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David Fairs' speech at LCP Annual Pensions conference

Tuesday 10 September 2019

Good afternoon everyone; thank you to Bob [Scott] for inviting me.

We are very busy down in Brighton as you can imagine.

  • Still assessing a number of master trust applications for authorisation and embarking on the supervision process for those that have passed.
  • Encouraging good governance across all schemes and we’re thinking about the best way to reduce the number of those that aren’t meeting standards. We’re looking forward to analysing the responses to our consultation on the future of trusteeship and governance – I encourage you to respond to the consultation if you haven’t already, you’ll find it on the TPR website and it’s open until 24 September.
  • Embedding our clearer, quicker, tougher approach into our daily work.

I know you want to hear from me about the new defined benefit (DB) funding code – and I’ll also touch briefly on this year’s annual funding statement (AFS), which illustrates our direction of travel.

Important to think about the new funding code in the context of the Pensions Bill. As well as including measures around funding we anticipate the Bill might also cover the pensions dashboard, DB superfunds and collective defined contribution (CDC) schemes. I think it is important that these are seen as a collection of measures to improve protection for members but also provide new opportunities and options for future pension provision.

New DB funding code

White Paper and TPR consultations

To give a bit of background – last year’s government White Paper on DB pension schemes said the funding regime was working largely as intended but improvements were needed. To ensure trustees focus on long-term strategic issues as the landscape matures and improve transparency and accountability on risks being taken on behalf of employers and members.

The White Paper also recognised that the fuzzy definition of ‘prudent Technical Provisions’ and ‘appropriate Recovery Plans’ that enabled a minority of schemes and employers to abuse flexibilities in the system. This makes TPR’s job of proving non-compliance and taking enforcement action more difficult.

To support these objectives Government announced a range of measures including that TPR would revise the code of practice on DB funding. Supported by changes in legislation, this would give greater clarity on funding standards, and introduce the concept of a ‘DB statement’ whereby trustees articulate their approach and decisions on funding and investments.

The White Paper introduced some key concepts, such as trustees setting a long -term objective (LTO) and how trustees should achieve the scheme’s statutory funding objective in that context. This will be at the heart of our revised code of practice.

The White Paper chimes with our messaging about trustees taking a long-term view when managing funding and investment strategies. As many schemes are getting close to their end game and only a few years away from reaching peak maturity this is becoming more urgent.

The ultimate purpose of the revised code is to make sure you – trustees, employers and advisers – have the support and tools to improve your scheme funding and manage the run-off phase for your scheme effectively and efficiently.

Clearly these are all complex and important questions. It’s important we get this right. We want a workable code, based on industry consensus and expert insight.

This is why we have already had a lot of informal conversations with trustees, employers, advisers and their representative organisation to help develop our thinking. And we also plan to undertake two formal consultations which will give everyone with an interest in DB pensions and how they should be funded an opportunity share their views and ideas. The first consultation will focus on options for a clearer framework for DB funding and the second consultation will be on the draft code itself. I will come on to the timings later.

New regulatory regime: Fast track and Bespoke

It is also particularly critical that our revised code strikes the right balance between providing clear guidelines to trustees and employers as to what good looks like and maintaining the scheme-specific nature of the funding regime.

We are not doing away with the flexibilities in the regime and we don’t intend to pursue a ‘one size fits all’ funding framework. The flexibilities in the funding regime will continue to help trustees and employers balance the need to pay promised benefits against the employer’s ability to run and grow their business. But we want to ensure they are not abused and that there is greater transparency about the risks DB schemes are running.

This is why we will propose and consult on a new approach in the code to reconcile these two objectives of greater direction and continued flexibility. We are seeking to introduce a twin track approach to demonstrating compliance with legislative requirements: The Fast track route and the Bespoke route.

Under Fast track, we will set out simple qualitative and quantitative rules and methodologies, call them compliance tests if you like. There will be some scheme specificity embedded in these rules, such as for instance variations by maturity and covenant. Schemes opting for this route will be considered compliant with part 3 funding subject to a few checks by TPR.

We are unlikely to engage further with the scheme. We think this will be of particular benefit to the 2,000 or so small schemes that have fewer than 100 members and less access to advice.

Some schemes may go down the Bespoke route, either by choice, or because they cannot comply with Fast track. In this option, there will be more flexibility to take account of unique or unusual scheme or covenant features; more sophisticated approaches or to take additional risk, providing the trustees explain, in the DB statement announced in the White Paper, why their approach is compliant and can evidence that the additional risk they are taking is managed and mitigated.

So 'Bespoke' would mean much more flexibility but more onus on trustees to explain their decisions and more regulatory scrutiny. If the Bespoke arrangements are not compliant, we would consider whether it is appropriate to take enforcement action.

Our first consultation: what we will propose and consult on:

In our first consultation, we will consult on options for a clearer framework and particularly what rules we might prescribe in the Fast track regime.

This includes what we see as a suitable long-term objective. The White Paper mentioned various suitable long-term objectives (LTOs) which maturing schemes could aim to achieve. This includes transaction-based LTOs where the scheme severs the link to its sponsoring employer, such as buy out and entry into a consolidator.

We do not think it would be appropriate for TPR to mandate ‘transaction-based’ LTOs. Our proposal will be that schemes should progressively reduce their reliance on the employer covenant over time and reach a position of low dependency on the covenant by the time they are significantly mature. This is in line with the good practice we already see in place for many schemes and should improve their resilience at time where risks associated with poor funding levels and shorter investment horizons are exacerbated.

This should also give trustees and employers a good platform to pursue strategies suitable for their circumstances; buying out, entering a consolidator or running off on a low risk basis. In our consultation we will set out our view of what low dependency funding should look like under Fast track and define significant maturity.

We will propose and consult on a low dependency funding basis with a discount rate in the range of gilts + 0.25% to gilts + 0.5. And under our proposed definition of significant maturity, a scheme of typical maturity now would reach their LTO in 15 to 20 years’ time.

We are saying ‘low dependency on the covenant’ rather than ‘self-sufficiency’. Self-sufficiency means different things to different people. We think the term ‘low dependency’ better reflects the fact the scheme is still carrying some risk and might still need to call on the sponsor, albeit in a limited way.

Schemes would not be required to be fully funded on their LTO until significantly mature but it is important that they have a good journey plan in place, with technical provisions (TPs) acting as milestones along the journey, to give the scheme the best chance of reaching their long-term objective. We will consult on key drivers of journey plans such as maturity and covenant and possible shapes for journey plans.

Based on these, we will be looking to set some parameters around acceptable journey plans and associated technical provisions under Fast track. This could for instance include a matrix of discount rates or funding ratios (expressed as TPs as a percentage of the LTO) by covenant strength and maturity. It would therefore be straightforward for trustees to identify whether their technical provisions would pass the Fast track test based on key scheme characteristics.

We also intend to be clearer on what constitutes appropriate recovery plans. Our view is that affordability should remain a key driver. Deficits should be recovered as soon as reasonably affordable without impacting on sustainable growth.

We will consult on our proposals for clearer guidelines about acceptable lengths of recovery and we will also consult on the appropriate mix of other flexibilities in Fast track recovery plans, [eg investment outperformance, re-spreading, back end loading, equitable treatment] so that we achieve the right balance between risks to the scheme and employers having the flexibility to manage their cash flows efficiently and avoid unnecessary over-funding.

Contingent security is an important tool for both trustees and employers to navigate funding challenges and we are keen to encourage greater use of these in funding solutions, for instance to support long recovery plans or risk taking in the TPs. We will consult on how we can make these more accessible to all schemes while ensuring they provide the support that schemes need. One idea is to promote the use of Pension Protection Fund-compliant contingent assets for Fast track purposes to help reduce burden on schemes.

This is Integrated Risk Management in practice. The picture would not be complete without mentioning investments. The investment strategy is an important factor in terms of the risk to member benefits and defining the appropriate level of prudence overall. We are not seeking to direct how trustees should invest but would like to ensure that investment risk is appropriate.

We will outline options for how trustees could assess investment risk under Fast track. For instance we could prescribe a simple stress test and the acceptable level of investment risk suitable for different maturities and covenant strength. Trustees who would like to take more risk would have to demonstrate in their statement how they propose to manage and underwrite it.

Long-term objectives and journey plans pose a question for open schemes. It’s good practice for open schemes to plan for the long term, although clearly also important to reflect the fact that they are maturing more slowly (or indeed not at all) compared to closed schemes. We are mindful that a funding framework should not increase the cost of future accruals or lead to unnecessary scheme closures.

We will consult on a range of solutions for open schemes which take these factors into consideration. We also need to ensure members’ past service is protected to the same degree as in closed schemes.

Impacts

We have heard concerns the new code may increase employer costs, stifle growth or put undue pressure on those already struggling. Affordability will remain a key component of recovery plans. Significant opportunities will remain for trustees and employers to flex funding plans.

As long as any risk taken is being adequately managed and supported and schemes are funded as well as they can be. We are mindful of potential impacts on employers and will undertake an impact assessment alongside the code next year to make sure member security and employer costs are balanced.

Timings

Now that I have hopefully whetted your appetite as to what will be in our first consultation, you will want to know when you can expect to see it. We are looking to time the publication of our first consultation with the Pensions Bill so that our proposals can be considered in the context of proposed legislative change.

However, as you know, there is a lot of political uncertainty at the moment so it is difficult to say when exactly we might expect the Bill to be introduced. We hope this will be in the Autumn but if delays are expected we will have to decide whether to go ahead with our consultation so that we can have this crucial debate about making sure the DB funding regime is on a sustainable footing for the future.

Annual Funding Statement

In the meantime we encourage trustees, employers and advisers to read our latest Annual Funding Statement.

We were much clearer this year about how schemes should approach forthcoming valuations and the messages in the AFS chime with the direction of travel for the DB code and Pensions Bill.

We made it clear we want trustees and employers to agree a strategy for achieving their long-term goals – we know that well-run schemes often have a long-term strategy that includes a long-term funding target, such as: to reach low dependency funding when reaching maturity. And the funding and investment strategies should deliver this target, and the regular actuarial valuations should provide a progress checks and suitable corrections along the way.

We also set clear expectations regarding the investment strategy and proposed a four-point framework:

  1. Set an asset allocation consistent with the long-term target.
  2. Be clear about your journey plan.
  3. Quantify the impact of adverse investment performance on your funding.
  4. Test and evidence the ability of the covenant to support this without extending the recovery plan.

We also explained that we are taking a tough stance on schemes with unacceptably long recovery plans.

And we want to see a balance between schemes and long recovery plans. The DB scheme is a key financial stakeholder and it should be treated fairly alongside others. 

Conclusion

As you can see, we’ve a lot going on in Brighton: supporting legislative proposals with the new funding code is keeping our policy team busy. We are also, as you’ve heard, busy on the DC side; with our work on trusteeship, with governance across all schemes, and of course with master trusts. But all of it is ultimately working towards the same goal – that of protecting savers.

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