41: Pension Schemes Act 2021 – implications for the funding of defined benefit pension schemes

The Pension Schemes Act 2021 (the Act) received Royal Assent on 11 February 2021. The Act has wide-ranging implications for the pensions industry, including changes to the Pensions Regulator’s powers, pensions dashboards, statutory transfers, climate change risk governance and collective defined contribution schemes.

In this blog we focus on how the Act lays the groundwork for future changes to the scheme funding regime for defined benefit (DB) pension schemes.

It is currently expected that the new scheme funding regime will first apply to valuations in 2022 (although it is possible that this may be delayed due to COVID-19).

The DWP will be consulting on supporting regulations in the first half of 2021 and the Pensions Regulator has confirmed that it will consult on the introduction of a new draft DB funding Code of Practice in the second half of 2021. This will include more detail on the new regime, following its previous principles based consultation in March 2020 which introduced the concept of the twin-track approach for the submission DB valuations under the ‘fast track’ and ‘bespoke’ funding approaches.

Below are the key points for trustees of DB schemes to be aware of at this stage.

Funding and investment strategy

The Act introduces a new requirement for trustees of DB schemes to put in place a strategy for ensuring that benefits can be provided over the long term (referred to as the ‘funding and investment strategy’). Trustees must review this strategy from time to time and revise it where necessary (regulations may specify how often trustees must carry out this process).

In particular, the funding and investment strategy must specify:

• the funding level the trustees intend the scheme to have achieved on a specific relevant date or dates; and
• the investments the trustees intend the scheme to hold on those dates.

Regulations may require trustees to take into account certain prescribed matters and follow prescribed principles (including adopting specified actuarial methods or assumptions).

Statement of strategy

As soon as reasonably practicable after putting in place the funding and investment strategy, trustees must prepare a written ‘statement of strategy’, which should be divided into two parts: the scheme’s funding and investment strategy (Part 1) and certain supplementary matters (Part 2). These supplementary matters include:

• the extent to which the funding and investment strategy is being successfully implemented and, where it is not, the steps the trustees propose to take to rectify this;
• the main risks faced by the scheme in implementing the funding and investment strategy and how the trustees intend to mitigate these; and
• the trustees’ reflections on any significant decisions taken by them in the past that are relevant to the funding and investment strategy (including any lessons learned that have affected other decisions or may do so in the future).

Trustees will need to review and revise Part 2 of the statement of strategy from time to time. There is a requirement to consult the employer when preparing or revising Part 2 of the statement of strategy and to agree the scheme’s funding and investment strategy with the employer. It is unclear at this stage how these new requirements interact with the existing legislation which provides that the trustees’ investment decisions should not be subject to employer consent.

The statement of strategy must be signed by the chair of trustees (and if a scheme does not have a chair of trustees, it must appoint one to sign it). Once the funding and investment strategy is in place, there is a requirement for the scheme’s technical provisions to be calculated in a way that is consistent with it.

There is currently no distinction in the new statutory framework between open and closed DB schemes (a proposed amendment to the Act to introduce this distinction was rejected). However, during the debate on the proposed amendment, the government committed to ensuring that the regulations would not prevent open schemes investing in riskier investments with higher returns where appropriate.

Trustees will be required to send an actuarial valuation to the Pensions Regulator as soon as reasonably practicable after completion together with further information that will be set out in regulations.

Trustees who fail to take all reasonable steps to comply with these requirements face fines of up to £5,000 in the case of an individual trustee and £50,000 in the case of a corporate trustee.

Commentary

The new framework is unlikely to come into effect before 2022 at the earliest and may be further delayed to allow the economy to recover.

The detail of the supporting regulations and the scope of the powers they confer on the Pensions Regulator to impose fast track funding parameters on schemes will be key to how the new funding regime operates. The potential impact on schemes open to new members is yet to be understood.

There is also concern about the potential for the fast track regulatory approach to become a benchmark for bespoke valuations under the new DB funding code, limiting the flexibility available under the bespoke approach and increasing the evidential burden for following it.

The potential scope and impact of the new DB funding regime should become clearer during the course of 2021. Trustees should be paying keen attention to developments here.