Scheme funding
The minimum funding requirement (MFR) will be replaced with scheme-specific funding requirements. Key elements of the new arrangements will be:
- a requirement for scheme trustees to prepare a Statement of Funding Principles (SFP) setting out the scheme's strategy for funding its pension commitments and for correcting funding deficits. The SFP will complement the Statement of Investment Principles which trustees are already required to prepare;
- regular actuarial valuations, based on a funding approach consistent with the strategy set out in the scheme’s SFP. Trustees will determine the the actuarial methods and assumptions to be used, having obtained advice from the scheme actuary;
- more effective communication with scheme members to ensure that they are better informed about the funding of their scheme;
- powers for The Pensions Regulator to help resolve disputes about funding issues between the trustees and the sponsoring employer; and
- clarification of the scheme actuary's role in respect of scheme funding.
Background
The MFR was introduced from April 1997, and applies to most private sector defined benefit pension schemes. Schemes subject to the MFR are required to hold a minimum level of assets to meet their pension liabilities (as assessed on the basis of the MFR test), and any funding shortfalls under the MFR must be made good within prescribed timescales (the MFR deficit correction periods).
- Find out more in Security for Occupational Pensions: The Government's Proposals (March 2001) (200KB)
Why is the change needed?
The MFR has been widely criticised since its introduction, and it is clear that it has not worked as intended. It has increased regulation and costs for sponsoring employers, without delivering the level of security which many people expected. It is also considered to have inhibited investment decisions by some schemes, causing them to focus on meeting the conditions of the MFR, rather than on developing an appropriate funding strategy for meeting their specific pension commitments.
What is changing?
Subject to the passage of the relevant legislation, schemes will not be required to fund to a common funding measure. Instead the scheme will have to meet a statutory funding objective which will require it to have sufficient and appropriate assets to cover its “technical provisions”. The term “technical provisions” is taken from the The EU Directive on Institutions for Occupational Retirement Provision 2003 / 41 (referred to as the Occupational Pensions Directive), and broadly means the amount of assets a scheme needs to hold now, on the basis of the actuarial methods and assumptions used, in order to pay its accrued pensions commitments as they fall due in the future.
The new requirements will allow funding arrangements to take account of the particular circumstances of each individual scheme. Pension scheme trustees, having taken advice from the actuary, will be required to agree with the sponsoring employer a strategy for funding the pension commitments and for correcting any funding deficits, and to set this out in a statement of funding principles. The new funding framework carries forward the existing statutory requirements for regular actuarial valuations and for a scheme to have in place a schedule of contributions.
How will the scheme funding changes improve the situation for employers?
The new scheme funding requirements involve a new focus on partnership in which the trustees and the sponsoring employer will develop a funding strategy to meet the pension commitments in full. While the overall responsibility for the funding decisions for a scheme will rest with the trustees, they will be generally required to seek the agreement of the sponsoring employer on the key issues affecting the funding of the scheme.
Why have two funding requirements – one for the Pension Protection Fund and another for scheme funding?
The new scheme funding requirements replace the minimum funding requirement with a scheme-specific funding framework. This will allow each scheme the flexibility to adopt the most appropriate funding strategy for meeting its specific pension commitments.
For the purposes of calculating the risk-based element of the Pension Protection Fund levy, a consistent funding measure will be used for all schemes – to do otherwise would be unfair. It is intended that this Pension Protection Fund funding measure will, as far as possible, build upon calculations which schemes are required to make for other purposes. But there will be no requirement for schemes to satisfy any funding requirements with reference to this measure.
- Find out more about the Government's pension reform plans.