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The opdu Report - Issue 19, November 2005
Comment
New Funding Requirements for Defined Benefits
Charlie Massey
New funding requirements
for defined benefits set out in the Pensions Act 2004 come into force at the end
of December. Charlie Massey, the Pensions Regulator’s Strategic Development
Director, explains the implications for trustees, employers and advisers.
The aim of the new legislation is to prevent the underfunding of defined benefit
schemes, and protect members’ benefits. The Pensions Act requires schemes to
make a prudent assessment of liabilities, determine the level of any deficit and
take action to tackle it.
Unless exempt, all occupational schemes that provide defined benefits will need
to comply, including normal final salary schemes and average salary schemes, as
well as those whose level of benefits is guaranteed under the scheme provisions
or where there is a minimum level of accumulation.
Employers, trustees and advisers will all have a role to play. Trustees in particular
will be faced with new challenges, as they will be responsible for implementing
the regime – and to help them comply with the new legislation, the Pensions
Regulator is developing a free e-learning programme.
Trustees will have to make key funding decisions after taking advice from their
actuary and usually with the agreement of the employer.
Employers will have to negotiate with trustees, rather than impose funding
decisions upon them, and will be required to secure a mutually acceptable
approach to the funding of their pension scheme.
Scheme actuaries will be expected to assist trustees when they are making pivotal
funding decisions – the actuary must advise on risk and on issues relating to the
requirement for prudence when coming to final funding decisions.
The key points of the requirements are:
- A statutory funding objective requiring schemes to aim to cover their
technical provisions. Technical provisions are an estimate of assets currently
necessary to make provision for benefits when they are due.
- A statement of funding principles
setting out exactly how the statutory funding objective will be met – prepared by
the trustees after consultation with the scheme
actuary and in agreement with the employer.
- A recovery plan, where the
statutory funding objective is not met.
- A schedule setting out contributions
due to be paid by the employer and active members. This must be
agreed with the employer and
certified by the actuary.
- Periodic actuarial valuations and
actuarial reports.
If there is found to be a shortfall, trustees must produce a recovery plan and
schedule of contributions and aim for any shortfall to be eliminated quickly –
what is possible and reasonable will depend on the employer’s financial
circumstances and business plans.
If the employer and the trustees cannot reach an agreement on funding, trustees
can modify the future accrual of benefits under the scheme, if employer agrees.
The employer will be required to consult active and prospective pension scheme
members. If it proves impossible to reach agreement, trustees must report to the
regulator which, as a last resort, may intervene.
There are also regulatory reporting requirements:
- Where a recovery plan is required,
trustees must send this, the supporting schedule of
contributions and a summary of the actuarial valuation on which the plan is
based, to the Pensions
Regulator within a reasonable
period of its preparation.
- Where an actuary is unable to
certify the calculation of the
scheme’s technical provisions, a
written report must be sent to the regulator.
- If trustees are unable to reach
agreement with the employer
where required to do so – for
example, over the schedule of
contributions – they must report
the failure to the regulator within a reasonable period.
- Trustees should investigate any
apparent failure on the employer’s
part to adhere to the schedule of
contributions, and also must report
to the regulator if there is a
significant contribution failure.
Another responsibility of trustees is to make copies of certain documents available
(including statement of funding principles, recovery plan, schedule of
contributions) on request and at nominal charge, to scheme members or
prospective members, spouses, other beneficiaries and relevant trade unions.
The regulator will work with trustees and employers to identify and help rectify
any problems. Where possible, we will provide support and advice to trustees,
administrators, employers and others to keep schemes on the right track for the
long term. However, where the trustees or actuary are unable to meet their
obligations under scheme funding requirements the Pensions Regulator can:
- modify future benefit accrual
- direct how technical provisions are
to be calculated
- direct how any failure to meet the
statutory funding objective is to be remedied, and the period within
which this must be done; and
- impose a schedule of contributions.
The new requirements come into force at the end of the year and apply to
valuations based on an effective date of 22 September 2005 onwards, but
completed after 30 December 2005. Once the requirements are in force, trustees
need to check when the first valuation under the new regime will be due.
Trustees should then draw up an action plan, after discussions with the employer
and the actuary. They must ensure that the statement of funding principles, any
recovery plan and the schedule of contributions are finalised within 15 months of
the effective date of the next actuarial valuation – although trustees beginning
their valuation between 22 September and 30 December will have 18 months.
The Pensions Act introduces the requirement for trustees to have sufficient
knowledge and understanding to run their scheme well, including pensions and
trust law, and occupational scheme funding and scheme investment. They are
also required to be conversant with their own scheme’s policy documents.
This will apply to around 126,000 trustees in 32,000 schemes, and while trustees
display a wide range of experience and needs, our research tells us that they are
largely untrained, except for induction training of variable quality in the largest
schemes.
The Pensions Regulator is committed to supporting pension scheme trustees in
continued professional development, and is developing a free e-learning
programme which will be available from January 2006. Although designed for
trustees, this will be available to anyone interested in using it – pensions
professionals, scheme administrators and scheme members. Consultation on a
code of practice on trustee knowledge and understanding has now closed. The
final code should be published by the end of the year and will come into effect in
April 2006.
A publication explaining how the Pensions Regulator intends to implement the
Scheme Funding regulations is planned for issue as a draft for public
consultation. The underpinning DWP regulations come into force on 30
December 2005, when the regulator will issue a code of practice on funding
defined benefits. For more information on scheme funding visit:
www.thepensionsregulator.gov.uk/codesAndGuidance
Charlie Massey
Strategic Development Director
The Pensions Regulator
0870 606 3636
customersupport@thepensionsregulator.gov.co.uk
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