Defined benefit pension scheme funding

The current funding regime for defined benefit (DB) pension schemes (which provide pension benefits based on salary and length of service) was introduced under the Pensions Act 2004 (part 3). These events had made it very evident that the previous regime, although intended to ensure that schemes had sufficient assets to protect pensions – did not guarantee the same for younger members. The result was that many found themselves expecting pensions far short of what had been promised.

 The funding regime introduced in the 2004 Act requires trustees to:

• Draw up a statement of funding principles (i.e. a written statement of the policy for meeting the statutory funding objective, which is that the scheme has ‘sufficient and appropriate assets’ to meet its liabilities);
• Obtain a full actuarial valuation of their scheme at least every three years; and
• Where the scheme is in deficit, prepare a recovery plan setting out the steps that will be taken to meet the funding objective over what time frame.

The aim is not to “eliminate all risk to members’ benefits” but rather to “strike a reasonable balance” between the demands on the employer and the security of member benefits, recognising that “a strong, sustainable employer is the best protection for a DB scheme” (Cm 9412, Executive Summary).

The regime is regulated by the Pensions Regulator TPR. To assist trustees, it issued a Code of Practice (Feb 2006). It issued a statement on its regulatory approach in May 2006. This explained, for example, that a trigger for it to intervene was if a scheme had a ‘recovery plan’ of longer than 10 years.

There have since been two major reforms to the scheme funding requirements. The first followed the introduction in Pensions Act 2014 of an objective for TPR – to minimise any adverse impact on the sustainable growth of an employer when regulating scheme funding. The context was concern about the costs of funding deficits for some employers. TPR issued new guidance, explaining that it would take a more risk-based approach, engaging more fully with fewer schemes that posed a greater risk. It would move away from specific triggers for intervention to a wider suite of risk factors.

In its December 2016 report on DB pensions, the Work and Pensions Committee made recommendations aimed at “reducing the risk of another scheme collapsing in the manner of BHS”. A major concern for the Committee had been the length of the recovery plan to repair the funding deficit (23 years) and the time it had taken the Pensions Regulator (TPR) to intervene.  

In its February 2017 Green Paper, Security and sustainability in Defined Benefit Pension Schemes, the Government said that while most schemes had a funding deficit, these were not generally ‘unaffordable’ for employers. However, there were some employers on whom the deficits were having a significant impact and for whom the level of contributions might become unsustainable. It asked for views on reform options, such as providing greater clarity over the requirements for scheme funding – perhaps with a comply or explain regime.

The White Paper published in February 2018 said there was no systemic problem in the regulatory and legislative framework governing DB schemes. Furthermore, However, DB scheme funding outcomes are affected by poor decision making, short-term thinking and a lack of accountability. It proposed a revised Code of Practice, which would clarify key terms. Legislation would require DB scheme trustees to appoint a Chair, who would report on key funding decisions. (Cm 9591, March 2018).

Provision for this is in clause 123 of the Pension Schemes Bill [HL] 2019/20.  In March 2020, TPR launched a consultation on a revised code of practice for DB scheme funding, to implement measures in the Bill. The proposal is for a twin-track approach, allowing trustees to choose either: a ‘fast track’ approach, if they could demonstrate that their valuation met the guidelines, or a ‘bespoke’ approach.

At Report Stage, the House of Lords voted to accept an Opposition amendment which would require a different approach to the regulation of scheme funding for open and closed schemes (HL Deb 30 June 2020 c679).

TPR published guidance for trustees on DB scheme funding and investment decisions during the COVID outbreak on 27 March 2020. It said that trustees should be open to requests to reduce or suspend deficit reduction contributions provided certain conditions were satisfied (i.e., it could be justified, there was a plan to catch up with deferred payments and to mitigate any detriment to the scheme, and the scheme was being treated fairly compared with other stakeholders). TPR would take a pragmatic approach to regulation.

In an update issued on 16 June 2020, TPR reported that around 10% of schemes had agreed a temporary suspension or reduction of DRCs (contributions to repair scheme deficits). However, others were in the process of discussing requests to suspend or reduce contributions, and extensions could be needed, as some employers continued to experience significant trading and liquidity pressures. TPR expected trustees to exercise due diligence in response to requests. It would expect trustees, wherever possible, to comply with their reporting requirements (for example, in relation to missed contributions) from 1 July 2020. It would “continue to regulate pragmatically and sympathetically.”

Other relevant briefing papers are: CBP 4368 The Pensions Regulator: powers to protect pension benefits (July 2020) and CBP 8219 Defined benefit pension schemes white paper (July 2018).