We submitted our response to The Pensions Regulator (TPR) on its thinking behind a new Defined Benefit (DB) Funding Code.
In general we are supportive of the direction of travel TPR are going in. However, there are some areas of concern.
It is integral to the current funding regime that it is flexible enough for schemes to adopt scheme specific funding and investment solutions, reflecting their own particular circumstances including current deficit, covenant strength and membership maturity. We are pleased that this remains.
However, the idea around the twin-track approach of Fast Track and Bespoke is still unclear and has the potential for unintended, but predictable, consequences.
Too few in Fast Track
A key concern is that so few schemes are able to meet the Fast Track standard that any form of triage of TPR resources is ineffective. This results in a lack of resources to focus on all those schemes that require intervention and we fall back into a situation very similar to the one we have now, with a risk based regulator focussing only on those schemes that present the greatest concern. Meanwhile, all schemes will have the added cost of working within the twin-track framework.
To be fair to TPR we do not know for sure what the Fast Track standard will look like but where it can be inferred from TPR’s views on funding and risk, we are led to expect it to be low risk with a low gilts-plus discount rate, aiming to reduce future volatility. This may in itself result in pressure on employers for greater employer contributions and reduce capacity for risk-taking in the investment portfolio. Is this a desirable solution across the board?
The Fast Track guidelines must be set at suitable levels and with sufficient flexibility, particularly for immature schemes. Otherwise, most schemes will be obliged to follow the Bespoke route, with further TPR scrutiny required.
Bespoke becomes too onerous
TPR acknowledges that some schemes will have good reasons for choosing the Bespoke route. If these schemes cannot be moved into Fast Track, we would encourage an appropriately light touch approach to compliance to avoid unnecessary engagement and cost, especially where the divergences are minor. Where schemes narrowly fail to tick all of the Fast Track boxes, and so fall into the Bespoke framework, the costs and work required could be disproportionate to the additional risks being run. This must be addressed in TPR’s second round of guidance.
We are also concerned about the additional administrative and advice burden of submitting a valuation on schemes using the Bespoke route. The 2018 DB White Paper recognised that most schemes are well-run and we firmly believe that TPR’s limited resources should be focussed on engaging with those where intervention is appropriate and expected to make a difference. Further, the Bespoke route requires additional evidence, and hence advisory costs, to demonstrate compliance, and for that reason, clarity around TPR’s expectations is crucial to an efficient outcome. The impact of an uncertain submission burden is particularly unhelpful for smaller schemes where resources are typically limited and will add little value for those that are well run.
Conflicted objectives
Finally, in introducing the twin-track approach to actuarial valuation compliance, TPR should provide greater clarity on what the Fast Track route truly represents.
Is it:
- a funding ‘gold standard’, aspirational for many schemes even in the medium term?
- a ‘triaging tool’ intended to help TPR sensibly focus its resources?
- a ‘management information’ tool, allowing easier comparison of diverse schemes? and/or
- a new required funding benchmark, setting out the minimum acceptable position?
The potential conflicts between these simultaneous objectives may lead to inconsistent messages and runs the risk of generating a compromise solution that leads to additional costs, without truly achieving any of the objectives.
What next?
The first stage of the consultation closed on 2nd September with stage two expected in the Spring of 2021.
Authors: Mike Calder & David Hamilton
