The UK Pensions Regulator’s (TPR) code of practice on funding for defined benefit (DB) pensions appears to have had little impact on schemes’ likelihood of de-risking. But its emphasis on schemes setting long-term objectives and its encouragement of greater investment and funding flexibility may yet exert an influence.
A year after the code was launched to provide a framework for complying with pensions legislation, the UK’s pension risk transfer market remains buoyant, suggesting the guidance has had little material effect on deals.
First-half PRT transaction values were on a steady course towards a third-consecutive year of breaching £40bn-plus, even while the number of deals has dipped. At the start of the year, forecasters predicted deal values would breach £50bn in 2025.
Nevertheless, legislation has created a new set of dynamics. Schemes must align their funding and investment decisions with a clear endgame plan by their next valuation. To achieve that, TPR’s code expects trustees to make firm long-term plans. It also recognises that there is no one-size-fits all solution to achieving every scheme’s goal and therefore encourages greater flexibility in their funding and investment strategies.
With run-ons among three key potential long-term objectives suggested by the code (along with buy-outs and offsetting risk to superfunds and other consolidators), observers have speculated that more sponsors may now be inclined to keep their schemes going.
The likelihood of that has been heightened by the government’s indication that it wants to allow sponsors to access surpluses without the need of a buy-out, according to Ian Wright, a Senior Lawyer at ARC Pensions Law.
“I don’t think it’s a game changer yet, but it’s starting to feed into conversations where employers and finance directors are starting to understand that it’s not a binary conversation any longer,” he said.
The code of practice, which came into force on 12th November last year, sets out TPR’s guidelines on the conduct and practice that governing bodies should meet to comply with the Pension Schemes Act 2021 and The Funding and Investment Strategy Regulations 2024.
While the code isn’t a statement in law and carries no penalty for non-adherence, TPR does expect practitioners to follow its guidance.
The code expects trustees to agree a long-term funding and risk management regime that sets schemes on a de-risking journey towards at least minimal dependence on sponsor contributions by the time they are “significantly mature”.
The timeline for these will vary according to the characteristics and duration of each scheme. Closed schemes, for instance, are expected to reach maturity soonest.
The code calls that the “relevant date”, when schemes have a duration of 10 years or less. (Consultancy Barnett Waddingham suggests open schemes may never mature at all, raising concern that the code will increase the costs of providing benefits.)
The code also prescribes new frameworks for valuations and journey plans towards maturity. All of this must be wrapped into a Statement of Strategy that sets out the scheme’s funding and investment strategy, and explain the risks faced and details of the employer covenant.
Although the code encourages boards to take a longer-term look at the funding of their schemes and have a keener focus on reaching a state of low-dependency of employer funding, experts suggest that may moderately influence decisions on PRT.
“With this flexibility to run-on and potentially benefit from the scheme, sponsors might want to do that rather than a PRT transaction,” said Richard Soldan, Partner and Head of the DB Funding Group at LCP.
ARC’s Wright agreed.
“If you can get to a point where the call on the covenant is so minimal that it’s non-existent for all practical purposes, but you have the ability to access surplus from time to time, then the pension scheme becomes a potential stream of funding that you might not have contemplated a couple of years ago,” he said.
The code has made the prospect of easier access to surplus funds more enticing. Debate on loosening surplus extraction rules has intensified within the industry as rising gilt yields have led to a rapid improvement in schemes’ funding positions. Chancellor of the Exchequer Rachel Reeves indicated to UK finance industry leaders in January that she was considering a rules change and it has since been included in the Pension Schemes Bill that is before the UK Parliament now.
Experts have suggested that easier access to surpluses could increase the likelihood of sponsors running on their schemes to maximise the capital they can extract, potentially deterring future risk-offset plans.
“With the better funding that we’re seeing, it means there’s more choice for schemes and they can go and do a PRT transaction, in many cases, without needing more contributions from the employer. In some cases, that will be why we’re seeing high activity in the PRT market,” said Soldan.
“Equally, a well-funded scheme could also be listening to the government’s encouragement for schemes to think about running on and seeing that there can be opportunities for the employer and potentially the pension scheme members to benefit from running on into future.”
The greater prospect of run-ons aside, the code isn’t expected to make PRT any more or less attractive. The schemes that might be most affected by the code are those that aren’t very well funded anyway and, after revaluations required by the code, could find they will need more money from their sponsor than they may have thought.
“There aren’t that many schemes in that situation, because schemes are so much better funded than they have been for decades, and those schemes are not ones that are imminently looking at PRT because they haven’t got enough money in the scheme to do so,” said Soldan.
“I haven’t got a sense that people are thinking, ‘Oh, we don’t want to go through the new funding regime so let’s go and buy-out the liabilities’.”