DWP consults on funding and investment regulations

Our viewpoint

News Alert 2022/05

At a glance

Draft regulations have been published to support the biggest shift in the DB pension funding regime for 15 years.  Whilst much is as expected, schemes and sponsors with weaker covenants may find the expected new legal requirement to de-risk pension schemes challenging, and sponsors who offer a stronger covenant may need to pay down pension deficits quicker in the future, potentially impacting the cash available for other parties including shareholders.  There is a lot more detail to come, including a new Code from the Pensions Regulator – and the new regime won’t apply to valuations until at least late 2023.

Key Actions


  • Consult with actuarial, investment and covenant advisers to assess to what extent the scheme’s current approach to DB funding and investment is likely to be impacted.  Consider responding to the consultation

Scheme sponsors

  • Take advice on the extent to which your schemes are impacted.  Negotiate with trustees on the funding and investment strategy (in particular the long-term investment allocation) given it requires sponsor agreement in many cases.  Consider responding to the consultation

The Detail

On 26 July 2022 the Department for Work and Pensions launched its long-awaited consultation on draft funding and investment regulations.  These amend and extend the current DB scheme funding regulations, providing the necessary legislative backing to enable the Pensions Regulator to deliver its new approach to scheme funding oversight through an updated Code of Practice on which it set out its first thoughts way back in March 2020 (see Pensions Bulletin 2020/09).  The regulations (alongside the Code) may also enable the Regulator to intervene more effectively than under the current regime.

The consultation package comprises the consultation document, draft regulations and an impact assessment.  In this News Alert we look at some of the key aspects of the new regime as now clarified (to the extent possible) by the draft regulations.

Scheme maturity

The new funding regime is to have a focus on what is expected by the time a scheme reaches “significant maturity” as measured by the duration of the scheme’s liabilities (ie the average time until the payment of pensions and other benefits, weighted by the discounted payments).  The draft regulations require that at this point the scheme follows the principles of low dependency on the employer in relation to both the investment and funding strategies.

  • Significant maturity – the consultation document indicates the Code will likely initially require a 12-year duration (this could change over time), which is as we expected and is in line with the Regulator’s first funding consultation. This is generally similar to the time when a scheme’s members are expected to become mostly pensioners
  • Low dependency investment allocation – this means schemes to “broadly match” cashflows with benefit payments and be such that the value of assets relative to liabilities is “highly resilient” to short-term adverse changes in market conditions. These terms are open to some interpretation but nonetheless this is potentially quite restrictive on investment allocations for schemes at or close to significant maturity.  Indeed, one of the consultation questions asks if additional risk should be permitted, if supported by contingent assets
  • Low dependency funding basis – the regulations describe this somewhat clumsily, but essentially the actuarial assumptions adopted should be consistent with the low dependency investment allocation

A scheme’s funding and investment strategy, which needs to be documented and revisited every three years alongside valuations, must include, amongst other things, a statement of the investments intended to be held at the future “relevant date” – broadly when significant maturity is reached.  Under the Pension Schemes Act 2021 such a strategy will require agreement of the sponsor in many cases, so this has the potential to restrict the trustees’ ability to set investment strategy.  This issue has been discussed in the industry for some time and there is a consultation question on this very point, which we expect may attract strong views on both sides.

Our viewpoint

Many schemes and sponsors already have funding and investment strategies that de-risk as the scheme matures, and the new requirements are likely to have little impact.  However, some schemes, particularly those with weak covenants, may have to significantly change their strategies where they have been relying on future investment returns to fill deficits.  We await the Pension Regulator’s Code to provide more detail.

Journey planning

As expected, schemes with strong covenants or ones that are less mature will be able to take more risk on their journey to significant maturity.  However, for the first time, the regulations provide for new rules on measuring the strength of the employer covenant on which we are expecting the Regulator to build extensive guidance, which will form part of their new Code.

Where funding deficits emerge along the journey, it is proposed that there will be a new legal requirement that recovery plans must follow the principle that the deficit is recovered “as soon as the employer can reasonably afford”.  This is stronger than in the current Code and the consultation document asks whether this requirement should be given primacy over existing matters that should be taken account of in setting recovery plans (as set out in the current regulations) – such as asset and liability structure, risk profile, liquidity needs, and member age profile.  This could have potentially significant implications for employers.  However, there is no mention of specific recovery plan lengths.  Presumably more will come on this in the Code.

There are also other areas covered, such as the requirement to prepare a “statement of strategy” to report progress to the Regulator, a requirement to appoint a Chair of Trustees to sign off the statement of strategy, and details of what must be included in that statement of strategy.  Most of this detail seems sensible but there is the potential for it to be onerous for smaller schemes.

Our viewpoint

The industry will need to grapple with new detailed requirements around covenant assessments, and a covenant assessment will need to be reported to the Pensions Regulator.  This will be a big step up for some schemes.  The legal requirement on recovery plans is unclear and could have potentially significant implications for the sponsor’s cashflow and perhaps even dividend policies.

What isn’t covered

There is no mention in the draft regulations or the consultation document of the “fast-track” or “bespoke” approaches that the Regulator put forward in its March 2020 consultation.  Our understanding is that these concepts still exist, but we will need to await the Code for the detail and to see to what extent they have evolved.

Similarly, there is little mention of open schemes and how the duration calculation for significant maturity will work here, though as a minimum, for such schemes the “relevant date” will of course be pushed out at each new valuation and revisiting of the funding and investment strategy.  And there is reassurance in the consultation document that the intention is not to restrict open schemes from investing in growth assets as appropriate.

The impact assessment issued alongside the consultation is high level and does not go into detail on the expected costs of the new regime in terms of additional recovery plan contributions – noting it is not possible to do so until the detail of the Code is known.  This is less than ideal.

Next steps

Consultation closes on 17 October 2022 and presumably it will be a little while before the DWP can finalise the regulations.  We think it likely that the Regulator cannot start its consultation on the replacement Code until the regulations are finalised and laid before Parliament.  So, although consultation on the Code was previously scheduled for this “Autumn”, this would now seem challenging, which suggests that the ambition to bring the new regime into force for valuation effective dates from September 2023 will slip to at least the end of 2023 and quite possibly into 2024.

Our viewpoint

These regulations mark a welcome milestone in the long and winding road towards a new framework for the funding of DB pension schemes.  The world has changed a great deal since initial ideas were first set out and we welcome the fact that consideration has clearly been given to this, as well as concerns raised by the industry.  However, we are still some way from a finished product.  And the potential material impact on some schemes should not be understated.

We look forward to when the Regulator will be able to publish its second Funding Code consultation, as this will show in detail the extent to which Government and the Regulator have listened to industry concerns about the potential rigidity of what was initially proposed.  Trustees and sponsors should already be preparing for this new world, with a particular focus on long-term journey planning and a deep understanding of the strength of the “covenant” of the sponsoring employer.  Nonetheless, this consultation represents an important step forward.

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