Consulting Actuaries

New DB Funding Code – a tough balancing act?

Royal London Consulting Actuaries

28 July 2014

The Pensions Regulator (TPR) has revised Code of Practice 03 (Funding Defined Benefits) to deal with its new objective on Scheme Funding: “to minimise any adverse impact on the sustainable growth of an employer”.

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Download the new DB funding code (PDF)

TPR’s existing objectives remain in place and focus on trustees’ requirements to comply with their fiduciary duties and ensure that scheme benefits can be paid as they fall due.  The new objective adds an extra dimension to trustees’ thinking in that it requires them to consider the employer’s requirements to develop the business.

Easier said than done?

TPR is keen to re-state that the best hope for a DB scheme is an ongoing and viable employer.  Hence the new objective.  TPR encourages trustees to build up a good understanding of the nature of the employer’s business – and how any plans for sustainable growth might enhance the employer’s covenant.  This may be far from straightforward in some cases, depending on how comfortable the employer is about being “open”.

Trustees will be aware of their ongoing requirement to have a view on the continuing strength of the employer.  However, they may find that the balancing act between carrying out their “normal” duties (to act in the best interests of the members) whilst giving point to “sustainable growth” pleas from the employer is a non-trivial challenge.

Possible problem scenario

Consider the trustees who, having regard to the new TPR objective, are prevailed upon by the employer to agree to a longer recovery plan than they might otherwise have wished.  The fact that the funding of the scheme will be delayed to some extent reduces the security of members’ benefits, at least in the short term.  The hope is that the employer will be able to use this flexibility to improve the prospects for the business and thereby, in the longer term, the covenant and backing for the scheme.  This is fine – if it works out.  But what happens if it does not and an aggrieved member receives reduced benefits and complains to the trustees?

Trustees will need to have sufficient business sense to be able to differentiate an employer request for flexibility for a case which has good prospects of success from other, less worthy, requests.  This won’t be easy for trustees, who may well be conflicted in trying to evaluate the merits of a presented case.

Helpful pointers from TPR

Collaboration

TPR points out that trustees and employer should work collaboratively on scheme funding matters.  In our experience this currently happens, with technical provisions and Recovery Plan payments resulting after a good dialogue between trustees and employer.

Risk taking

The Code points out that the trustees can take risks, but that they need to understand and manage those risks.  They need to be aware of the upside and downside potential of those risks and their potential effect.  For example, how well placed is the employer to deal with poor investment performance?

Integrated risk management

The Code also points out the trustees need to understand that risks are related to each other.  Employer covenant, investment and funding risks are all bound up together.  It may help trustees to understand this better if they were to consider some “what if” scenarios, and how an adverse change to one risk would affect the others.

Proportionate

Helpfully, TPR suggests that trustees should act proportionately. For example they should consider the size of the scheme, in absolute terms and in relation to the employer, in deciding how to act.

Flexibilities

TPR encourages trustees and employers to use the flexibilities present in the funding regime.  These flexibilities have always been there but until now. TPR policing has served as a barrier to their full use. 

Our View

The updated Code has been written to guide trustees to have regard to sustainable growth aspirations of the employer.  However, trustees’ duties, in law, still require them to act in the best interests of members.  Our view is that the conflict of interest being introduced by TPR’s new objective for trustees leaves them in an unenviable position!

To find out more, please contact us.