New funding and investment regime: what has changed and what do schemes need to do?

DB schemes will need to have a funding and investment strategy (FIS) for ensuring that benefits can be provided over the long term. The FIS will have to include a targeted funding level(s) to be achieved by a particular date(s) and information on the investments intended to be held as at particular dates. A scheme's technical provisions, as set out in its actuarial valuations, will need to be calculated in a way that is consistent with its FIS.

The FIS must be set out in a statement of strategy (SoS), alongside supplementary matters concerning aspects of the FIS and its implementation. Trustees must obtain the agreement of the employer to the scheme's FIS (unless they unilaterally set employer contributions, in which case the obligation is only to consult) and must consult the employer on the supplementary content in the SoS.

Under the new regime:

• Schemes will be expected to have a long term objective for how they will provide or secure benefits (for example, buy-out, consolidation or run-off).
  
  
• Trustees must follow the principle that, on or after the "relevant date", the scheme will be funded at the "minimum funding level", with its liabilities calculated on a low dependency funding basis.  This means calculating the liabilities on the assumption that further employer contributions would not be expected to be required, and that the scheme's assets are invested in accordance with a low dependency investment allocation (LDIA).
  
  
• The "relevant date" will be the date on which the actuary estimates that the scheme will reach "significant maturity", or, where a scheme has reached significant maturity, the effective date of the valuation to which the FIS relates.
  
  
• Trustees must take into account the objective that scheme assets be invested in accordance with an LDIA on and after the relevant date (see What are the key investment changes?, below).
  
  
• Trustees will need to have their first FIS in place within 15 months of the effective date of the first actuarial valuation with an effective date on or after 22 September 2024 and then review it within 15 months of the effective date of all subsequent valuations. This is the responsibility of the trustees but the FIS must be agreed with the employer (save in the circumstances noted above).
  
  
• Recovery plans will have to be prepared following a new principle that deficits must be recovered as soon as the employer can reasonably afford, although there will be scope to take account of the impact of the recovery plan on the sustainable growth of the employer when determining what is reasonably affordable.
  
  
• Trustees must take into account certain matters (including covenant) when setting their FIS and preparing the content of the SoS.
  
  
• The SoS must be submitted to the Regulator as soon as reasonably practical after it has been prepared or revised, whether or not this is in or out of cycle with an actuarial valuation. It must be signed by the trustee chair.

Further detail on the key additional steps that trustees and employers will need to take to comply with the new regime is set out below (see New requirements for scheme funding documents, below).

The Department for Work and Pensions (DWP) consulted on the draft funding regulations from July to October 2022. Its response to that consultation (issued in January 2024) outlined some notable changes. Some of these reflect how pension schemes were affected by the volatility crisis in the UK gilts market in autumn 2022 and others are intended to promote the Government's productive finance agenda and its call for evidence on options for DB schemes.

What are the key investment changes?

• Low dependency investment allocation (LDIA): The definition of the LDIA has been simplified, so that it no longer requires scheme assets to be invested in way that generates a cashflow broadly matching the liabilities to pay benefits. The LDIA will now mean that the assets of a scheme are invested in such a way that the value of the assets relative to the value of the scheme’s liabilities is highly resilient to short-term adverse changes in market conditions so that further employer contributions are not expected to be required. The DWP hopes that this revised definition will increase scope for schemes to invest in a wider range of assets, including productive finance. The DWP has also provided reassurance that the changes to the Regulations are intended to ensure that the objective to invest in line with the LDIA "clearly does not apply to surplus funding" (see Surpluses, below).
  
  
• The FIS will not bind trustees on scheme investments: In determining the FIS, trustees must take into account the objective that, on and after the relevant date, the scheme assets to which the minimum funding level relates are invested in accordance with an LDIA. However, there is no requirement that assets "must be invested in accordance with" the LDIA, as in the earlier draft regulations. This is intended to preserve trustee independence on investment matters, so that it is clear that investments are not part of the FIS and that employers do not need to agree them. A further change is to make it clear that this objective does not apply to assets held in excess of the minimum funding level (see Surpluses, below). Nevertheless, the DWP notes the Regulator will still expect investment strategies to be "broadly consistent" with the FIS, so there may be more detail on this in the upcoming Code.
  
  
• Disclosure in the Statement of Strategy (SoS): Trustees will be required to disclose information on the scheme's asset allocation and level of risk in relation to the "intended" investments.  This appears to recognise that these may differ from the actual assets held by the scheme.
  
  
• Liquidity: In determining their FIS, trustees will need to follow the principle that scheme assets must be invested in investments with sufficient liquidity to enable them to meet expected cash flow requirements and to make reasonable allowance for unexpected cashflow requirements. However, this requirement has been simplified from the previous proposals that a scheme should anticipate liquidity "as it moves along its journey plan" and "on or after the relevant date". The DWP recognises in its response that the Regulator "will only need information on how trustees have factored liquidity into their current strategy".

What are the key funding changes?

• Surpluses: In determining their FIS, trustees will need to follow the principle that they are required to be funded at the "minimum funding level", reflecting the low dependency funding basis, on and after the relevant date. The DWP has responded to industry concerns that this could result in "trapped" surpluses by referring to its call for evidence on options for DB schemes, and request for views on how investing surpluses can be encouraged and best utilised. As noted above, the DWP has confirmed that the objective to invest in line with the LDIA is not intended to apply to surplus funding.
  
  
• Definition of "significantly mature": A scheme reaches significant maturity when the duration of its liabilities is the number of years (or such other date) as the Regulator specifies in its Code, determined using a formula. The Regulator may specify different durations of liabilities in years, or dates, for different types of scheme. To reduce the sensitivity of this measure to market volatility, the duration of liabilities calculation is now to be based on financial conditions at a fixed date (31 March 2023).
  
  
• Open schemes: The Regulations include a new provision which provides explicitly for open schemes to make a reasonable allowance for new entrants and future accrual in scheme maturity calculations, provided that such assumptions are reasonable and based on an assessment of the employer covenant.
  
  
• Definition of "relevant date": This has been  adjusted for schemes already past significant maturity, so that it will be the effective date of the valuation to which the FIS relates. The Regulations also include a new partial exemption for schemes that have a cash balance section which operates alongside a collective money purchase sections from the requirement to adopt the "relevant date".
  
  
• The FIS will apply to journey plans: The definition of "journey plan" has been revised to make it clear that it starts at the effective valuation date of the actuarial valuation to which the FIS relates and ends with the relevant date (see above). Certain requirements to include details on the actuarial assumptions used by the scheme will now apply to the FIS, rather than the SoS, the aim being to "ensure that technical provisions must be consistent with the funding journey plan, as well as the low dependency funding basis as at the relevant date".
  
  
• Deficit repair contributions: The 2005 scheme funding regulations will still be amended to include a principle that deficits should be recovered as soon as the employer can reasonably afford. But trustees will now also be required to take account of the "impact of the recovery plan on the sustainable growth of the employer" when preparing or revising a recovery plan.

What are the key covenant changes?

• Definition of "employer covenant": This now refers expressly to the financial ability of the employer, in relation to "its legal obligations" to the scheme, to support the scheme. Trustees will be able to take into account both the immediate and "future ability" of the employer to support the scheme. Trustees and their advisers will need to consider the "expected" level of support that trustees could "reasonably expect" from contingent assets, the "expected" future cash flow, the "future development and resilience" of the employer's business, the "likelihood of an insolvency event occurring" and how long they can be "reasonably certain" of both their assessment and the employer's continuing ability to support the scheme.
  
  
• References to the Code have been removed: The draft regulations provided for the Regulator to set out factors that trustees should consider in assessing the financial ability of the employer to support the scheme (including concerning its cashflow, and other factors likely to affect the performance or development of the employer's business). These references have been removed as the DWP considers that " it is important to maintain the primacy of the Regulations".
  
  
• Definition of "contingent assets": The draft regulations stated that this term "includes guarantees". The definition has now been removed, to avoid any implication that contingent assets are limited to guarantees.

Funding and investment strategy (FIS)

In order to prepare the FIS, trustees will need to:

• Agree with the employer (save in the circumstances noted above) a long term objective for the way in which scheme benefits will be provided (for example, buy-out, consolidation or run-off). Trustees of schemes where employer contributions are determined by the actuary may need to consider how the new regime applies to their scheme.
  
  
• Ask the actuary when the scheme is expected to (or did) reach significant maturity. This will occur when the scheme reaches the duration of liabilities in years (or such other date) as the Regulator specifies in its Code, determined using a formula. These may vary between different types of scheme. Trustees can take into account whether new members may be admitted and the future accrual of benefits, provided that such assumptions are reasonable and also consider their assessment of the employer covenant.
  
  
• Select a relevant date. This is a date in the scheme year in which the actuary estimates the scheme will reach (or did reach) significant maturity. It can change in subsequent FISs (and is highly likely to do so for schemes that have ongoing accrual).
  
  
• Assess the strength of the employer covenant. This is defined as:
  
  
  • the financial ability of the employer, in relation to its legal obligations to the scheme, to support the scheme; and
    
    
  • the expected level of support from contingent assets that the trustees could reasonably expect to be legally enforceable and which will be sufficient to provide that support when enforced.

Factors including employer cash flow (and expected future cash flow), matters likely to affect the employer's future ability to support the scheme (including the performance, future development and resilience of the employer's business) and the likelihood of an insolvency event must be taken into account. Trustees must consider both how long they can be reasonably certain that they can rely on an assessment of those factors and how long they can be reasonably certain that the employer will be able to support the scheme.

In determining or revising the FIS, the trustees must:

• Follow certain principles so as to expect to meet the following minimum requirements:
   
  • On and after the relevant date, the scheme must hold sufficient and appropriate assets such that the funding level is at least 1:1 on a low dependency funding basis. At this point, further employer past service contributions are not expected to be required because the scheme is fully funded.
    
    
  • The level of risk that can be taken in determining actuarial assumptions in relation to scheme liabilities along the scheme's journey plan is also dependent on the strength of the employer covenant and how near the scheme is to reaching the relevant date.
    
    
  • Scheme investments must have sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements.
    
    
• Take into account:
  
  
  • The objective that scheme assets be invested in accordance with an LDIA on and after the relevant date.
    
    
  • The actuary’s estimate of the date on which the scheme is expected to (or did) reach significant maturity, as set out in the actuarial valuation to which the FIS relates.
    
    
  • The actuary’s estimate of the maturity of the scheme as at the effective date of the actuarial valuation to which the FIS relates, as set out in that actuarial valuation.
    
    
• Set out:
  
  
  • The way in which they intend scheme benefits to be provided over the long term.
    
    
  • The proportion of scheme assets the trustees intend to allocate to different categories of investments on the relevant date.
    
    
  • The funding level of the scheme as at the effective date of the relevant actuarial valuation and:
    
    
    • Before the relevant date: the expected maturity of the scheme at the relevant date and the assumptions used in specifying the intended funding level as at the relevant date and how they are different from the valuation's technical provisions assumptions.
      
      
    • After the relevant date, the assumptions used in the actuary's estimate of the funding level as at the effective date of the valuation.

• • The discount rate(s) and other assumptions used in calculating the technical provisions in the relevant valuation and how the trustees expect the discount rate(s) to change over time.

Trustees will need to have their first FIS in place within 15 months of the effective date of the first actuarial valuation obtained on or after 22 September 2024. Thereafter, the timescale will be the same as for actuarial valuations, i.e. by 15 months after the effective date of the valuation. It must be reviewed as soon as reasonably practicable after any material change in the circumstances of the scheme or of the employer.

Statement of strategy (SoS)

Part 1 of the SoS will be a written statement of the FIS, as agreed with the employer (save in the circumstances noted above).

Part 2 of the SOS will cover supplementary matters, some of which are set out in the statute and some of which will be prescribed in the Regulations. The Regulator may exercise discretion as to the level of detail required in respect of each of these matters. (References here to FIS principles are to principles outlined above.) The employer must be consulted on all of the following matters. The required content is:

• The extent to which, in the trustees' opinion, the FIS is being successfully implemented and, where it is not, the steps the trustees propose to take to remedy the position.
  
  
• The main risks faced by the scheme in implementing the FIS and how the trustees intend to mitigate or manage them. Trustees must also set out what action they intend to take in the event that those risks materialise.
  
  
• Reflections of the trustees on any significant decisions taken by them in the past that are relevant to the FIS (including any lessons learned that have affected other decisions or may do so in the future).
  
  
• The actuary's estimate of the maturity of the scheme as at the effective date of the relevant valuation and (for a scheme that has not reached the relevant date) how the maturity is expected to change over time. The trustees must explain the evidence on which this is based.
  
  
• The level of intended investment risk relating to the actuarial valuation to which the FIS relates and:
  
  
  • Before the relevant date, the level of intended investment risk as the scheme moves along its journey plan.
    
    
  • After the relevant date, how the level of investment risk complies with the objective that on or after the relevant date, the scheme assets are invested in accordance with a low dependency investment allocation.

The detail must set out the evidence on which this is based and include the proportion of assets allocated to different categories of investments.

• How the scheme investments comply with the FIS liquidity principle.
  
  
• An assessment of the strength of the employer covenant, how long it is reasonable to rely on that assessment and the evidence on which this is based.
  
  
• The extent to which the FIS is or remains appropriate.
  
  
• Confirmation that the trustees have consulted the employer on part 2 of the SoS and any comments that the employer asked to be included.

The SoS must be reviewed as soon as reasonably practicable after any review of the FIS, even if the FIS is not revised.

The SoS must be submitted to the Regulator in a form which it will set out, as soon as reasonably practical after it has been prepared or revised, whether or not this in or out of cycle with an actuarial valuation. It must be signed by the trustee chair.

New requirements for valuations and recovery plans

The Pension Schemes Act 2021 provided for a scheme's technical provisions to be calculated in a way that is consistent with the scheme's FIS. The Regulations will also make the following further adjustments to the current scheme funding regime:

• The actuarial valuation report must include estimates of maturity (as at the valuation date (where this is different from the relevant date), the relevant date and the date the scheme is expected to (or did) reach significant maturity) and the percentage funding level on the basis of the FIS requirements.
  
  
• In determining whether a recovery plan is appropriate, the trustees will have to follow the new principle that funding deficits must be recovered "as soon as the employer can reasonably afford". Trustees will also be required to take account of the "impact of the recovery plan on the sustainable growth of the employer" when preparing or revising a recovery plan.