These two reforms have a fundamentally different perspective on the direction of travel for DB scheme funding, the allocation of capital and investment risk.
Mansion House reforms – a huge boost for DB scheme sponsors?
The DWP has issued a call for evidence following the Chancellor’s recent Mansion House speech, centred on the idea that pension schemes embrace greater investment risk by investing in “productive finance”. The intention of these “Mansion House” reforms is that surplus returns could be generated for pension scheme sponsors and members, benefiting the UK economy as a whole.
Based on analysis conducted by Barnett Waddingham of the FTSE 350 DB schemes, they estimate that around £50 billion of surplus funds would currently be available to be returned to sponsors of FTSE 350 DB schemes if the Mansion House proposals are agreed.
This is equivalent to around 10% of FTSE 350 DB scheme assets, and is also equivalent to around two-thirds of the total dividends paid in 2022 by the FTSE 350 DB scheme sponsors.
The analysis assumes that any surplus above 105% funding on the Pensions Regulator’s proposed “Fast Track” low dependency basis would be available to be returned to sponsors.
Of course, not all schemes will be able to return surplus funds to sponsors in full (some will already be in the process of buying out with an insurance company, while tax and improving member benefits may add further complications), but nevertheless it is clear that the Mansion House reforms could have a profound impact for sponsors of DB schemes.
DB Funding Code – overtaken by events?
The DB Funding Code has been a number of years in the making and will require DB schemes to target a low dependency funding basis over the long term. The current expectation is that this will be in force next year, but given the vastly improved funding position of DB schemes following the increase in bond yields over the last year, the relevance of the DB Funding Code is being called into question.
BW have analysed how well placed the FTSE 350 DB schemes are to comply with the requirements set out in the draft DB Funding Code.
BW’s analysis suggests that around 80% of the FTSE 350 DB schemes are likely to pass all three of The Pensions Regulator’s (TPR’s) strict Fast Track tests as at 30 June 2023. This is substantially higher than TPR’s own assessment that 51% of schemes would pass all three tests as of 31 March 2021, largely reflecting the significant improvement in average scheme funding positions over the past two years.
Others will already be complying with the strict requirements of the Code, which are less prudent than the Fast Track tests, and opt for a “Bespoke” submission. Specifically, BW estimate that around 90% of FTSE 350 DB schemes are already broadly compliant with the guidance in the Code.
This raises the obvious question: is the new Code really needed to change pension scheme behaviour? Given the material improvement in funding positions generally, much of the new requirements now appear superfluous for the vast majority of schemes. Therefore, will the additional costs of complying with the new requirements for all schemes outweigh any benefit that might be achieved by increasing security for a diminishing number of underfunded schemes?
Mark Tinsley, Principal at Barnett Waddingham, said: “Many pension schemes have seen large improvements in their funding positions over the past year and now have significant surplus funds. Sponsors therefore stand to benefit considerably if the rules around returning surplus funds are relaxed, as is being considered under the so called “Mansion House” reforms. However, any reforms should ensure that members of pension schemes are not adversely affected, meaning that extra forms of security may also be needed.
Improvements in scheme funding positions also call into question the benefit of requiring all schemes to target a low dependency funding level, as is separately being planned by the DWP and to be reflected in a new Funding Code issued by the Pensions Regulator. The vast majority of pension schemes are now already meeting the proposed stricter funding requirements, so the additional costs associated with requiring all schemes to comply with the proposed changes to the Funding Code may now be difficult to justify.“
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