The Pensions Regulator (TPR) has urged defined benefit (DB) pension trustees and sponsors to reassess their long-term objectives, after its Annual Funding Statement showed that half of schemes have exceeded their estimated buyout funding levels.

TPR’s statement showed that most schemes have seen "material improvements" in their funding levels, with a range of options in addition to buyout, including targeting surplus generation or consolidation, available to well-funded schemes.

"We would encourage trustees to consider all options and not just accept the status quo," the statement said, confirming that TPR is also intending to publish guidance on DB alternative arrangements for consolidation later this year, which will provide more detail.

Despite the broader improvements, TPR acknowledged that around a quarter of schemes are expected to remain in deficit on a technical provision basis, encouraging trustees of such schemes to focus on achieving a recovery plan that is as short as reasonable, based on the employer’s affordability.

TPR interim director of regulatory analysis and advice, Louise Davey, said: “Where funding levels have improved significantly, trustees should review objectives and strategies, set during a period of low interest rates, to ensure they remain in the best interests of members.

“If they are not, trustees should look to redirect some of their funding level improvements towards a funding and investment strategy that is aligned with their plans for the scheme.

“Options range from moving to a long-term target with the potential to generate additional surplus, to entering a consolidator or insurance arrangement.”

In addition to highlighting the full range of endgame options facing DB schemes, TPR's statement included increased reference to climate risk, geopolitical instability, sustainability, and other environmental, social and governance considerations and their importance, including when thinking about longer term strategy, and encouragement for trustees to consider sustainability when selecting an insurer.

TPR also provided further insight into its expectations on discretionary increases, acknowledging that DB schemes are increasingly facing calls from employers to reduce or suspend contributions, as well as from members for discretionary increases, given that pension increases may not have kept pace with inflation.

For example, some employers are asking to reduce or suspend contributions, and members are requesting discretionary increases.

When considering these requests, TPR urged trustees to remain mindful of their overall position, the resilience of their investment strategy to future financial market movements, and level of covenant support.

It also encouraged trustees to think about the situation of members who would benefit from a discretionary increase, and whether their scheme has a history of making such awards.

The 2024 statement is expected to be the last such statement under TPR's current DB funding regime, with the new funding regime due to apply to valuation dates from 22 September 2024.

Industry experts have broadly welcomed the update from TPR, particularly the focus on broader endgame options, as Mercer partner and UK wealth corporate lead, Simon Turner, stressed that "handing pension schemes over to insurance companies is not the only option".

"We see this as a pivotal moment for stakeholders to take stock and reassess their future plans," he continued.

"For some, insurance solutions remain the right outcome. For others, running schemes on could present an opportunity for members to receive higher benefits and companies to see a return of some of the billions of pounds of contributions they have sunk into UK pension schemes.”

This was echoed by PwC pensions employer covenant and restructuring partner, Katie Lightstone, who said that the regulator’s statement strikes a “notably different tone” this year, with a greater focus on schemes running on to generate surplus to benefit members and sponsors and encouragement for schemes to review granting discretionary increases.

Barnett Waddingham partner, Paul Houghton, also agreed that the greater prominence given to the option of running-on schemes beyond buyout funding is welcome, as is the spotlighting of emerging, innovative capital-backed solutions.

However, he argued that the regulator’s slightly cautious tone here is "disappointing", stating that "there should be no presumption that these options are second best, especially where it is expected that they will result in enhanced member benefits".

More broadly, LCP partner, Jon Forsyth, said that it was “really interesting” to see TPR’s greater emphasis on broader systemic risks, such as climate risks, geopolitical uncertainty and sustainability, the latter particularly when considering insurance options.

“We’re finding trustees are increasingly interested in exploring the potential impact of these systemic challenges, and, having taken the step back to consider these issues, are making different decisions as a result,” he stated.

However, Houghton argued that despite the "significant focus" on climate and sustainability risks, the expectations for schemes, including what TPR views as proportionate, could still be clearer.

He also pointed out that "“we are still receiving messages that really relate to a new funding regime that has been promised for several years – and not the one technically in force".

"What we’d really like to receive from the regulator is the new Code of Practice that these messages are geared toward," he added.

This was echoed by Aon partner, Matthew Arends, who said that whilst it is reassuring that TPR has recognised the very significant recent DB funding improvements, this could place an "even stronger spotlight on the question of why TPR is still implementing a new Funding Code and funding regime that will be brought in later in 2024?”

Despite industry concerns, TPR's statement confirmed that it remains on track to share the revised DB code this summer, along with supporting documentation and a consultation on updated covenant guidance.

Given this, TPR said that it would be good practice for trustees to consider the steps they can take now to align (even if broadly) with the funding code when it is published, and to avoid having to make significant changes at the next valuation to be compliant.

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