Pensions Regulator Defined Benefit Funding Code of Practice 2024

Baroness Sherlock Excerpts

Monday 21st October 2024 Grand Committee

To conclude, I am aware that a code of practice is not a legal document but is designed to give clear guidance to those who have significant responsibility for managing our defined benefit schemes. To this extent it seems to have achieved its aims.

[The Parliamentary Under-Secretary of State, Department for Work and Pensions (Baroness Sherlock) (Lab)]

My Lords, I thank my noble friend Lord Davies for securing and opening this debate and all noble Lords for their thoughtful and constructive contributions. I say to my opposite number, the noble Viscount, that it is easier asking questions than answering them in this space, so I hope that noble Lords will bear with me. More questions were asked today than I can conceivably answer in the time I have, but I will do my best to get through them. I assure noble Lords that we will carefully scrutinise Hansard and write to them with the answers to any questions that I cannot pick up.

First, by way of background, as my noble friend noted, earlier this year the House approved the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024. It is worth remembering that, alongside those regulations, the code of practice we are discussing is a key component of the new arrangements for the funding of DB occupational pension schemes. I am grateful to the noble Lord, Lord Palmer, for explaining what a DB scheme is to those watching at home. I hope that those watching at home who have never heard of a DB pension scheme are enjoying themselves, and I encourage them to read Hansard afterwards.

The code is designed to provide practical guidance for trustees and employers to meet their legal obligations, and it includes key metrics needed to implement the requirements. We moved very quickly to lay the code in the new Parliament to give schemes and industry the certainty they have been calling for. It may not be noticed from reading the debate that in fact the code has been well received. A lot of consultation has gone on.

The new scheme is designed to ensure the security and sustainability of DB pensions. Let us not forget the reason we needed to act at all: the damage done by schemes that were not appropriately run and the ensuing loss of benefits to members. Not taking action was not an option. These reforms strengthen the funding regime by providing clearer, more enforceable funding standards with a greater focus on long-term planning.

My noble friend Lord Davies noted that we have published two consultations on the code. The first, in 2020, considered the key principles to underpin the new regime and the proposed regulatory approach. The second was a consultation on the first draft of the code that we are debating today. DWP and the regulator worked collaboratively with and listened to a wide range of stakeholders. As a result, changes have been made to the code to provide more flexibility. For example, the regulator developed a chapter specifically for open schemes. When the code was published in July, it was welcomed for providing clarity and achieving a flexible approach. There is broad consensus that the code strikes the right balance between member security and employer affordability. Crucially, it provides sufficient scheme-specific flexibility to take account of the very wide range of scheme circumstances. I thank the noble Lord, Lord Palmer, for his support and the noble Viscount, Lord Younger, for the acknowledgment. Broadly speaking, we are looking at detail, but we think we are doing the right thing in the right way.

The new framework, including the code, has been revised following extensive engagement with industry to ensure that it provides flexibility for schemes to invest in a wide range of asset classes, including growth assets, both before and after significant maturity. Open schemes, like others, will have significant flexibility to invest in riskier investments with potentially higher returns, if the risk can be supported, so member benefits are protected. It also makes clear that the open schemes will not be made to derisk as long as they remain open to new members, are not maturing and the risk they are taking is supported by the employer covenant.

I will try to go through as many of noble Lords’ questions as I can. First, the phrase box-ticking has been used once or twice. I reassure noble Lords that this regime is absolutely not a box-ticking exercise. The regulator is taking the opportunity provided by the introduction of the new regime to evolve the way it regulates DB funding. This includes proportionate measures with flexibility for different schemes. The regime will be based on clear metrics designed to protect members’ benefits as well as to take account of employer affordability.

The Pensions Regulator operates on a risk-based and outcome-focused approach. We think that that proportionality is in the right space. The regulator is introducing a twin-track approach: fast-track and bespoke. This aims to help target its engagements with the sector effectively. Where a scheme meets a series of fast-track parameters, the regulator will ask for less information and is less likely to engage with trustees. On the other hand, the bespoke route allows schemes to take a different approach and to provide evidence of why this is appropriate. Many of them are unlikely to require further engagement between the regulator and trustees.

My noble friend Lord Davies asked about the use of scheme surplus. I remind the Committee that, in February, the options for defined benefit schemes consultation sought views on the potential benefits of introducing additional flexibilities for the use of surplus funding on DB pensions schemes. The Government will continue to consider the potential of such flexibilities to benefit scheme members and sponsoring employers while supporting economic growth.

The noble Viscount, Lord Younger, asked about low dependency investment allocation. The flexibility of the UK’s funding regime is one of its greatest assets and one that we have been careful not to undermine in the new arrangements. Pension schemes are many and varied and each has its own circumstances, so they are best managed through scheme-specific arrangements. That is why we try to balance clear metrics on how liabilities have to be calculated with scheme-specific flexibilities that allow trustees the discretion to react to changing circumstances and act in the best interests of their members while strengthening the ability of the regulator to intervene and act if things go wrong. Noble Lords may have other views. We believe that this balance is right and in the interests of members of schemes.

There was a question about whether trustees have the flexibility to take decisions in the light of the circumstances of their individual schemes. Flexibility is a key strength of the regime, but it is balanced with those funding standards and the key metrics of the new arrangements. The bottom line is that it is fine to take supportable risk. Taking investment risk to benefit from potentially higher returns is fine if there is enough time for asset values to recover or a sponsor with enough resources to pay more in the future. That is why the new regime focuses on the key metrics of maturity and covenant strength.

The noble Baronesses, Lady McIntosh and Lady Altmann, raised costs to scheme members. It is worth putting those absolute costs in the context of the scale of our pensions world. The impact assessment for the code indicates that costs will amount to around £7,000 per scheme on average, with ongoing administrative costs of approximately £1,100 on average per scheme. That excludes costs associated with changes in deficit repair contribution payments, of course. Those are small costs compared to the overall liabilities of a scheme. They are unlikely to have a significant impact, and certainly not on members. Most schemes are closed, and members of those schemes will not be paying contributions. Modestly increased costs are unlikely to have any impact on the probability of members’ benefits being paid in full. There are some members in schemes which share costs and are still open for accrual, but they are the minority. Only 4% of schemes are fully open; 20% are closed to new members. As the costs per scheme are estimated to be low, we do not anticipate any significant material impact on members overall. This must be seen in the context of the impact of clearer funding arrangements with more emphasis on long-term planning, which should make members more confident that their benefits will be paid in full.

We were asked what will be done to monitor the costs. We will continue to monitor the costs. Although there is some uncertainty about trustee behaviour and response, as we cannot know that, the impact assessment used data from March 2022 and modelled, on average, an overall net saving of around £20 million per year. I can write with more detail if Members would like that.

It is worth understanding that the regulations and code are principle-based. The code is practical guidance for implementing the regulations.

The noble Lord, Lord Davies, asked about different valuation methods. I will not get into TAS but will write to him on how TAS interacts. However, I have a word for the broader audience watching from home about the different valuation methods. There are two main ones. The technical provisions are, rightly, used to assess contributions and deficit recovery contributions because they are calibrated to balance member security with employer affordability. On the other hand, the solvency measure is much more generic and less scheme-specific. It is used to assess funding against the cost of insurance buyout. That is a much stronger measure. Schemes are not required to be funded to that level because that would make DB much more expensive, if not unsustainable. The use of these technical measures does not push schemes into inappropriate de-risking or into a risk-adverse approach. Schemes can choose a variety of approaches to setting their liabilities, including by reference to the investments that they intend to hold. They will be affected by a whole range of considerations, not least the route to compliance with TPR that they choose to use.

The new regime is extremely scheme-specific and flexible. Even at significant maturity, schemes can invest in a proportion of return-seeking assets provided that the risk can be supported. Most schemes are currently investing more prudently than the new regime requires. Indeed, the regime suggests that there is headroom for some schemes to take more investment risk than they are taking currently, of which I am sure the noble Baroness, Lady Altmann, will be very conscious. The requirement in this to derisk will, as intended, mostly impact outliers which have been pushing the scheme-specific flexibilities further than they were ever expected to stretch and, in doing so, putting members’ benefits at risk. It is right that those outliers should be required to derisk to protect members’ benefits through the clearer and more enforceable metrics of the revised regime.