Pensions Bulletin 2024/47

Pensions Regulator issues covenant guidance 

On 4 December 2024 the Pensions Regulator published its long-awaited updated guidance for trustees on how a DB scheme sponsor’s covenant should be assessed. This is “regulatory guidance” rather than a Code of Practice, but it does build on the employer covenant section of the DB Funding Code and so arguably extends the Regulator’s expectations in this important area. The DB Funding Code itself came into force on 12 November 2024 (see Pensions Bulletin 2024/44). The guidance has immediate effect.

Taking into account, in a proportionate way, the employer covenant is a vital part of the approach to setting a DB scheme’s technical provisions, valuing contingent assets, and assessing the affordability of recovery plans. The Code gives an introduction to the subject, along with the Regulator’s formal expectations.

The covenant guidance goes further and after an introduction (of which the overview section is of particular use), divides its material into eight modules, each tackling a particular area of interest, with clear signposts back to the Code in each of them.

The modules include the following:

• Assessing cash flow – one of the most important aspects of establishing employer covenant strength in the short to medium term, this lengthy module includes some worked examples after discussing the approach to assessing cash flow.
• Prospects – which examines how to understand the extent and duration of reliance that can be placed on employers to continue providing sufficient scheme support and highlights risks to that support deteriorating. Assessing employer prospects is key in determining the reliability period and covenant longevity. Various characteristics of an employer’s prospects are examined, with some illustrated through worked examples.
• Determining the reliability period and covenant longevity period – two key measures in the new DB scheme funding regime, this shorter module discusses how they should be determined, concluding with some worked examples.
• Determining the covenant inputs required to assess supportable risk – understanding the available covenant support is a vital ingredient in determining the funding and investment strategy, so that the risk being taken is “supportable” both in the reliability period and after it. It is also important when considering the backing for any recovery plan. This module examines both, along with some material on contingent asset support (which is further expanded in the contingent assets module), with all sections accompanied by worked examples. These sections are particularly helpful given the Regulator has become more prescriptive in its approach in these areas.

The covenant guidance replaces that issued by the Pensions Regulator in August 2015 and this has now been withdrawn from the Regulator’s website.  Whilst the new guidance is heavily focused on content outlined in the DB Funding Code, it is worth remembering that it applies to all covenant assessments. This means that when trustees are looking at how corporate activity, for example M&A transactions or a restructuring, could impact the covenant, they will need to consider any changes to things like the covenant reliability and longevity periods.

LCP News Alert – applying inheritance tax to pensions proves to be taxing 

At the Autumn Budget the Chancellor announced that most unused pension funds and death benefits would be brought into a person’s estate for inheritance tax purposes from 6 April 2027 (see Pensions Bulletin 2024/42). HMRC also published a consultation on the complex processes required to implement these changes. This showed, amongst other things, the potential for these new processes to result in significant delays in pension schemes being able to pay out death benefits.

HMRC has now initiated a series of workshops with pensions industry representatives, including from LCP, that examine each step of the “journey” that the new processes will require in order that the necessary information is exchanged between various parties and any inheritance tax due on pension benefits is identified, calculated and paid to HMRC, with beneficiaries receiving less from the pension scheme as a result. These workshops are being run in tandem with the consultation which closes on 22 January 2025.

However, this policy shift requires more than an understanding of how these new processes can be best made to work. In our 2 December 2024-published LCP News Alert we look at some of the implications for pension schemes and their sponsors of a new regime in which nearly all death benefits are potentially subject to inheritance tax.  

Bank of England calls for follow up work on LDI usage in DB schemes  

The Bank of England has now concluded its system-wide exploratory scenario exercise (SWES) in which it sought to improve understanding of the behaviours of banks and non-bank financial institutions (such as pension schemes) during stressed financial market conditions and how those behaviours might interact to amplify shocks in UK financial markets that are core to UK financial stability. This is the first such exercise that includes non-bank institutions such as pension schemes. 

Launched in June 2023 (see Pensions Bulletin 2023/25), the final report, which was published on 29 November 2024, draws six conclusions, three of which are particularly pertinent to the use by DB schemes of LDI funds.

In Conclusion 1 the Bank says that “firms’ collective actions amplify the initial shock” (ie as delivered by the stress in the modelled scenario). While non-bank resilience has increased in a number of sectors and firms over recent years, some of that resilience could deteriorate or change over time, risking greater amplification by the financial sector in the future. The Bank points out recent regulatory reforms for LDI funds which have significantly reduced their liquidity risk and leverage and hence increased their capacity to weather a gilt market stress without recourse to asset sales.

In Conclusion 3 the Bank says that actions taken by authorities and market participants following recent market shocks have improved gilt market resilience, but further work is required given the other vulnerabilities highlighted by the SWES (the Bank noting that outcomes in the gilt market are inherently tied to those of other markets – most importantly, repo financing markets and rates derivative markets). The Bank goes on to say that the Pensions Regulator’s 2023 guidance to increase the financial and operational resilience of pension schemes’ LDI positions (see Pensions Bulletin 2023/17) is instrumental in limiting the risk of forced gilt sales in a stress, and emphasises the importance of maintaining it.

In Conclusion 4 the Bank says that the sterling corporate bond market could face a ‘jump to illiquidity’ in stress, whereby the speed of selling pressures significantly exceeds purchasing capacity and prices need to fall rapidly for the market to clear. Working closely with the Bank, the Pensions Regulator will be taking forward follow-up work with the pension industry to explore potential improvements to existing data collections to provide insight around intended aggregate asset sales, in order that firms are aware of potential correlation risks in their pre-planned liquidity waterfalls (ie the assets they plan to sell, if needed, to support their LDI positions). In addition, the Regulator is planning to better understand the discretionary behaviour of pension schemes under stressed market conditions and whether the functioning of key sources of liquidity can be improved.

The Pensions Regulator has welcomed these conclusions, saying that they demonstrate that pension funds have significantly improved their resilience with respect to LDI over the past two years. The Regulator also promises to explore improvements to its data collection “to make sure we keep savers safe”.

Pensions Regulator announces shift to “prudential-style of regulation” 

Nausicaa Delfas, CEO of the Pensions Regulator, set out plans for the future approach to regulation by her organisation during a speech on 27 November 2024 which was accompanied by a press release the same day.

Ms Delfas welcomed the reforms announced by the Chancellor at Mansion House (see Pensions Bulletin 2024/45) but acknowledged that as the pensions market changes, so must the Regulator. The Regulator’s own modelling suggests that, even without Government intervention, in 10 years’ time the master trust market will contain schemes of systemically important size – seven schemes with more than £50 billion assets under management on a consolidated basis, four of which will be responsible for well over £100 billion each.

Therefore, the Regulator is to shift to a more prudential-style of regulation, which is intended to address risks not just at an individual scheme level, but also those risks which could impact the wider financial ecosystem.

As part of this new approach, the Regulator is restructuring how it approaches DC supervision, with tiers of engagement depending on the risks schemes present to the market and saver outcomes. This will move towards a model which groups such schemes into four segments with particular characteristics: monoline master trusts, commercial master trusts, non-commercial master trusts, and single employer trusts and CDC schemes.

Ms Delfas stated the Regulator’s priorities are in three key areas:

• Scheme investments – stepping up the focus on investments across both DB and DC schemes.
• Data quality – inviting some of the largest pensions administrators to voluntarily collaborate with the Regulator to understand how they operate and mitigate systemic risks where they are found (see Pensions Bulletin 2024/35). Ms Delfas also reiterated that the Regulator will be writing to all chairs of trustees several times in the year leading up to their dashboard connection date setting out the clear actions they must take. She warned that trustees are accountable for this and must not assume that their administrator has this handled.
• Trusteeship – raising standards of trusteeship, which she said was the most important priority. She confirmed her previous announcement to establish formal relationships with the ten professional trustee firms that now govern over £1 trillion of assets (see Pensions Bulletin 2024/40).

DB and hybrid scheme returns – new questions published

As is customary around this time of year the Pensions Regulator has published some information to help trustees prepare for and complete the annual scheme return for defined benefit or hybrid benefit schemes. The 2025 return must be submitted by 31 March 2025. 

There are some new questions and updates this time round but nothing on the scale of what we saw for the 2024 return (see Pensions Bulletin 2024/02).

In the 2025 return there will be:

• Additional questions about scheme member data quality (previously referred to as “record-keeping”) – to bring the questions in this area more in line with the Regulator’s expectations and the General Code. In particular, trustees will be asked to confirm if they have measured their scheme’s common or scheme specific data in the last year, instead of the past three years in previous returns. 
• Four new questions about scheme membership details – so that the Regulator can calculate the General Levy payable for the year starting 1 April 2025.
• Three new questions about the performance of investment consultancy providers against any objectives they have been set, and whether those objectives have been reviewed.

Although most wait for the Regulator to issue its request to the scheme to complete the return, certain details in the return can be completed now. 

PASA issues data scoring guidance 

The Pensions Administration Standards Association has published new guidance on data scoring with the aim of supporting trustees and providers in achieving higher data standards, whilst aligning with broader industry expectations. 

The new guidance reminds trustees of the minimum requirements set out by the Pensions Regulator, and recommends additional practices trustees and administrators could undertake on record keeping and scoring. The guidance also includes a list of scheme-specific data items that trustees should consider testing and references other relevant PASA guidance materials that will help trustees monitor and improve data quality. It also highlights the importance of consistent testing methodology, both within the scheme over time, and across the industry, to ensure comparability of data scores and the best outcomes for scheme members.

The guidance has been welcomed by Fiona Frobisher, the new Head of Policy at the Pensions Regulator, who encourages scheme administrators and trustees to review their existing scoring approach to ensure they meet minimum requirements, and adapt the good practices highlighted in the guidance to score member data in a consistent way. 

PDP issues progress update report 

The Pensions Dashboards Programme has published its latest progress update report, setting out progress over the last six months. The following are of particular note:

• Details of how the PDP is working with a group of over 20 volunteer participants for connection testing to the ecosystem. Since August, eight organisations have started their “connection journey” and two have completed integration testing.
• Confirmation that the PDP is continuing to work towards the connection timetable set out in the DWP guidance under which the first cohort of pension providers and schemes is expected to be ready for connection to the ecosystem in April 2025.  However, the PDP expects there will need to be flexibility and this cohort may not have been successfully connected by then, especially as there are uncertainties about when the volunteer participants will have completed their connection process.
• News that in July 2024 the MoneyHelper pensions dashboard passed an Alpha Assessment as part of the GOV.UK Service Standard Assessment process. The PDP hopes to begin a process of end-to-end testing of this dashboard with pension providers and schemes from spring 2025.
• An update on the PDP’s standards. The reporting standards were published in November, together with updates to the data standards and the code of connection; this leaves the design standards to be the only remaining standard to be published.

Introducing the report, Chris Curry, Principal of the PDP says that it comes at a time of great momentum for the programme and expresses his gratitude to all parties for the hard work and collaborative spirit they have shown in what is a “complex and unprecedented” task.

Ombudsman dishonesty unit finds trustees liable in another pension scam case

Following an extensive investigation by the Pensions Ombudsman’s Pensions Dishonesty Unit into three supposed occupational pension schemes, a pensions administration company and the trustees of the three schemes, the Deputy Pensions Ombudsman has found that scheme funds relating to just under 120 individuals were invested in breach of trustee investment duties, in furtherance of a pension liberation arrangement and by trustees in a position of conflicting interests. 

The two individual trustees were found to have acted dishonestly and so attracted personal liability, and an administrator was found liable as a dishonest assistant in respect of one of the breaches of trust. 

The current Deputy Pensions Ombudsman, Anthony Arter, has directed that over £5.2m is repaid by the trustees into the schemes for the benefit of the membership as a whole, and also to pay two of the applicants £6,000 each and three of the applicants £4,000 each in recognition of the exceptional distress and inconvenience each has suffered. 

This case follows on in short order from the results of another investigation by the Pensions Dishonesty Unit relating to another two supposed occupational pension schemes that had been established with the primary intention of channelling money into specific, predetermined investments. In this case the current Deputy Pensions Ombudsman directed that a former director of the trustee company (Ecroignard Trustees Ltd) personally pay some £9.8m into the schemes for the benefit of all members and to pay each applicant £5,000 in recognition of the exceptional distress and inconvenience each had suffered. 

In a separate development, Camilla Barry has been confirmed for the appointment of Deputy Pensions Ombudsman and Deputy Pension Protection Fund Ombudsman by the Pensions Minister. Her appointment will run for four years from 9 December 2024 and she will take over from Anthony Arter.

EastEnders episode prompts call to report scams to Action Fraud 

The Pensions Regulator has used an EastEnders storyline that aired on 28 November 2024 and which it facilitated, to urge the pensions industry to report scams and suspicions of scams to Action Fraud. It also hopes that the episode will empower viewers to recognise scams and encourage them to report any suspicious activity to Action Fraud too.

The Regulator says that pension schemes should report any knowledge or suspicions of pension scams and those involved if:

• The scheme believes a scam has already happened 
• A red flag is raised when making a transfer
• The scheme suspects that a pension scam is taking place or is suspicious of those involved – this may be because of other risks that have been noticed such as amber flags in a transfer request.

The Regulator’s current expectations on reporting forms part of its Avoid pension scams webpage. This includes the instruction to email the Financial Conduct Authority about all transfers of concern and also report potential scams to the FCA (after reporting to Action Fraud).