TPR has published its revised scheme funding code

Introduction

TPR has published its revised code of practice, Funding Defined Benefits, along with a number of connected documents. The new code of practice and other documents look forward to the introduction of the sustainable growth objective for TPR included in the Pensions Act 2014, which will come into force on 14 July 2014.

In this Alert:

• Key points 
• What documents have been published?
  
• The new objective
  
• Softening of approach
  
• Key funding principles
  
• Risk indicators
  
• Regulatory intervention
• 2014 annual funding statement
  
• Application
  

Key points

• There are 9 key funding principles set out in the code, universally applicable to all schemes. There have been no fundamental changes to the principles from the draft code.
• The code places a new emphasis on all parties working in a “collaborative and transparent way” on scheme funding.
• The code seems to represent a significant softening of approach to that set out in the draft code, with a greater focus on TPR’s new objective.
• The new sustainable growth objective in the Pensions Act 2014 comes into force on 14 July and TPR anticipates that the code will come into force on 22 July 2014 (subject to the parliamentary process).
• The code will apply to schemes with valuation dates after the code comes into force, TPR having accepted that it is not practical for schemes which have already completed a “substantial amount of work” towards their valuation to use the new code.

What documents have been published?

The suite of documents on scheme funding which have been published are:

• the revised code of practice on funding defined benefits (now 20 pages shorter than the draft code)
• a defined benefit funding regulatory and enforcement policy, which sets out how TPR balances its statutory objectives when regulating DB schemes
• a defined benefit regulatory strategy, which sets out TPR’s approach to regulating DB schemes
• the essential guide to the DB code, primarily for trustees and employers and
• TPR’s response to its December 2013 consultation.

Alongside the code, TPR has also published the 2014 annual funding statementwhich applies to schemes in Tranche 9 (those schemes with valuation dates falling between 22 September 2013 and 21 September 2014).

The new objective

TPR’s new statutory objective is to minimise any adverse impact on the sustainable growth of an employer when exercising its scheme funding functions.

The new sustainable growth objective applies to TPR and not to trustees of DB schemes. The trustees’ responsibility is to comply with their fiduciary and legislative duties, and to ensure that benefits are paid as they fall due.

Whilst acknowledging the potential tension this may cause, TPR point to the alignment of the outcomes sought by TPR and the trustees. Both parties are looking for a successful employer to support the scheme. TPR’s view is that a “strong, ongoing employer alongside an appropriate funding plan is the best support for a well-governed scheme”.

Softening of approach

The revised code represents a softening in approach to that outlined in the draft code issued in December 2013. There is a much greater focus on the position of the employer relative to the scheme, as would be expected given the new objective.

For instance, the code now acknowledges that the “payment of dividends by an employer is a normal business activity which can be consistent with both the employer’s sustainable growth plans and the trustees’ funding objective”. Contrast this with the draft code which referred to the need for trustees to consider whether dividend payments are “in line with industry norms” (which, in the consultation response, TPR acknowledges is not something that they expect trustees to assess).

Key funding principles

TPR has retained the 9 key funding principles from the draft code, although in some cases there is a change of emphasis in line with the general softening of approach:

• Working collaboratively – the important first principle remains intact. Trustees and employers should work together in an open and transparent manner to reach funding solutions that recognise the needs of the scheme and the employer’s plans for sustainable growth
• Managing risk – the focus of the code remains on trustees implementing an approach which integrates the management of employer covenant, investment and funding risks
• Taking risk – the reference to the need to trustees to mitigate risk has been removed, with the main focus instead on the employer’s risk tolerance and ability to “address a range of likely adverse outcomes”
• Taking a long-term view – meaning that trustees’ decisions should be consistent with their long-term funding and investment target, as well as their view of the employer’s covenant
• Proportionality – trustees need to act proportionately bearing in mind the scheme’s size, complexity and circumstances
• Balance – the key new principle remains but has been toned down in the revised code, with the emphasis now on trustees’ seeking an appropriate funding outcome which balances the need to pay promised benefits with minimising any adverse impact on the employer’s sustainable growth
• Well-governed – trustees should adopt good governance standards
• Fair treatment – this has not changed and TPR remains of the view that trustees should seek to ensure that the scheme is treated “fairly” amongst the competing demands on the employer
• Reaching funding targets – this principle has softened significantly, with TPR making it clear that trustees should aim for deficits to be eliminated over an “appropriate” period, rather than “as quickly as the employer can reasonably afford” (which was the requirement in the original draft).

Risk indicators

Perhaps the biggest shift from the draft code is how TPR will regulate the funding of DB schemes. TPR’s proposed risk management tool, the Balanced Funding Outcome (BFO) indicator,  has not survived the final cut. The BFO has been renamed the funding risk indicator (FRI) and is just one of a range of risk indicators against which a scheme will be tested before TPR considers intervention. Although TPR originally proposed publishing the level of the BFO, it has confirmed that it does not intend to publish the level of the FRI.

The other risk indicators include:

• TPR’s bespoke covenant assessment
• investment strategy risk, having regard to scheme maturity
• prudence in setting mortality assumptions
• back-end loading of, or a reduction in contributions from the previous recovery plan
• poor governance.

Regulatory intervention

But not all schemes identified through the risk indicators will be the subject of regulatory intervention. Scheme selection will be informed by a number of factors including:

• the position of the scheme compared to the risk indicators
• the size of the scheme’s liabilities
• the potential impact of any intervention and
• TPR’s overall resources.

2014 annual funding statement

As in previous years, TPR has published an annual funding statement. This statement is relevant to all trustees and employers of DB schemes but is “primarily aimed” at those who are undertaking valuations with effective dates in the period 22 September 2013 to 21 September 2014 (Tranche 9).

The statement sets out TPR’s view of market conditions and concludes that despite improvement in the markets, they expect 2014 valuations to show a larger deficit. The key message, therefore, focuses on all parties using the flexibilities in the system (highlighted in the revised code) to manage deficits.

TPR will, again, select a number of schemes for proactive (or early) engagement. All schemes which have been selected should have been contacted by the end of June 2014. In all other cases, TPR will review valuations and recovery plans on submission.

Application