The new defined benefit pension scheme funding regime will soon be effective. Pension advisory firm, LCP, explains how the changes will affect charities and what charities will need to do next.
We now have key details of the new defined benefit (DB) pension scheme funding regime, which will apply to scheme valuations with effective dates after 22 September 2024.
Any charity with a DB pension scheme will be impacted and may have to pay more contributions, agree more prudent investment strategies and provide more detailed information to the trustees of their pension schemes.
What is changing?
The Funding Code is published by the UK's Pensions Regulator and sets out its expectations for how DB pension schemes should be funded.
From the next triennial valuation after 22 September 2024:
- Charities will need to agree (in most cases) a formal funding and investment strategy with the trustees of their pension schemes;
- This will need to assume that risks are reduced in their investment strategy by the time the scheme is significantly mature (broadly when most members benefits are in payment) or before if it appears the charity will not survive that long.
- The net impact is likely to mean more prudence in funding targets, putting more reliance on contributions from the charity to pay benefits and less reliance on future investment returns; and
- Those contributions must be paid as quickly as the charity can “reasonably afford” – a difficult concept to define for charities.
There are also additional reporting requirements, most notably a “Statement of Strategy” that will summarise some of the above information (with some easements for schemes of less than 200 members).
How are charities likely to be impacted?
This largely depends on how well funded a pension scheme is already – by which we mean the level of the assets relative to the pension scheme’s liabilities.
Fortunately, we have seen material improvements in funding positions for many schemes with rising yields on government bond leading to falling liabilities.
Where this is the case, the main impact may simply be additional governance costs for all the new compliance work and light-touch covenant assessments. This can be mitigated to some extent by using “Fast Track” which attracts reduced regulatory scrutiny.
However, for charities where funding is not so strong the funding regime is going to result in higher contributions needed to make up any shortfall. How much higher will depend on what is “reasonably affordable” and we expect charities to be asked by their pension scheme trustees for much more information about financial strength and affordability.
Where charities and the trustees of the pension scheme have not taken professional advice, this is likely to become necessary.
LCP’s view is that “reasonably affordable” does not necessarily mean that a large proportion of charitable spending will now need to be directed to the pension scheme.
The Funding Code recognises that charities run reputational risk if too large a proportion of its available cash gets diverted to a DB scheme, and given charitable projects are critical to a charity’s purpose there is not an expectation that these cease.
Equally, any restricted funds can be excluded. That said, our view is there will be charitable spending which could be argued to be more discretionary in nature, and there will need to be a debate with the scheme's trustees as to whether this should be directed to pension scheme funding.
What should charities do?
- Find out more about the likely impact of the regime on your scheme – as stated above this may be a major issue for you or it may be that you are fortunate to be in a strong funding position.
- Take control of the areas where you have a role – the funding and investment strategy normally needs to be agreed between charity and pension trustees so you can lead the discussions and influence the direction. This will be critical to the level of contributions payable.
- Prepare for the additional information request – both in terms of the additional work and how you position any responses so you are clear with pension scheme trustees what projects are critical to the charities purpose
Further resources
The Pensions Regulator: DB Scheme Funding and Costs
The Pensions Regulator press release, July 2024: New DB funding code paid in parliament
CFG press release, 29 March 2023: CFG responds to TPR's consultation on funding code of practice
About LCP
LCP is an independent UK pension advisory firm with a specialist team dedicated to charities and other not for profits who provide actuarial, investment and covenant advice.
If you want to read more about LCP’s charity team, you can find our more on their website: Charity pensions consulting (lcp.com).