increase the chances of the scheme paying full benefits to members, we would expect this unsupportable risk to be taken through the scheme’s actual investment allocation only.
As suggested, we have also revisited our wording in relation to stopping accrual of future service benefits, making this subject to restrictions in the scheme rules.
We have also clarified that, where trustees and/or the employer consider wind-up the best option for protecting members’ benefits, they should seek appropriate advice and carefully consider the extent to which the employer might be expected to continue in the longer term. This could allow more time for the scheme to recover and member benefits to be paid in full.
Risk management principles
Everyone who responded agreed that the principles we set out around risk management are sensible, noting that implementation of risk management needs to be tailored to individual circumstances and varies significantly in its quality. Therefore, the key will be in how we will assess pragmatism and how it will be interpreted by advisers and trustees.
Suggestions for other areas to consider included:
- emphasising the importance of governance, climate and ESG-related risks
- examples of helpful dashboards for risk management
- what ‘proportionate’ risk management approaches and contingency plans might look like for small schemes on low budgets, schemes with weak employers and well-funded schemes running low risk
Response
In the final draft code we have updated the following.
- Drawn attention to the requirements of the general code, which has specific modules to assist trustees to develop an effective system of governance (ESOG) and to test its effectiveness through an own risk assessment (ORA). We have included guidance to allow trustees to manage the key risks from their funding and investment strategies within this framework.
- Clarified that trustees need to consider as part of their ESOG whether the difference between actual and notional investment risk is a key risk and, if so, to ensure that it is supportable by the covenant and to consider the effectiveness of their policy to manage the risk in their ORA.
- Referred to climate change risk in appropriate places throughout the code.
- Clarified our expectations from limited affordability schemes, whose circumstances are fundamentally incompatible with the funding regime as they cannot comply with the principles of supportable risk. We have provided guidance on the amount of unsupported risk they should consider in their actual investment strategy, as well as our expectations on how they should approach their journey plan and set their TPs in these circumstances.
Systemic risk
There was a general feeling that systemic risk cannot be eradicated and that the considerations we set out in the consultation were helpful mitigations to minimise such risk.
The majority of those who responded cautioned generally against the use of principles, rules, parameters and expectations in the code that could encourage trustees to adopt herding behaviours towards particular asset strategies, which may increase the risk of schemes collectively selling/unwinding these strategies in the event of unforeseen events.
Response
In the final draft code, we have addressed further ideas to encourage greater diversity between schemes and provide additional flexibility to mitigate systemic risk. These include:
- greater encouragement for trustees to consider tail risks
- reduction in requirements that may incentivise herding (such as the previous emphasis on broad cash flow matching)
- clarity on the flexibility and breadth of options available to trustees in making investment decisions, both regarding notional and actual investment allocations
- removal of what was perceived as a prescriptive approach to stress testing the high resilience of the low dependency investment allocation, as well as the assessment of supportable risk in the journey plan
Climate change risk
Some respondents pointed out that climate risk is an important consideration for trustees. One example of where this applies could be assessing the resilience of the investment portfolio or assessing the covenant.
Response
We have referred to climate change risk in appropriate places throughout the final draft code. Our revised covenant guidance will also include further direction for trustees on how to identify and assess climate change risks and opportunities in relation to the employer covenant as part of their wider assessment of ESG matters.
Open schemes
Add section for open schemes
As well as other issues discussed earlier in relation to open schemes, we received feedback that it would be useful for open schemes to have a separate section specific to them. People thought this would aid in recognising open schemes’ unique characteristics and act as a summary of how the code applies to them.
Response
Acting on this feedback, we have introduced such a section. This new section summarises the guidance specific for open schemes. It also signposts where this can be found in the code with the intention of it being a useful additional resource for open schemes.
Appendix 3: low dependency funding basis – expectations for setting assumptions
We received many useful and detailed responses, which has led to some significant changes to the drafting of this appendix.
Status of the appendix
Some respondents expressed confusion as to whether this (and other appendices) were part of the code or separate guidance.
Response
This and the other appendices included in the first draft code do form part of the code. We have clarified this further in the final draft by integrating the appendices directly into the relevant sections. For Appendix 3 this is the low dependency funding basis module.
Layering of prudence
A key theme from the consultation was that the appendix might imply that prudence was needed in every assumption, and if so, that a ‘layering’ of prudence on every assumption could lead to a basis that overall was too prudent.
Response
This was not our intention and we have added wording to make clear we expect schemes to consider the prudence of the basis as a whole when deciding on an appropriate assumption. This also addresses a concern that some respondents thought we were suggesting best estimate assumptions could not be used for any assumption.
Issue – level of detail
Respondents thought we should concentrate on principles in this appendix.
Response
We have edited our wording to streamline our messaging and avoid repetition. A key goal for the new regulatory framework is for more transparency in our approach and so we have retained more detail in this section than simply a reference to existing regulations as some respondents had asked for.
However, in light of this feedback, we have not added our expectations for carrying out scheme-specific analysis as a small number of respondents had requested.
Within the revised drafting we have also taken on board many individual comments. For example, we have made it clear that market-related factors can be assumed for cash commutation, where agreed future commutation factors can be allowed for. We also explicitly referenced ‘hard capping’ in our list of examples of actuarial models that might be used for pension increases.
Appendix 4: low dependency funding basis – allowance for expenses in low dependency liabilities
As noted under Appendix 3, this appendix has now been integrated in the low dependency funding basis module.
Issue – legal obligation to pay expenses
Some respondents called for less prescription in this area. Several asked that any legally binding obligation for future expenses to be met by an employer should be treated in the same way as an obligation set out in the scheme rules.
However, one respondent thought we should make it more explicit we are excluding any agreement made under the schedule of contributions. One respondent also suggested all schemes should be required to have an expense reserve regardless of the scheme rules.
Response
We have decided not to make significant changes. The final draft code sets out our expectations that will be appropriate for most schemes. We recognise that there may be some occasions where scheme-specific circumstances might mean that a different approach could be thought to meet the principles underlying our approach in the code as well as the legislative framework.
As we reference in the code, if the scheme is relying on the employer to pay ongoing expenses, this generates some dependency on the employer which may not be compatible with a low dependency basis. This could equally remain the case even if there is a separate obligation to pay expenses, depending on the nature of that obligation.
Therefore, we do not believe that the existence of any legal obligation would automatically change the expectations we have set out in the code. It would be impractical to codify the full range of approaches that may be appropriate. We therefore believe adding further prescription here would be unhelpful.
We have taken the opportunity to modify the wording to clarify that our expectations are based on any statutory employer being required to pay expenses under the scheme rules.
Issue – Future expenses to be included
Some respondents stated the expense reserve should cover expenses up to the anticipated date of buying out, then the costs of buy out and wind up, which may be lower than for indefinite run-on.
Response
When describing what we expect the expense reserve to be if the trustees’ long-term strategy assumes the scheme will run on, we have deleted the words ‘until all benefits are paid’. This leaves it open for trustees to consider what the expenses are likely to be over the whole lifetime of the scheme.
We recognise that in practice, even a scheme with a long-term strategy to run on would likely buy out at a certain point in the future once the scheme becomes too small to be economical.
Appendix A: summary of responses to our draft DB funding code consultation
An outline of the funding regime
Question 1: funding regime
We asked:
Are there any areas of the summary you disagree with or would like more or less detail? If yes, what areas and why?
You said:
Most respondents had general comments on our approach and suggested useful drafting changes, rather than specific disagreements with this section. A key theme was on the role of the low dependency investment allocation (LDIA) and whether trustees could depart from the LDIA in the actual investment decisions.
More detail was requested on where employer agreement was required, particularly focusing on the LDIA. The introduction of a new open schemes section was also suggested to signpost to all relevant guidance for trustees of open schemes.
Low dependency investment allocation
Question 2: matching assets principles
We asked:
Do you agree with the below principles for defining a matching asset?
- The income and capital payments are stable and predictable.
- They provide either fixed cash flows or cash flows linked to inflationary indices.
If not, why not? What do you think is a more appropriate definition?
You said:
Responses overall were supportive. However, there was a strong consensus that the definition is too restrictive and needs to be broadened. Respondents felt that the definition of matching asset should reflect other ways of matching besides the generation of cash flows.
Some concerns were also raised that the definition unintentionally excludes certain types of assets and investment vehicles from qualifying as matching assets.
Question 3: defining broadly matched
We asked:
Do you agree with our approach for defining broad cash flow matching? If not, why not and what would you prefer?
You said:
Responses were generally supportive, often welcoming the allowance for some cash flow matching combined with hedging of interest rate and inflation sensitivities. The most frequently raised observation was that the code appears more flexible than the underlying regulations (with respondents expressing a preference for the code’s approach).
The main objection was that the code should put less emphasis on cash flow matching and more on the availability of liquidity. Respondents were generally favourable on the flexibility offered by the code on investment decisions.
Question 4: assessing cash flow matching
We asked:
Do you think ‘draft’ adequately describes the process of assessing cashflow matching? What else would be appropriate to include in the code on this aspect?
You said:
Most respondents were supportive. Some suggested areas where the cash flow matching assessment process could be more clearly defined, but the majority favoured the less prescriptive approach taken in the code.
Question 5: categorising investments
We asked:
Should the code set out a list of the categories of investments into which assets can be grouped for the purposes of the funding and investment strategy? If so, what would you suggest as being appropriate?
You said:
Most respondents did not agree with including a list of categories of investments into which assets can be grouped. A wide range of reasons were given. These included concerns about excessive prescription restricting trustees’ investment powers, stifling innovation, and difficulty in categorising investments appropriately.
A minority of respondents supported the idea, but on the condition the categories were optional, or that we didn’t dictate which assets fall into which category.
Question 6: assets sensitivity
We asked:
Do you agree that 90% is a reasonable benchmark for the sensitivity of the assets to the interest rate and inflation risk of the liabilities?
You said:
Most respondents were not supportive of specifying a benchmark hedging level, noting that doing so would be too prescriptive. Where respondents gave a view on the proposed hedging level, most argued for a lower number than 90%. Several noted the need to clarify the basis on which the hedging is measured, and whether it refers to a percentage of assets or liabilities.
Question 7: cash flow matching and proportionality
We asked:
Should we, and how would we, make this approach to broad cash flow matching more proportionate to different scheme circumstances (such as large vs small)?
You said:
Many respondents felt there was no need to vary the code for different circumstances, noting the code’s existing flexibility in allowing schemes (particularly small schemes) to be pragmatic and proportionate in their application of broad cash flow matching.
The responses supporting clearer proportionality mainly mentioned smaller schemes, although most did not offer specific suggestions on how to achieve this.
Question 8: stress test
We asked:
Do you agree with our approach that a stress test is the most reasonable way to assess high resilience?
You said:
There was a fair balance of opinion in response to this question. The most common objections were that a range of risk metrics should be used, rather than just one, and that stress tests could be disproportionate or onerous for smaller schemes.
However, many supported the use of a stress test as a simple and accessible approach for all schemes. Several respondents noted that this requirement should be kept flexible and proportionate.
Question 9: maximum stress limit
We asked:
Do you agree that setting the limit of a 4.5% maximum stress based on a one year one-in-six approach is reasonable? If not, why not and what would you suggest as an alternative?
You said:
There was general wariness of this approach, but no clear consensus. Some respondents preferred more flexibility and less prescription in defining the stress criteria, while others requested detailed technical clarifications.
The code’s intended approach to a ‘simple’ stress test as a minimum standard was appreciated by some respondents. However, this did not come across to others, who instead perceived a requirement for more complex analysis. The most common response was noting that one-in-six likelihood is an uncommon parameter, not currently widely used in industry.
Many were comfortable with the proposed maximum threshold, which is a 4.5% limit. Some respondents queried whether it was either too constraining or not enough. Nonetheless, many respondents were supportive of the overall approach.
Question 10: stress test prescription
We asked:
Do you agree that we should not set specifications for the stress test but leave this to trustees to justify their approach? If not, what would you suggest as an alternative?
You said:
Most respondents agreed that we should not provide prescription. Common reasons given included:
- avoiding restricting innovation
- maintaining flexibility
- minimising herding behaviour that may lead to systemic risks
Question 11: liquidity and proportionality
We asked:
Do you agree with our approach for not expecting a detailed assessment of liquidity for the low dependency investment allocation since we have set out detailed expectations in relation to schemes’ actual asset portfolios?
You said:
There was near unanimous agreement with the proposed approach. Supporting comments noted that the low dependency investment allocation will frequently be set far in advance of being in force, and that liquidity planning should be based on actual market conditions and the actual assets held at the time of reaching significant maturity.
Low dependency funding basis
Question 12: stochastic analysis
We asked:
Do you agree with our approach to not expect a stochastic analysis for each assumption to demonstrate that further employer contributions would not be expected to be required for accrued rights, but rather focussing on them being chosen prudently? If not, what would you suggest as an alternative?
You said:
There was widespread support for the approach and no responses supported requiring a stochastic analysis. Reasons for agreeing with our approach included the following:
- requiring a stochastic analysis would be onerous and expensive, especially for small schemes
- assessing prudence is a well-established process when determining the TPs basis
- schemes are still free to adopt a stochastic approach if they wish
Many responses raised linked points on the definition of ‘prudence’ and requested that ‘reasonably foreseeable’ be clarified in the definition of the low dependency funding basis.
It was noted that ‘reasonably foreseeable’ potentially sets the bar very high and there were requests for further explanation or examples of what trustees should consider.
Question 13: discount rate approaches
We asked:
Do you agree that the two approaches we have set out for the discount rate for the low dependency discount rate are the main ones most schemes will adopt? Should we expand or amend these descriptions, if so, how?
You said:
The majority supported our view that the two discount rate approaches are the main ones that most schemes will adopt. There were requests to state more explicitly that trustees can use other discount rate approaches if appropriate for their scheme circumstances.
A few alternatives were suggested, like a dual-discount rate, or a different addition for pensioners and deferred pensioners as a proxy to buy-out costs.
Some respondents raised technical points on the dynamic discount rate, in particular whether credit can be taken for the return on cash flow matching assets not yet bought. A few comments challenged the general expectation to use yield curves, viewing this as disproportionate for smaller schemes. They also queried whether a single equivalent rate derived from the curve could be used.
Several respondents suggested including an expectation that trustees obtain advice from their scheme actuary when considering their low dependency funding basis, to align with the requirement for TPs assumptions.
Question 14: other discount rate methodologies
We asked:
Should we provide guidance for any other methodologies?
You said:
There was widespread consensus that guidance for other methodologies is not required. Some respondents raised similar points to those summarised under Q13 above and a minority called for asset-based discount rates to be included as an additional option.
Question 15: other assumptions
We asked:
Do you agree with the guidance and principles set out in Appendices 3 and 4 of the draft code? Are there any specific assumptions here you would prefer a different approach? If so, which ones, why and how would you prefer we approached it?
You said:
In respect of Appendix 3, responses to this question covered a range of assumptions with many offering useful comments specific to the individual assumptions, as well as the overall approach. Considering the appendix as a whole, many thought that giving expectations for each individual assumption (as in Appendix 3) was too detailed.
Many respondents also felt our approach may lead trustees to include more prudence than is required, particularly for smaller schemes. A number also asked for clarity if the appendix formed part of the code. Some respondents queried if our intention was not to allow best-estimate assumptions.
A small number also suggested we make clear when we would consider it proportionate for a scheme to carry out an analysis of scheme-specific experience. In addition, as referenced, we received detailed comments on elements of the drafting for individual assumptions, particularly in relation to the cash commutation factors.
In respect of Appendix 4, very few responses argued against including any expense allowance. Some called for a less prescriptive approach, like simply requiring trustees to make an ‘appropriate’ allowance for expenses. Several respondents asked that any legally binding obligation for expenses to be met by an employer should be treated in the same way as an obligation set out in the scheme rules.
However, another said that an expense reserve should be required for all schemes, viewing any dependency on the employer to pay expenses as incompatible with low dependency.
Many respondents asked to allow expenses to be paid into an escrow account, to avoid trapped surplus. A few asked to clarify the requirement where the employer has a legal obligation just to meet part of the expenses.
Others thought the expense reserve should cover expenses up to the anticipated date of buying out, then the costs of buy out and wind up, which may be lower than for indefinite run-on. Some noted an expense reserve would be proportionately larger for smaller schemes. There were suggestions for shortening and clarifying the section.
Relevant date and significant maturity
Question 16: duration approach for small schemes
We asked:
Do you agree that a simplified approach to calculating duration for small schemes is appropriate?
You said:
A significant majority of respondents agreed that using a simplified approach was appropriate. However, many respondents queried the definition of ‘smaller’ schemes, requesting clarity or further guidance. Some noted that could mean small schemes were defined as fewer than 100 members in line with elsewhere in the code and in the Fast Track consultation.
Other respondents mentioned they would prefer there to be a broader definition of a smaller scheme. This could either be based on the size of the scheme’s liabilities or a higher number of members. A few respondents questioned whether a simplified approach could be used by all schemes, given the difference in the answer is small. Some respondents asked for clarity on the treatment of buy ins for the calculation of duration.
Question 17: earlier significant maturity point in Fast Track
We asked:
Do you think setting an earlier point for significant maturity within Fast Track as compared to the code (as described in option 3 in this section of the consultation document) would be helpful for managing the volatility risk of using duration? If yes, where would you set it and why?
You said:
The vast majority were against setting an earlier point for significant maturity within Fast Track compared to the code, which was Option 3 in the consultation document. Many respondents preferred a version of Option 1, which involved using a fixed set of low dependency assumptions when calculating duration, as an alternative.
Many respondents also mentioned that the definition of significant maturity should be reviewed and we should adopt a materially lower duration of liabilities than 12 years.
Employer covenant
Question 18: visibility, reliability, longevity
We asked:
Do you agree with the definitions for visibility, reliability, and longevity? If not, what would you suggest as an alternative?
You said:
Very few respondents disagreed with the definitions of visibility, reliability, and longevity. However, the majority felt that these terms were very subjective, making them difficult to calculate (particularly if trustees are not allowed to provide a date range) and could lead to material differences in opinion between trustees, sponsors, and advisers.
Many respondents requested access to the covenant guidance to better understand our expectations on how to assess these periods in a proportionate manner.
Question 19: cash flow
We asked:
Do you agree with the approach we have set out for assessing the sponsors cash flow? If not, what would you suggest as an alternative?
You said:
Most respondents agreed with the approach to assessing cash flows. However, most felt that calculating free cash flow was subjective but also did not want the code to be overly prescriptive.
Further guidance was requested on what adjustments should be made when assessing cash flow forecasts. This included transfer pricing and distinguishing between maintenance costs versus investment in sustainable growth. Respondents also requested more guidance on when liquid assets could be taken into account.
Question 20: prospects
We asked:
Do you agree with the approach we have set out for assessing the employer’s prospects? If not, what would you suggest as an alternative?
You said:
Almost all respondents agreed with the approach as outlined for assessing employer prospects, although most encouraged the code and regulations to be more aligned in the way they deal with the risk of an insolvency event. Multiple respondents requested that the assessment of prospects be explicitly linked to the trustees’ assessment of reliability, and not just covenant longevity.
Most respondents agreed with the list of factors to assess employer prospects. However, they also noted that this would require additional work, which could be costly. More guidance on proportionality was encouraged as the current level of detail requested will be too onerous and expensive, particularly for small schemes.
Question 21: contingent assets
We asked:
Do you agree with the following principles we have set out for contingent assets?
- They are legally enforceable.
- They will be sufficient to provide that level of support.
If not, what would you suggest as an alternative?
You said:
Most respondents agreed with the principles set out in the regulations and code. However, many respondents were concerned that a too prescriptive approach would not fully capture the benefits that a lot of contingent assets provide. This includes ensuring trustees are informed on a timely basis of any employer-related events that could impact the employer covenant, like a potential transaction.
Respondents also noted that an overly prescriptive approach here could disincentivise employers offering contingent support, particularly when no credit is given for these for scheme valuation purposes. Respondents asked for more guidance and examples. They also requested clarification of what is meant by ‘legal enforceability’ in the code and guidance.
Question 22: security arrangements
We asked:
Do you agree with the approach we have set out for valuing security arrangements? If not, what would you suggest as an alternative?
You said:
Most responses agreed with the way security is valued. However, many of them also requested that we use a similar valuation approach as the Pension Protection Fund (PPF), so trustees do not incur unnecessary cost in valuing security in two different ways. There were also comments around potentially excessive costs in respect of valuing security in general.
Some respondents did not think the value attributed to security should directly correlate to taking additional risk as implied in the maximum supportable risk test. This is especially relevant when the security cannot be accessed to support a scheme stress event.
Most respondents noted that asset-backed contributions and contingent funding mechanisms were not covered in the code and asked for further guidance on these areas. They also requested more guidance on when it would be proportionate to incur the time and cost of revaluing contingent assets.
Question 23: guarantees
We asked:
Do you agree with the approach we have set out for valuing guarantees? If not, what would you suggest as an alternative?
You said:
Most respondents were in broad agreement with the approach on valuing guarantees. Their primary concern was that the focus on look-through guarantees could discourage and disincentivise employers from providing other types of guarantees. These could offer the scheme much needed additional covenant support.
Further guidance and examples were also requested on how to value guarantees.
Question 24: multi-employer schemes
We asked:
Do you agree with the approach we have set out for multi-employer schemes? If not, what would you suggest as an alternative?
You said:
Almost all respondents agreed with the overall approach to multi-employer schemes in the code. However, they requested examples be included in the guidance for multi-employer schemes and non-associated multi-employer schemes.
Almost all respondents also noted that the code does not differentiate between associated and non-associated multi-employer schemes and suggested that this be added. Concerns were raised that the draft regulations may not be appropriate for multi-employer schemes. This was because this could be interpreted as requiring trustees to perform a full covenant assessment for each employer to the scheme.
Question 25: not-for-profits
We asked:
Do you agree with the approach we have set out for not-for-profit (NFP) covenant assessments? If not, what would you suggest as an alternative?
You said:
Most respondents agreed with the broad principles set out for NFPs, although with some reservations. Concerns were raised on how to apply the code principles set out in the employer covenant module to varying types of NFP employers, with requests made for further guidance on how this is expected to be done.
Respondents suggested that NFPs should be allowed to take more credit for balance sheet assets than other types of employers.
Journey planning
Question 26: approach to maturity
We asked:
Do you agree with how we approached how maturity has been factored into the code? If not, what would you suggest as an alternative, with reference to the draft regulations?
You said:
There was broad agreement that it is reasonable for maturity to be a key determinant of the level of acceptable risk. Where respondents expressed concerns, some highlighted the approach as ‘one-size-fits-all' and potentially unsuitable for open schemes.
Other respondents noted the potential for cliff-edge de-risking in journey plans (for example once significant maturity is reached) and transitional problems for those already near significant maturity. Some wished for the proposed focus on maturity-based de-risking to be complemented by funding-based de-risking.
Several respondents also commented more broadly that the proposed measure of maturity (market-based duration measure) is too volatile.
Question 27: journey plan structure
We said:
Do you agree with the way in which we have split the journey plan between the period of covenant reliability and after the period of covenant reliability? If not, what would you suggest as an alternative?
You said:
Most responses agreed with the principle, but queried how practical the proposals are. Many responses noted that covenant reliability periods are subjective and potentially volatile. Some highlighted a lack of TPR guidance on how covenant reliability should be measured.
Some responses perceived the proposed approach as too complex for small schemes. Where alternatives were put forward, they were based on:
- less formulaic structures focused on pragmatism and flexibility
- looking at journey plans holistically
- understanding how the covenant can underwrite them
Question 28: stress test
We asked:
Do you agree that trustees should, as a minimum, look at a one year one-in-six stress test and assess this against the employer’s ability to support that risk?
You said:
There was widespread agreement with the principle that risk taken should be supported by the employer covenant. Some respondents supported the one-in-six stress test proposal, seeing it as helpful for smaller schemes.
However, many of the other respondents expressed concerns ranging from:
- its utility as a decision-making tool
- the possible cost burden of this analysis
- doubt regarding whether the proposed test parameters are prudent enough
Many respondents raised concerns on the subjective nature of the assumptions required. They suggested some alternatives, including a principles-based approach, or one that allowed scenario analysis.
Question 29: focus on cash
We asked:
Do you agree that if trustees are relying on the employer to make future payments to the scheme to mitigate these risks, then the trustees should assess the employer’s available cash after deducting DRCs to the scheme and other DB schemes the employer sponsors?
You said:
There was support for the principle of deducting DRCs when considering available cash. However, several respondents highlighted practical complications and potential unintended consequences.
These range from the difficulty in factoring in how other schemes with the same employer sponsor might react to a stress event and affect employer affordability, to encouraging employers to seek to reduce DRCs to increase the scope for risk-taking.
Question 30: maximum risk
We asked:
Do you agree that this approach is reasonable for assessing the maximum risk that trustees should take during the period of covenant reliability?
You said:
Many supported the underlying principles but there was significant opposition and concern around the complexity of the proposed approach. It was noted that the maximum risk formula could be very complex to calculate. This could potentially lead some schemes to incur costs disproportionate to the practical benefit they would generate.
It would also add further steps to already complex negotiations between trustees and employers. Many respondents expressed a preference for the maximum risk formula to form part of illustrative guidance rather than to be in the code itself. Such guidance could also more generally help schemes, especially smaller schemes, approach this issue in a proportionate way.
Question 31: de-risking after covenant reliability
We asked:
Do you agree with the considerations we have set out regarding de-risking after the period of covenant reliability?
You said:
Respondents offered mixed views on this. While the underlying principles gathered some support, many responses raised concerns over the complexity of the approach, including possible disproportionate cost impacts of regularly updating the analysis. They also highlighted lack of clarity in some of the provisions.
Some respondents mentioned possible unintended consequences ranging from shifting the market from funding level based de-risking triggers to fixed time-based triggers. Another concern raised was potentially encouraging a greater level of risk-taking than is currently the case during the reliability period. This could continue for longer if the reliability period keeps getting extended.
Some responses also noted that the underlying approach is too simplistic, preferring a less prescriptive approach.
Question 32: journey plan shape
We asked:
Do you agree with our approach of not being prescriptive regarding the journey plan shape?
You said:
There was unanimous support for flexibility. However, many commented that the journey plan section as a whole is very prescriptive and inflexible. Several respondents perceived that the journey plan shape post-reliability period would be constrained to linear de-risking.
Question 33: maximum risk shape
We asked:
Do you agree with our approach that the maximum risk trustees should assume in their journey plan is a linear de-risking approach where they are taking the maximum risk for the period of covenant reliability?
You said:
Most respondents agreed with the principle of reducing risk as the ability to rely on covenant diminishes. Linear de-risking for schemes taking the maximum risk was generally thought to be a sensible approach for many schemes. However, there were many comments noting that linear de-risking might not be appropriate in all cases, preferring a less prescriptive approach.
Statement of strategy
Question 34: statement of strategy
We asked:
Do you agree with our explanation of the statement of strategy? Are there areas it would be helpful for us to expand on in this section?
You said:
Respondents felt that the draft code did not provide any further clarity on the draft regulations, or any explanation concerning the level of detail required for the various aspects of the statement of strategy.
Concerns were raised that the statement of strategy may be lengthy and burdensome. There were calls for a template or checklist for clarifying expectations on the level of detail required for different types of schemes, and what needs to be agreed on with the employer.
Technical provisions
Question 35: consistency of technical provisions with the funding and investment strategy
We asked:
Do you agree with how we have described the consistency of the TPs with the funding and investment strategy? If not, why not? What would you suggest as an alternative?
You said:
In the main, there was a positive response and the majority agreed with our approach. There were some queries of a specific use of the word “must” in the code. Our use of the phrase ‘actuarially consistent’, as opposed to just consistent, was flagged as being confusing by some.
Question 36: open schemes – allowance for future accrual
We asked:
Do you agree that open schemes could make an allowance for future accrual, and thereby funding at a lower level, without undermining the principle that security should be consistent with that of a closed scheme?
You said:
There was broad support for this proposal. However, some respondents wanted an exemption for open schemes from funding and investment strategy requirements. Some examples could be:
- open schemes in a steady state
- immature open schemes
- open schemes with other special characteristics
Some of those respondents thought those then exempt should have to have contingency plans in place covering the scenario that the scheme closes. A small minority of respondents did not like the wording referencing the principle of equal security applying to all schemes. They felt such wording was unnecessary and unclear.
Question 37: open schemes – period of covenant reliability
We asked:
Do you agree that this should normally be restricted to the period of covenant reliability? If not, why not? What do you suggest as an alternative?
You said:
There was a relatively evenly balanced response to this question, but most respondents disagreed to some degree. There were concerns that covenant reliability would be too restrictive and difficult to assess objectively.
Some respondents believing that covenant longevity would be a more appropriate measure. Covenant guidance, including how to evidence longer covenant reliability periods, was viewed as important by some respondents.
Some respondents wanted the freedom to use other measures in different circumstances. In addition, a few thought it should be left to the trustees to decide.
Question 38: approach to future service costs
We asked:
Do you agree with our principled based approach to future service costs? If not, why not? What do you suggest as an alternative?
You said:
Most respondents agreed with the proposal. Some thought our wording implied that trustees should be considering whether to ‘allow’ future service to continue rather than determining the contributions required for the future cost.
Recovery plans
Question 39: reasonable alternative uses
We asked:
Do you agree with our approach to defining reasonable alternative uses? If not, why not and what would you suggest as an alternative?
You said:
Most respondents considered the guidance in the draft code to be helpful. They felt that the three main alternative uses of cash it identified captured most circumstances of competing interests and fair treatment. These three main alternative uses of cash are:
- investment in sustainable growth
- covenant leakage
- discretionary payments
However, many responses expressed reservations relating to the conflict between the narrow requirements of the legislation and the more flexible interpretation in the draft code. There were also frequent calls for further clarification on some aspects of implementing the guidance in practice.
Question 40: reasonable affordability
We asked:
Do you agree with the description in the draft code of the interaction between the principles that funding deficits must be recovered as soon as the employer can reasonably afford and the matters that must be considered in Regulation 8(2) of the Occupational Pension Schemes (Scheme Funding) Regulations 2005?
You said:
Respondents were generally positive about our messaging on reasonable affordability. Most respondents focused on the conflict between the draft legislation and the draft code, keen to emphasise that affordability should not take precedence over all other relevant factors in the legislation.
Many respondents pointed out that a narrow interpretation of the new requirement would make affordability the only driver for setting a recovery plan. The more nuanced interpretation in the draft code was generally welcomed.
However, some respondents felt it could be open to challenge given potential misalignment with the draft regulations. The preference generally was for the regulations to be aligned with the draft code.
Question 41: employer’s cash
We asked:
Do you agree that reliability of employer’s available cash should be factored in when determining a scheme’s recovery plan length?
You said:
A large majority of respondents agreed that the reliability period should be a factor in determining recovery plan length as it is a key consideration when assessing covenant support and affordability of contributions.
However, almost all respondents emphasised that this measure should not be applied in a formulaic manner. This is because it is one of many factors to be considered, and there may be some situations where it is reasonable for the recovery plan length to be longer than the reliability period.
Many respondents also referred to the qualitative nature of the reliability period and its subjectivity as a result. They noted that this could lead to tensions between stakeholders, such as trustees, employers, and their advisers.
Question 42: alternative uses of cash
We asked:
Do you agree with the principles we set out when considering alternative uses of cash? If not, which ones do you not agree with, and why? What other principles or examples would it be helpful for us to include?
You said:
In general, respondents agreed with the principles set out for considering alternative uses of cash.
Some concerns were raised over the practical application of individual principles. This might include prioritising DRCs over dividends, particularly where they are considered to be part of the normal course of business.
Another example could be prioritising DRCs over sustainable growth, which could detrimentally impact the overall support available to the scheme from the employer covenant over the scheme’s journey plan. The interaction between the different principles was also considered to be less clear.
Respondents commented that where the principles are open to different interpretations, more clarity was required about flexibilities available and our expectations. Respondents requested more guidance on assessing the benefits of sustainable growth investment in a proportionate way.
Question 43: recovery plan structure: post-valuation experience
We asked:
Do you agree with our approach to post-valuation experience? If not, why not and what you suggest as an alternative?
You said:
There was overwhelming agreement that the option of allowing for post-valuation experience is important and should be allowed. Respondents felt that the considerations set out in the draft code were all reasonable except one.
The exception was on the consideration about prudence, which could be read as enabling trustees only to allow for post-valuation experience if it results in a higher deficit or DRCs but not a lower deficit or DRCs.
Question 44: recovery plan structure: investment out-performance
We asked:
Do you agree with our approach to investment outperformance? If not, why not and what you suggest as an alternative?
You said:
Except for one individual respondent, all those who commented on this said they were in favour of trustees having the option to make an allowance for investment outperformance in recovery plans. This would apply to the extent that it could be supported by employer covenant or contingent assets, where plans were in place to mitigate risk of investment underperformance, or both.
There were requests for clarification on some points, including:
- which contingent assets could be used to support investment allowance
- if investment outperformance could be allowed for after significant maturity or after the reliability period
Question 45: recovery plan structure: risk protection
We asked:
Should we set out more specifics around what we would expect by way of security to protect against the additional risks?
You said:
On balance, respondents were positive about the expectations and principles-based approach set out in the draft code and did not feel that further specifics were required. Some respondents expressed concern that more specifics being included may result in the code being too prescriptive. This could limit the ways contingent asset structures could be used to manage and mitigate risk.
Some respondents interpreted the current drafting as meaning that the only contingent assets that could be used to support investment outperformance were contingent funding mechanisms. They requested that other contingent assets be considered alongside this.
The general principle that trustees should satisfy themselves that they are taking an appropriate amount of risk in the context of their circumstances was considered reasonable by respondents.
Responses also noted that this could be enhanced by requiring trustees to consider what the implied recovery plan position will be at the next valuation if no investment outperformance is achieved. An alternative to this could be applying a more comprehensive test around poor investment returns overall.
Respondents also queried whether the covenant, including any third-party contingent asset support, would be able to afford the resulting increase in DRCs. Here, it would be preferable for the employer to be made aware of the contribution risk and able to pre-identify the support that would be provided to keep the journey plan on track.
Investment and risk management considerations
Question 46: consistency of investment decisions with funding and investment strategies
We asked:
Do you agree with our approach that, while trustees’ discretion over investment matters is not limited by the funding and investment strategy, we expect investment decisions by trustees should generally be consistent with the strategies set out in the funding and investment strategy? If not, why not? What would you suggest as an alternative?
You said:
The responses were generally positive, although some respondents highlighted concerns that, by requiring employer consent on the funding and investment strategy, trustees may face difficulty in achieving their investment obligations. These were particularly aimed at the draft regulations.
Queries were raised about whether the code could further clarify that trustees’ existing investment powers are not altered by the draft regulations or the draft code. Respondents also asked if the code could clarify that employers only need to be consulted on changes in actual strategy set out in a scheme’s statement of investment principles.
Further clarity was requested on what should happen if the trustees and employer cannot agree on the funding and investment strategy or the statement of strategy.
Question 47: examples where there is inconsistency
We asked:
Do you agree with the examples we have given for when trustees’ investment strategies may not mirror their funding and investment strategy? Are there other examples we should consider?
You said:
Most respondents agreed with the examples provided. However, there were comments that examples cannot cover every set of circumstances, and that trustees and advisers should not feel constrained if their specific situation is not included.
A common concern was the risk of confusion regarding the interaction of the statement of strategy with the statement of investment principles, with requests for clarification that the former one cannot override the latter.
Question 48: stressed employers
We asked:
Do you agree with the expectations regarding trustees with stressed employers? If not, why not? What would you suggest as an alternative?
You said:
Most respondents agreed with the approach to stressed employers and those schemes that may not be able to meet all the principles for assessing supportable risk. However, some appeared confused regarding which expectations applied to one or both scenarios.
When dealing with stressed employers, some respondents requested further clarification on how to deal with employers that have a high probability of insolvency. Others requested further guidance on how we will interact with schemes that have a stressed employer.
Some respondents required further clarification on whether unsupportable risk can be accounted for through the scheme’s TPs. Others suggested we soften the requirements for trustees to consider stopping future accrual and winding up the scheme.
Question 49: integrated risk management
We asked:
Do you agree with the principles we have set out regarding risk management? Are there other aspects it would be helpful for us to include?
You said:
All respondents agreed with the high-level principles detailed in the code. Several respondents expressed a wish for further guidance offering examples of good practice on matters of:
- governance
- climate and ESG-related risks
- suitable and proportionate risk monitoring
- management approaches and contingency plans
These respondents noted such guidance would be particularly helpful to small schemes with limited time and governance budgets.
Question 50: liquidity principles
We asked:
Do you agree with the principles we have set out regarding liquidity? If not, why not? What do you suggest as an alternative?
You said:
The consensus was decisively in favour of the code’s proposed approach to liquidity. Most respondents who provided feedback suggested minor amendments.
The area that gathered most feedback pertained to guidance on leveraged LDI and related liquidity guidance. Some respondents wanted this guidance to be expanded and made more specific, while others asked for it to be reduced and made more generic.
Question 51: security, profitability and quality
We asked:
Do you agree with how we have approached security, profitability and quality? If not, why not? What do you suggest as an alternative?
You said:
All respondents were in favour of our approach. However, some noted a lack of detail in this section, and highlighted that the section was not user friendly. This was because the section redirected readers to other areas in the code where these issues apply.
Question 52: investments – other aspects to be included
We asked:
Are there other aspects it would be helpful for us to include?
You said:
Most respondents were in favour of our approach. Some noted an expectation that we would include guidance on responsible investment or ESG integration in the code. A few specific drafting suggestions were made, such as being clearer on what we mean by ‘liquidity’.
Question 53 – Systemic risks
We asked:
Whether the checks and balances we set out in the draft code are such that the code and regulations were unlikely to create material systemic risks?
You said:
Respondents were in overall agreement that the code captures the key systemic risks dynamics. However, several perceived the code as reinforcing current market practice, and thus not addressing existing systemic risk.
Suggestions for improving this included, amongst others, more stringent stress tests, which would allow for capturing more tail risks. Another suggestion was reducing prescriptive interpretations of the regulatory regime that may incentivise herding into a narrow set of investment opportunities.
Question 54 – Systemic risks
We asked:
Do you think there are any areas of systemic risk that should be considered further in light of our draft code? If yes, please explain your response.
You said:
Most respondents cautioned against the use of principles, rules, parameters and expectations in the code that could encourage trustees to adopt herding behaviours towards particular asset strategies.
Of particular concern was:
- concentration in a small set of matching assets
- herding towards a narrow set of end-game options (specifically buy out)
- the use of prescription (for example, in stress testing) which might drive further coordinated behaviour
Respondents expressed a wish for TPR to recognise greater diversity between schemes. They generally agreed that flexibility would help, particularly for employers with strong covenants or those prepared to provide contingent security or other protections.
Appendix B: list of respondents
- 3M Pensioner Action Group
- A&O Shearman
- Aon
- ARC Benefits Ltd
- Arc Pensions Law LLP
- Association of Consulting Actuaries (ACA)
- Association of Pension Lawyers (APL)
- Association of Professional Pension Trustees (APPT)
- Atkin Trustees
- Barnett Waddingham
- BlackRock
- British Airways Pensions
- British Telecommunications plc (BT)
- BT Pension Scheme Management Ltd
- Buck
- Cardano Group
- CBI
- CFA Society UK
- Chairty Finance Group
- C-Suite Pension Strategies
- Dalriada Trustees Ltd
- David Miles
- Deloitte
- Dennis Leech
- Dominic May
- Employer Covenant Practitioners Association (ECPA)
- Ernst & Young LLP
- First Actuarial
- Freshfields Bruckhaus Deringer LLP
- Hewlett Packard Pension Association (HPPA)
- Insight Investment
- Institute for Family Business (IFB)
- Isio
- Jonathan Pickering
- Law Debenture
- LCP
- Mablethorpe & Sutton Town Council
- Make My Money Matter
- Mercer
- Milford Haven Port Authority DB Pension Scheme
- Penfida
- Pension Protection Fund
- Pensions Management Institute (PMI)
- Pi Partnership Group
- PLSA
- Raleigh Pensions Scheme
- Redington Ltd
- Royal Mail
- RSM UK Restructuring Advisory LLP
- Samworth Brothers Limited
- SAUL
- Schroders Solutions
- SEI
- Siemens
- Spence and Partners
- STV Group plc
- The Co-operative Group Limited
- The Institute of Chartered Accounts of Scotland (ICAS)
- The Investment Association
- The Society of Pensions Professionals (SPP)
- Transport For London (TFL)
- Trustee of UCW Pensions 2001
- UNISON
- University of Cambridge
- USS
- Willis Towers Watson
- Zephyrus Partners
- Zurich Financial Services UK Pension Trustee Ltd
- 20 respondents did not want to be named or did not confirm otherwise