TPR final draft funding code laid before Parliament: key points to note

Maturity in the regulations is measured by reference to ‘how far a scheme is through its lifetime’ in years, using a specified duration of liabilities measure which is set out in the code to allow sufficient flexibility.

TPR can set different maturity durations for different types of scheme.

Duration is the weighted mean time until benefit payments are expected to be made weighted by the discounted value of those payments. 

The code has moved significant maturity from being when duration reaches 12 years to 10 years (cash balance – 8 years, weighted for hybrid and a proxy for small Fast Track schemes defined as schemes with 200 members or fewer at the valuation date). This takes account of market condition changes since 31 March 2021, using economic conditions on 31 March 2023 as required by the regulations. 

The regulations added an investment objective (that, on and after the relevant date, scheme assets are invested in line with a low dependency investment allocation (LDIA)) as a matter to be considered when producing the FIS. This was to address concerns about potential encroachment on trustee investment powers. 

Although the FIS must reflect the principle of reaching full funding by the relevant date, there is no free-standing requirement to invest in line with a LDIA. The investment objective only applies up to full funding on a low dependency basis, so does not apply to surplus. 

Code consultation responses said it was unclear whether trustees must invest in line with the investments outlined in the FIS. 

The code confirms that neither the FIS nor the journey plan “interfere’ with the trustees’ duty to invest in the best interests of members and their powers over the scheme’s actual investments as detailed in the scheme’s governing documents.”

The code clarifies that the ‘notional investment allocation’ in the FIS does not restrict how trustees actually invest. There is a difference between ‘notional’ and ‘actual’ investment allocation. Nevertheless, in most cases, TPR expects the ‘actual investment strategy to be in line with the FIS and the notional investment allocation detailed in the journey plan. 

The expectation is that, for the majority, investing in keeping with the LDIA at and after the relevant date will be in members’ best interests – however, this is not a requirement. 

The regulations dropped the reference to the cash flow having to broadly match benefits payments to address concerns around this leading to ‘excessive de-risking’ and to allow higher growth investing after significant maturity. Instead, LDIA in the regulations refers to assets being invested so they are “highly resilient to short-term adverse changes in market conditions”.

The LDIA module now reflects the final regulations. The code has also been changed to remove a prescriptive approach to testing high resilience. Instead, there is now a principles-based approach so that trustees can use an appropriate test for the scheme.

The Code Response notes that the new regime has flexibility to allow scheme-specific investment strategies and investment in productive assets “where appropriate and supportable. There are no specific restrictions on the assets trustees choose to invest in.”

Code feedback: There were concerns over having a formulaic test in the code that trustees would use to assess maximum supportable risk levels during the journey plan. 

To address concerns, TPR has adopted a principles-based approach to supportability which accounts for the different ways that trustees assess risk and how risk is supported. 

To give trustees an idea of suitability, TPR includes testing that should be carried out to ensure the scheme has enough cash flow and contingent asset support over the reliability period to recover any deficit. The regulatory approach document will include a formula which will act as a preliminary prompt for a regulatory risk assessment.

The regulations were amended to clarify that the journey plan as regards funding forms part of the FIS. The journey plan so far as it relates to investment does not form part of the FIS, but the investment objective (see above) must be considered when producing the FIS.  

The code explains that although the FIS only contains the funding element of the journey plan, the journey plan itself also includes investment and how the current notional investment allocation will move to the LDIA.

The regulations make an allowance for new members and future accrual when assessing maturity. Using ‘open’ assumptions should be reasonable and based on a covenant assessment. 

The code has been updated to reflect this change with additional flexibility included for the assumptions that can be used. There is also a new section in the code for open schemes which pulls together the different open scheme references with signposting.

Under the regulations, employer covenant strength (which is legally defined for the first time by reference to financial ability relating to legal obligations and legally enforceable contingent assets) must be assessed by reference to the scheme’s deficit or surplus. When assessing financial ability certain matters must be taken into account.

Proportionate account must be taken of the employer’s covenant when determining the assumptions to be used in calculating scheme liabilities. 

The updates to the code include more detail generally and explanations about when a lighter touch or more thorough assessment might be appropriate.

There is a move away from the existing four covenant gradings to an assessment of financial ability and contingent asset support (in line with the legal definition of covenant strength) and the matters that must be considered under the regulations. 

The assessment should cover: (1) the reliability period (how long the trustees can with reasonable certainty rely on cash flow – typically using a short to medium term of 3-6 years); and (2) covenant longevity (how long with reasonable certainty it can be said that the employer will continue to support the scheme – usually this will not go over 10 years). 

The code has been updated to make clearer how reliability and covenant longevity periods should be assessed. It also emphasises the importance of continuing to monitor covenant after low dependency, albeit this can be light touch.

Employer forecast visibility references have been removed from the core assessment. However, this is still “considered a starting block” in considering cash flow and establishing the applicable reliability period.

To address concerns about the new Affordability Principle, the regulations added in a new matter that trustees need to consider when producing a recovery plan – the impact of the plan on the employer’s sustainable growth.

The code clarifies the earlier draft’s core messaging around the primacy of the Affordability Principle. It also now reflects the new sustainable growth impact consideration – this is the first matter that trustees should look at under the Affordability Principle. Reasonable affordability should be assessed “at least on a year by year basis”, with action taken to decrease the deficit in keeping with this analysis, “even if this leads to an unusual recovery plan structure.”