Draft DB funding code of practice

This draft code forms part of the defined benefit funding code consultation.

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The funding regime

Chapter 1 – Codes of Practice

Introduction

1. This code of practice is issued by The Pensions Regulator (TPR), the body that regulates occupational pension schemes in the UK.
2. Publication of this code of practice is a statutory requirement. It provides practical guidance on how to comply with the scheme funding set out in:
   • Primary legislation – Part 3 of the Pensions Act 2004
   • Secondary legislation:
     • Occupation Pension Schemes (Scheme Funding) Regulations 2005
     • Occupation Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023
3. This code applies to valuations with an effective date on or after [TBC].
4. The code does not cover all aspects of pensions legislation. Trustees will be expected to seek the help of advisers and look beyond this code to help them understand all their legal obligations.
5. The code is for trust-based occupational pension schemes providing defined benefits and is primarily for the scheme trustees and the scheme’s sponsoring employer. Certain aspects will apply to actuaries and other professional advisers will also find it of interest, including covenant and investment advisers.

Status of codes of practice

6. Codes of practice are not statements of the law and failure to comply with the code does not of itself make a person liable to legal proceedings. However, legislation has delegated various matters to the code, which may (indirectly) be relevant to determining whether legal requirements have been met.
7. When determining whether relevant legal requirements have been met, a court or tribunal must take any relevant provisions of this code of practice into account.
8. In some scenarios there may be grounds for the regulator to pursue further action in the event of non-compliance with the requirements of Part 3 of the Pensions Act 2004. We may issue a s13 improvement notice, directing a person to take, or refrain from taking, such steps as are specified in the notice, or a s10 penalty notice. We may also use our s231 power to:
   • modify future accrual;
   • direct trustees to revise the scheme’s funding and investment strategy, the method and assumptions to be used in calculating the scheme’s technical provisions and/or the recovery plan, and/or
   • impose a schedule of contributions
9. These directions may be worded by reference to a code of practice issued by us.

Terms used in this code

10. This code of practice sets out our interpretation of how to comply with relevant legislative requirements. Trustees may choose to follow an alternative approach to that appearing in this code of practice, provided they are satisfied that underlying legal requirements are met.
11. In this code we use the word ‘must’ when referencing legal duties.
12. Where we use the word ‘should’ or ‘expect’, or refer to our expectations, this indicates our view of good practice, rather than an express legal duty.
13. We use ‘need’ where the process is necessary to allow a scheme to operate even though there is no expectation or legal requirement in place.

Related guidance

14. We will make clear on our website which code-related guidance derives from this code.

Chapter 2 – An outline of the funding regime

15. The scheme funding regime comprises two separate, but interlinked, requirements:
    1. To plan for the long-term funding of the scheme.
    2. To carry out valuations showing the current funding position of the scheme.
16. This section summarises these requirements. Further details are set out in the rest of this draft code.

Long-term planning

17. The Funding and Investment Strategy Regulations require trustees to carry out these steps in planning for the long-term funding of the scheme:
    1. To determine a funding and investment strategy, dealing with:
       • the planned funding ‘end game’ over the long-term
       • the journey plan, bridging from the current funding position to that ‘end game’.
    2. To record the above, and further supplementary matters, in a statement of strategy.

Funding and investment strategy

18. For the purposes of determining their ‘end game’, trustees must determine:
    • how they intend the scheme to provide benefits in the long-term (their long-term objective or 'LTO')
    • the funding level they intend the scheme to have reached, and the investments they intend to hold, at a particular date (the relevant date).
19. The funding level the trustees intend the scheme to have reached must be calculated on the low dependency funding basis.
20. Trustees must obtain the employer’s agreement to the funding and investment strategy.

The LTO

21. Benefits can be provided by schemes in a number of ways, including:
    • running off the scheme, paying the benefits from the scheme as they fall due
    • buying out members’ benefits with an insurer
    • transferring the scheme assets and liabilities to a DB superfund or another consolidation vehicle
22. The chosen strategy should be taken into account when considering the other elements of the funding and investment strategy, for example if the strategy is to buy out benefits, the trustees may adopt a higher funding target at the relevant date.
23. For open schemes, trustees need to consider how they would provide accrued benefits for existing members over the long term, as set out above. However, we recognise that, if trustees assume that membership will remain stable over time, the scheme may not get closer to its relevant date in practice.

The relevant date

24. A scheme’s relevant date is set by the trustees. It must not be later than the end of the scheme year in which the scheme is expected to reach (or did reach) significant maturity (though it can be any date in advance of this deadline).
25. The scheme actuary is responsible for estimating the date of significant maturity. This estimate must be produced by reference to the ‘duration’ of the scheme’s liabilities. Further detail is set out in Chapter 5.
26. Where a scheme has not reached the relevant date, the actuary should also estimate the expected maturity of the scheme at that (future) date.

Investments after the Relevant Date

27. For the purposes of the funding and investment strategy, trustees must assume that scheme assets will be invested in accordance with a low dependency investment allocation on and after the relevant date.
28. A low dependency investment allocation is an investment strategy under which:
    • the cash flow from the investments is broadly matched with the payments under the scheme, and
    • the value of the assets relative to the value of the scheme’s liabilities is highly resilient to short-term adverse changes in market conditions
29. Trustees must ensure that the risks in the assumed investment strategy are sufficiently prudent, so that no further contributions would be expected to be required from the employer if the scheme was fully funded (further detail in relation to this test is set out in Chapter 3).
30. Trustees must also assume that scheme assets will be invested on and after the relevant date in investments with sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements.
31. Further details on how trustees should approach these requirements are set out in Chapter 3.

Low Dependency Funding Basis

32. A scheme’s liabilities must be calculated in accordance with the low dependency funding basis for the purposes of the funding and investment strategy.
33. A low dependency funding basis must use actuarial assumptions which are set such that if one was to presume that:
    • the scheme was fully funded on that basis, and
    • the scheme’s assets were invested in accordance with the Low Dependency Investment Allocation, then
      no further employer contributions would be expected to be required.
34. Further details on how trustees should approach these requirements are set out in Chapter 4.

The long-term funding target

35. Trustees must determine the funding level they intend the scheme to have achieved as at the relevant date – the long-term funding target. This must be calculated by reference to the low dependency funding basis.
36. The long-term funding target level must be at least 100% - ie as a minimum, the trustees’ target must aim to be fully funded on the low dependency funding basis. However, trustees may target a higher funding level, for example if their strategy is to buy out benefits.

Journey plan

37. Trustees must plan how they intend the scheme to reach its long-term funding target. This is referred to as the journey plan.
38. When determining the journey plan as part of the funding and investment strategy, trustees must consider how they intend to transition from their current investment strategy to a strategy which would meet the standards of a low dependency investment allocation.
39. Trustees must ensure that this transition is:
    • dependent on the strength of the employer covenant, where more risk can be taken if the covenant is strong
    • subject to the above, dependent on the maturity of the scheme
40. Trustees’ investment plans must be expected to provide sufficient liquidity to enable the scheme to meet expected cash flow requirements and make reasonable allowance for unexpected cash flow requirements.

Statement of strategy

41. Trustees must prepare a written statement of strategy made up of two parts:
    • Part 1, which records the funding and investment strategy
    • Part 2, which records various supplementary matters (including matters related to the journey plan, how well the funding and investment strategy is being implemented, the main risks to the strategy and how they are being managed)
42. The level of evidence and explanation required in the statement of strategy will depend on the complexity of the risk taken.
43. Trustees must consult with the employer when preparing or revising Part 2 of the statement of strategy.

Determination, review and revision

44. A scheme’s first funding and investment strategy must be determined within 15 months of the effective date of the first applicable actuarial valuation. The first applicable actuarial valuation is the first valuation with an effective date on or after [date].
45. The funding and investment strategy must be reviewed and, if applicable, revised within 15 months of the effective date of each subsequent valuation (and in the other circumstances set out in Appendix 2).
46. Trustees must record their first funding and investment strategy, in a statement of strategy, a copy of which must be sent to us with the relevant actuarial valuation.
47. Whenever the funding and investment strategy is reviewed:
    • if that review has led to a revision of the funding and investment strategy, Part 1 of the statement of strategy must be updated to reflect the revisions; and
    • regardless of whether there has been any revision of the funding and investment strategy, Part 2 of the statement of strategy must be reviewed and, if applicable, revised.
48. A scheme’s first statement of strategy must be sent to us with the first valuation after the regulations come into force. The statement of strategy must be reviewed and, if needed, revised after any review of the scheme’s funding and investment strategy, which must be at least as often as the scheme’s valuations.
49. If the statement of strategy is revised as part of a corresponding valuation process, that revised statement must be sent to us. A statement of strategy that is revised between valuations does not need to be sent to us.

Valuations

50. Every DB scheme is subject to the statutory funding objective, which is to have sufficient and appropriate assets to cover its technical provisions (TPs).
51. Under Part 3 of the Pensions Act 2004, trustees must obtain actuarial valuations every year. However, trustees can choose to obtain valuations at up to triennial intervals, provided that they obtain an actuarial report for each intervening year.
52. An actuarial valuation is a written report prepared and signed by the scheme actuary, valuing the scheme’s assets and calculating the scheme’s TPs on a specific date, known as the effective date.
53. Where a valuation shows that a scheme did not meet the statutory funding objective on the effective date, a recovery plan must be put in place in order to return the scheme to full funding.

Interaction between the funding and investment strategy and valuations

54. There is a close interrelation between actuarial valuations and the long-term planning requirements. These include the following:
    • Each actuarial valuation must include the actuary’s estimate of the maturity of the scheme (calculated in accordance with the funding and investment strategy regulations) and the date on which the scheme will reach significant maturity.
    • Each actuarial valuation must estimate the funding position of the scheme as at the effective date, calculated on the low dependency funding basis as determined in the funding and investment strategy.
    • The assumptions used in the actuarial valuation must be consistent with the funding and investment strategy in the following ways:
      • The valuation assumptions applicable to the period following the relevant date must be actuarially consistent with the low dependency funding basis assumptions as determined in the funding and investment strategy;
      • The valuation assumptions applicable to the period preceding the relevant date must be calculated in a way that is consistent with the planned investment transition, as set out in the journey plan element of the funding and investment strategy.
    • The relevant date used for the purposes of the funding and investment strategy depends on the actuary’s estimate of significant maturity, as set out in the corresponding actuarial valuation.
55. Given this interaction, we expect trustees to consider the funding and investment strategy and valuation together as one. This is likely to be an iterative process as trustees’ understanding of their scheme and employer covenant develops, their plans evolve for managing the scheme risks, and ongoing dialogue with their employers develop. We expect trustees and employers to work collaboratively during this process (see Appendix 1).
56. Trustees are not required to invest in accordance with the low dependency asset allocation determined as part of the funding and investment strategy. There may be good reasons not to do so, for example an employer refusing to agree to a strengthening of the LDIA that the trustees consider appropriate being recorded in the FIS or where a scheme has a material surplus after the relevant date. However, given that significantly mature schemes have less capacity to make good negative investment outcomes, in most cases we expect trustees to exercise their investment powers after the relevant date in a way that is consistent with the low dependency investment allocation.
57. The following sections in this code set out our expectations for how trustees should approach these various elements and processes.

Long term planning

Chapter 3 - Low dependency investment allocation

58. For the purposes of the funding and investment strategy, trustees must assume that on and from the relevant date scheme assets will be invested in accordance with two principles:
    • The investments would meet the requirements of a low dependency investment allocation; and
    • The assets would be sufficiently liquid to enable the scheme to meet expected cash flow requirements, and with reasonable allowance for unexpected cash flow requirements.
59. A low dependency investment allocation is an investment strategy under which:
    • the cash flows from the investments are broadly matched with the payments of benefits under the scheme, and
    • the value of the assets relative to the value of the scheme’s liabilities is highly resilient to short-term adverse changes in market conditions.
60. The assumed investment strategy must meet the requirements above with the result that, when considering the overall prudence of the scheme’s low dependency funding basis, no further employer contributions are expected to be required to meet the benefits under the scheme in respect of accrued rights. Further details of this test are set out in Low dependency funding basis chapter below.

Broad cash flow matching

61. ‘Cash flow matching’ is an approach which allows schemes to hold assets whose expected cash flows to the scheme mirror those of the schemes expected benefit and expense payments. This gives the trustees confidence that the assets they hold will be able to pay the benefits and expenses as they fall due.
62. Scheme investments can be classified as being either 'growth' or 'matching' assets. Assets that meet the below criteria can be considered to be matching assets:
    • The income and capital payments are stable and predictable; and
    • They provide either fixed cash flows or cash flows linked-to inflationary indices.
63. The main asset classes that would meet these criteria include cash, government bonds and corporate bonds. Interest rate and inflation derivatives (including gilt repos) can also be deemed as matching where they provide payments to match the liabilities of the scheme. Illiquid and alternative credit including, for example, some property and infrastructure related investments, can also be used for matching purposes if they meet the criteria above.
64. We would expect that matching assets would be heavily weighted towards investment grade bonds (or equivalent) but some sub-investment grade assets may usefully contribute to meet scheme outgo.
65. As one of the requirements in the definition of 'low dependency investment allocation' is to be broadly cashflow matched with the payment of pensions and other benefits under the scheme, trustees should consider the expected payments from the scheme. In this regard it will be necessary for the Trustees to take advice from the scheme actuary regarding the expected cash flows and whether any adjustments are required to the funding assumptions for this purpose. For example, it may be necessary to take account of different levels of tax-free cash at retirement to reflect actual experience or whether allowance should be made for either early or late retirement patterns (which might be cost neutral for funding purposes). It is important that Trustees understand the risks from actual scheme outgo differing from expected scheme outgo and how changes in the key demographic assumptions impact on those expected cashflows.
66. Trustees may choose to determine an investment portfolio for the purposes of their funding and investment strategy under which the scheme assets would match all future payments from the scheme. However, that level of cashflow matching is not required for the purposes of the low dependency investment allocation as the minimum requirement is only for broad cashflow matching. A scheme’s low dependency asset allocation can therefore contain a mix of 'growth' and 'matching' assets.
67. Trustees may choose to determine an investment portfolio for the purposes of the low dependency investment allocation that only partially matches future liability cashflows, but plan to put in place alternative hedging strategies to manage their interest rate and inflation risks in relation to the portion of their future liability cash flows that are not matched.
68. Future interest rates and inflation are not necessarily expected to remain the same. The yield curve describes the rate of interest that is obtainable (in real and nominal terms) over different time periods. If interest rates or inflation pricing changes, the shape of yield curves can change whilst at the same time the average interest rate or inflation assumption for the scheme might remain unchanged. Therefore, when determining the low dependency investment allocation, it is important to consider hedging against the shape of the interest rate yield curve or inflation yield curve rather than just the average duration of the liabilities only.
69. It is acceptable for trustees to 'bucket' cash flows from the scheme by aggregating the expected cash flows of the scheme over, for example, short, medium and long durations (or by defined periods) in order to determine where the liabilities fall on the yield curve. This will enable trustees to plan for the purchase of matching assets and implement hedging strategies so that they are aligned with the duration of the liability cash flows.
70. We therefore believe an approach where the scheme adopts a low dependency investment allocation which assumes some cash flow matching for a portion of their liabilities combined with high levels of hedging for interest rate and inflation consistent with the duration of their liabilities – including differing points along the yield curve – would be sufficient to be deemed broadly cash flow matched.
71. We expect that, through the above approaches, and consistent with the broadly matched requirements, schemes should seek to have a minimum level of interest rate and inflation hedging of at least 90% for the purposes of their low dependency investment allocation.
72. One example of meeting our expectation would be to have a low dependency investment allocation made up of the following asset classes:
    • corporate bonds and government gilts: 85% (assuming appropriate maturities and durations for the bonds)
    • growth assets: 15%
    We consider a scheme adopting this type of approach as its low dependency investment allocation would be considered to meet the requirement to be broadly matched with the payment of pensions and other benefits under the scheme.
73. When determining the low dependency investment allocation, trustees should also consider the requirements of high resilience to short-term adverse market changes and liquidity (as discussed below).
74. The extent of the level of accuracy should be proportionate to the size of the scheme and governance arrangements. In addition, where the allocation of growth assets in the low dependency investment allocation is higher, more attention should be paid to the composition of the matching assets. The key variables that can be varied in the matching portfolio will be the quantum of leverage and increasing the duration of the matching assets relative to the liabilities. Further consideration of governance arrangements will also be needed given the liquidity risks associated with any leverage arrangements.

High resilience to short-term adverse changes in market conditions

75. The investment strategy assumed for the purposes of the funding and investment strategy must also be such that the value of the assets relative to the value of the scheme’s liabilities is highly resilient to short-term adverse changes in market conditions.
76. We expect trustees to carry out a suitable level of analysis to enable them to assess the resilience of their low dependency investment allocation to short-term adverse market changes. The complexity and sophistication of this analysis will depend on the individual circumstances of the scheme.
77. Trustees must assess both the asset and liability side.
78. As the low dependency investment allocation will contain matching assets to match payments from the scheme, changes in the short-term market value of these assets should not affect their ability to continue to meet the liability cash flows. In this scenario, it is expected that the movement in the value of the assets, and the consequential movement in the yield on those assets, will cause a similar movement in the value of the liabilities.
79. Detrimental returns on growth assets would also reduce the level of assets in relation to the liabilities. Trustees should also be cognisant of the market and illiquidity risks of the growth assets and how this affects the riskiness of the investment strategy relative to the liabilities when considering the proportion of growth assets within any low dependency investment allocation portfolio.
80. As a minimum, we expect schemes to test for a one-year, 1-in- 6 stress scenario when testing for resilience and, assuming they are fully funded on a low dependency funding basis, for the results of this test to be limited to a change in funding level of 4.5%. Beyond this level is likely to mean that the scheme is not sufficiently cash flow matched and/or the level of growth assets is such that the overall portfolio is not resilient to changes in short-term market conditions.
81. Trustees should also assess how well the assets match the liabilities by looking at the sensitivity of the assets and liabilities at different maturity terms of the liabilities. This could be done by scenario testing, or more detailed analysis looking at changes in the overall shape of the yield curve to determine the impact of changes in both the value of assets and liabilities at different maturity terms.
82. We would also expect trustees to consider other forms of analysis to understand the resilience of their low dependency investment allocation portfolio. For example, in relation to the cashflow matching assets, trustees should consider how the cashflows generated are likely to perform compared to the expected scheme outgo under a range of different stresses and scenarios.
83. These scenarios could include consideration of alternative scenarios in relation to the matching assets for default rates (net of recovery), the impact of collateral calls for schemes using leverage and how the shape and level of the liability cashflows impacts the resilience. Trustees should discuss with the actuary when understanding cashflow projections the impacts of the key assumptions impacting those projections and the effects of prudence.

Liquidity

84. When the trustees have identified a hypothetical portfolio which meets the cashflow and resilience criteria, they should consider whether the investments would provide sufficient liquidity.
85. We do not expect a detailed assessment of liquidity for the purposes of setting the low dependency investment allocation. Instead, trustees should consider the general characteristics of the asset classes.
86. More detailed consideration in relation to liquidity for the assets schemes hold is set out in the Liquidity section in the Application section of this code.

Proportionality

87. We expect schemes to take a proportionate approach in setting their low dependency investment allocation strategy in line with the above expectations.
88. We expect a greater focus on the granularity of the approach to matching and the risks associated with their low dependency asset allocation as a scheme approaches their relevant date.
89. For a scheme of average maturity, it would be reasonable to articulate their low dependency investment allocation in terms of expected return, broad asset allocation and level of interest rate and inflation hedging. As a scheme approaches its relevant date, we would expect the level of detail for the low dependency investment allocation to increase.
90. This is because, for the purposes of setting the funding and investment strategy, trustees must follow the principle that scheme assets are invested in accordance with the low dependency investment allocation on and after the relevant date. As set out in the section on 'investment and risk management considerations', when it comes to the way the scheme actually invests, our expectation is that investment decisions by trustees (and fund managers to whom decision making has been delegated) will generally be consistent with the strategies set out in the funding and investment strategy (which, after the relevant date, means the low dependency investment allocation).

Chapter 4 - Low dependency funding basis

Introduction

91. A low dependency funding basis must use actuarial assumptions that are set so that if:
    • the scheme was already funded on a low dependency basis, and
    • the scheme’s assets were invested in accordance with the low dependency investment allocation, then
    it is expected that no further employer contributions would be required (the low dependency test).
92. Trustees should assess whether the low dependency test would be met under most reasonably foreseeable scenarios.

Setting individual assumptions

93. We do not expect trustees to have to stochastically model each assumption or set of assumptions to satisfy themselves that the low dependency test has been met.
94. Trustees should ensure that the assumptions are chosen prudently and understand the risk in the funding basis so that they can be satisfied that further contributions are not expected to be required.
95. Assumptions should refer to statistically credible data where relevant. This is data considered to be accurate, complete and large enough that it can reasonably be used to estimate future experience with a high degree of confidence. Consideration should be given to the time period the data is collected over, noting that they should be drawn from a time period expected to give a good guide to future experience. We would generally expect this to be the most recent data available but ignoring any time period where the data collected may be considered anomalous.
96. We recognise that trustees may choose to include a high level of prudence in some assumptions, while others are closer to a best estimate approach.
97. Some assumptions may also be more uncertain and have a greater effect on the measurement of liabilities than others. As such, trustees should pay closer attention to the prudence included in these assumptions and ensure it is sufficient for them to be confident it would not undermine the low dependency test.
98. Appendix 3 sets out how we expect trustees to approach the main individual assumptions (excluding the discount rate, which is set out below).
99. The table in appendix 3 sets out our expectations on expenses for use in the low dependency funding basis, depending on what the scheme rules require about the employer to pay expenses, the maturity of the scheme, and whether the scheme is at/past the relevant date.

The low dependency discount rate

Approach to setting the discount rate

100. The main approaches we expect trustees to take when setting the low dependency discount rate are as follows:

Risk-free rate + approach

101. Under this method, the discount rate could be expressed allowing for a margin over a risk-free yield.
102. An acceptable risk-free yield includes:
     • the gilt yield, or
     • the yield on swaps if adjusted for the probability of default
103. The margin added to the risk-free rate should be a prudent estimate of the return on the trustees’ low dependency investment allocation.

Dynamic discount rate approach

104. Where a scheme has purchased cash flow matching assets that meet the expectations in this code, the discount rate can be based on the return of those assets adjusted to allow for a prudent level of default and downgrade informed and evidenced by historical data to give a return.

A combination of both approaches

105. Trustees may choose to use a combination of the two methods. For example, they may use the risk-free rate + approach for parts of the portfolio with longer durations and the dynamic discount rate where, post relevant date, assets match the cash flows. As and when further matching assets are bought and become appropriate, the associated liabilities can be moved to the dynamic discount rate approach.

Use of gilt yield curve for the discount rate

106. Consistent with our expectations for TPs, our general expectation is that yield curves should be used.

Chapter 5 - Relevant date and significant maturity

Introduction

107. The funding and investment strategy must set out the trustees’ long term objective and the funding level they intend the scheme to have reached, and the investments they intend to hold, at the relevant date.
108. A scheme’s relevant date is set by the trustees. It must not be later than the end of the scheme year in which the scheme is expected to reach (or did reach) significant maturity (though it can be any date in advance of this deadline).
109. The scheme actuary is responsible for estimating the date of significant maturity. This estimate must be produced by reference to the ‘duration’ of the scheme’s liabilities, calculated on the scheme’s low dependency funding basis. A scheme reaches significant maturity when it reaches the duration of its liabilities (measured in years) specified in this code. The specified duration can be found below.
110. A scheme’s year may be modified in certain circumstances. However, for the purpose of setting the relevant date, trustees should assume that the current scheme year end will continue unamended.

Calculating current and projected duration (maturity)

111. Payments in respect of pensions and other benefits will be made from a scheme at different points in time and those payments will have different values. Duration is the weighted mean time until those payments are expected to be made weighted by the discounted value of those payments. Duration is measured in years.
112. The scheme actuary should calculate the current and projected duration of the scheme. When calculating duration, the payments expected to be made from the scheme should be estimated using the scheme’s low dependency funding basis.
113. In most cases, we expect trustees to calculate duration using the following formula for the Macaulay duration (though for smaller schemes, trustees may choose to adopt a simplified approach so long as the output is duration of liabilities measured in years):
     

     ∑_i t_icf_iv_i  ∕  ∑_i cf_iv_i

     Where;

     cf_i is the i^th projected cashflow
     t_i is the (average) time that cf_i is expected to be paid
     v_i is the discount factor appropriate at time i
     The denominator in the equation is the value of the low dependency liabilities.
     The calculation can be rounded to one decimal place.
     Cashflows can be aggregated into those expected over a period of a year or less.

Significant maturity

114. For the purposes of regulation 4(1)(b) of the funding and investment strategy regulations, the duration at which a scheme reaches significant maturity is 12 years.
115. The estimate of the date on which the scheme is expected to (or, if applicable, did) reach significant maturity must be reviewed on each occasion the funding and investment strategy is reviewed.
116. However, where a previously determined relevant date has passed, and the trustees have no reason to believe that the date of significant maturity has materially changed, trustees may choose to instruct the scheme actuary to carry out a broad approximate estimate of the date of significant maturity. In these circumstances, we would not expect any detailed calculations to be carried out to determine this date.

Relevant date

117. Trustees must determine their relevant date, which cannot be later than the end of the scheme year in which the scheme reaches significant maturity.
118. When setting the relevant date, trustees should assume that the scheme year will remain as it is at the time the funding and investment strategy is being set or revised (as appropriate).
119. Where a scheme has not reached the relevant date, the scheme actuary must estimate the expected maturity of the scheme at that date. If the trustees consider it convenient, the actuary may use the maturity as at any date within the scheme year in which the relevant date will fall, as being representative of the maturity as at the relevant date.

Chapter 6 - Employer covenant

Introduction

120. A scheme’s journey plan is their planned progress in accordance with its funding and investment strategy as it moves towards the relevant date.
121. In order to assess what journey plan would be appropriate, trustees must bear in mind the strength of the employer covenant. In particular, that the investment de-risking journey should be:
     • dependent on the strength of the employer covenant, where more risk can be taken if the covenant is strong
     • subject to the above, dependent on the maturity of the scheme
122. This section sets out how we expect trustees to assess the strength of the employer covenant. This assessment should be proportionate to the specific circumstances of the scheme and employer. The journey planning section gives more details of this proportionality.

Covenant assessment

123. The strength of the employer covenant is determined by:
     • the financial ability of the employer to support the scheme
     • scheme support from any contingent assets to the extent these:
       • are legally enforceable, and
       • will be sufficient to provide that level of support when required
124. Trustees must consider the following matters when assessing the employer’s financial ability to support the scheme:
     • The employer’s cash flow.
     • The likelihood of an employer insolvency event^[1] occurring.
     • Other factors that are likely to affect the performance and development of the employer(s) business.
125. The nature of the trustee’s assessment will depend on the circumstances of the scheme and employer. We would expect the strength of the employer covenant to be considered relative to the scheme’s:
     • low dependency deficit, and
     • solvency deficit
126. For employers where insolvency is highly unlikely over the short to medium term, their strength relative to the low dependency deficit will help the trustees understand the support available for their journey plan. The higher the risk of insolvency, which would trigger a debt due under section 75 of the Pensions Act 1995, the more weight there should be on employer support relative to the solvency deficit.

General principles and expectations

127. Trustees are required to carry out an employer covenant assessment to understand the extent to which the employer can support the scheme now and in the future. In general, trustees should focus on the ability of the employer to make cash contributions to the scheme to address downside investment risk. Contingent assets can also be valuable where the trustees can evidence that the contingent asset is legally enforceable, will be sufficient to provide the level of support when required, for example where a guarantor is substantially stronger than the employer and provides an all monies guarantee.
128. We expect trustees of all DB schemes to assess covenant support. However, the required depth and frequency of an assessment should be proportionate to the circumstances of the scheme and employer. The approach taken should be documented and trustees should be able to justify why it is reasonable and appropriate.
129. The covenant should be assessed in the context of, and relative to, the scheme’s funding and investment risk. Trustees should consider the following:
     • The size of the scheme’s low dependency liabilities relative to the strength of covenant support.
     • The level of investment and funding risk, providing an indication of how the scheme’s funding requirements and reliance on covenant support could change over time with changes in market and financial conditions.
     • The maturity and the expected cash flows of the scheme, as this will affect the timing of the scheme’s reliance on the covenant.
130. We expect employers (and, where relevant, third parties that have provided contingent assets) to provide trustees with the information required to assess covenant. If appropriate information is not provided, trustees are unlikely to be able to demonstrate how the covenant can support the risks the scheme is taking. Consequently, where appropriate, trustees should consider reducing their reliance on covenant when setting investment and funding strategies in their funding and investment strategy.

The financial ability of an employer to support the scheme

131. The financial ability of an employer to support the scheme derives from the following:
     • The employer’s cash flow, as set out in this code.
     • Other factors that are likely to affect the performance and development of the employer(s) business, including the likelihood of an employer insolvency event occurring, as set out in this code (the employer’s prospects).
132. An assessment of the employer’s financial ability to support the scheme is primarily forward-looking and should consider the following:
     • Visibility over employer’s forecasts. This typically covers a period of between one to three years. In addition to considering the forecast cash flows, trustees will need to consider profit and loss account and balance sheet forecasts to understand the short-term prospects of an employer. When assessing the reasonableness of employer forecasts, trustees should consider the historical accuracy of managements forecasts as well as the appropriateness of the assumptions underpinning these forecasts.
     • Reliability over available cash. This represents the period where trustees have reasonable certainty over the employer’s available cash to fund the scheme. When assessing reliability, trustees should consider the employer’s forecasts, to the extent that these are available and deemed reasonable, and the employer’s prospects (including its capital structure and overall resilience, and the market in which it operates). Most employers will only have reliable periods over the medium term. However, some employers’ reliable period may extend to the long term.
     • Longevity of the covenant. This represents the maximum period in which trustees can reasonably assume that the employer will remain in existence to support the scheme.

Identifying employers

133. Trustees should identify which entities are employers for the purposes of Part 3 of the Pensions Act 2004.
134. Entities that are not employers for these purposes should not be taken into account directly when considering this element of covenant. However, where the employer’s financial performance is heavily dependent on a third-party or group obligation (for example under a cost-sharing agreement), or the overall performance of the wider group, trustees should consider the implications of this when assessing an employer’s cash flow forecasts and prospects.
135. If a group entity or other third-party provides contractually binding support directly to the scheme, this may amount to a contingent asset and should be considered as set out in the 'Contingent assets' section below.

Assessing cash flow

136. An employer’s cash flow means the free cash flow generated by the employer after taking account of reasonable operational costs (for example utility costs, essential maintenance, staff costs), but before deficit repair contributions (DRCs) to the scheme or other possible uses of free cash, as set out in the recovery plan section. These include:
     • investment in the sustainable growth of the employer
     • payments that result in covenant leakage
     • discretionary payments to other creditors
137. Trustees should also ‘add back’ contributions made to other DB schemes sponsored by the employer in order to assess cash flow but should recognise that contributions may need to be made to those other schemes.
138. Trustees’ assessment of free cash flow should primarily be based on management forecast cash flow information.
139. When reviewing the reasonableness of employer cash flow forecasts, trustees should be mindful of the employer’s position in its wider group, its interactions with other group companies (for example through transfer pricing, intergroup trading and/ or intergroup financing) and the impact this may have on free cash flows.
140. Trustees should consider the appropriateness of management assumptions underpinning cash flow forecasts (relative to the risks and opportunities identified when assessing the employer’s market and overall prospects, as discussed below) and the sensitivity of these assumptions to future events, making appropriate adjustments where necessary.
141. Where cash flow information is not produced for the employer (or it is not proportionate to produce for covenant assessment purposes), trustees should work with the employer to find a suitable proxy (for example EBITDA, profit before tax or consolidated cash flow), adjusted as necessary to best reflect the employer’s cash flow position.
142. Where the employer’s cash flow is cyclical or subject to variance, trustees should consider using an average free cash flow over an appropriate period.
143. Trustees may consider cash flows beyond the visible period. However, the reliability of cash support post visibility is determined as part of the trustee’s assessment of employer prospects.

Assessing an employer’s prospects

144. The other factors likely to affect the performance or development of the employer(s) business that the trustees should consider are as follows:
     • The employer's market outlook
       • All material markets in which the employer operates, in terms of the relevant product/ service market and the geographical market.
       • General market trends (for example whether it is a growing, stable or declining market, whether it is cyclical), the economic outlook for the countries that the employer or group operates in, and any potential risks to these markets.
     • The employer's position within its market
       • The employer's current market position, and the key strengths and weaknesses facing the employer and how these may impact the employer's market position in the future.
     • The strategic importance of the employer within its group (if applicable)
       • The employer’s position within the group and its interactions with other group companies.
       • If the employer has strong operational or financial ties to the wider group, or the risks and opportunities associated with the wider group.
     • The diversity of the employer’s operations
       • The products and/ or services offered by the employer, the regions and markets they operate in, and the reliance or diversity of key customers and suppliers of the employer.
     • Environmental, social and governance (ESG) factors
       • ESG-related risks and opportunities facing the employer and how these may impact on the employer’s prospects.
     • The resilience of the employer and the wider group (where applicable)
       • The ability of the employer (and where applicable the group) to withstand market shocks or unanticipated events based on:
         • the employer’s balance sheet, capital structure and other financial information
         • the group’s financial resources to the extent that these are available to support the employer
         • other non-financial indicators of resilience
     • The risk of an employer insolvency event
       • The employer’s insolvency risk and the potential outcome to the scheme in insolvency.
       • The level of detail should be proportionate to the risk of insolvency, and the reliance placed by trustees on realising value from assets to fund the scheme and support risk.
     • Any other relevant factors
       • Other factors (including more general macroeconomic and geopolitical factors) that may be relevant to the circumstances of the employer’s business or market that may impact on the employer’s prospects.
145. Trustees should consider how these factors might affect the reasonableness of the employer’s forecasts, and the employer’s profitability, free cash generation and balance sheet strength (including financing arrangements) beyond the visibility period.
146. Together, these factors allow trustees to assess the employer’s prospects, and will in turn inform the trustees’ view on the maximum period in which trustees can reasonably assume that the employer will remain in existence to support the scheme, ie the employer’s covenant longevity.
147. Where trustees are satisfied that covenant longevity extends to or beyond the scheme’s relevant date, the employer’s prospects are likely to be considered stronger. However, where covenant longevity is shorter than the period to the relevant date, prospects are more uncertain.

Contingent assets

148. A contingent asset contributes to the strength of the covenant to the extent that:
     • it is legally enforceable
     • it will be sufficient to provide that level of support when required
149. A contingent asset’s legal enforceability is determined by the terms and conditions of the relevant agreement and the applicable law. Trustees should consider obtaining legal advice in relation to the enforceability of proposed contingent assets.
150. Common types of contingent asset are:
     • guarantees from third parties, such as parent and group companies
     • securities over cash, real estate and securities
     • letters of credit and bank guarantees
151. To understand whether a contingent asset will provide a particular level of support when required, trustees must identify the following:
     • The scenario in which the contingent asset is likely (or able) to be called upon (for example in the event of insolvency of the employer).
     • An appropriate method to assess the expected realisable value of the contingent asset. This will primarily be driven by the type of contingent asset, ie whether it is a security arrangement (for example security over an asset, cash in escrow, letter of credit) or a group or parental guarantee.

Valuing security arrangements

152. Some assets have clear, demonstrable, readily recoverable value (for example cash in escrow or a letter of credit or surety bond provided by a recognised financial institutions), allowing trustees to recognise this value in full, subject to any limitations in the scheme’s legal access.
153. Other assets have less certain value. For example, the value of security over a tangible asset such as a building or machinery will depend on the future market value for that asset and its condition at that time. Trustees must determine the most appropriate valuation methodology, considering the scenario and the timing in which any asset value is likely to be realised (for example insolvency) and their expectation of the development of the relevant market for that asset in the future.
154. Where the contingent asset is provided by the employer (rather than a third-party), trustees must be mindful of the impact enforcing the security may have on the employer’s continued performance and financial ability to support the scheme. Where enforcement will have a material negative impact on the employer’s financial ability to support the scheme, trustees must also factor that cost into its valuation.
155. Trustees should reassess the value of a security arrangement at each valuation as a minimum.

Valuing guarantees

156. Some guarantees are structured in such a way that they largely replicate the obligations placed on a statutory employer. This includes providing a formal look through to the guarantor for affordability purposes. These guarantees provide an unfettered ability for trustees to claim against the guarantor in respect of all monies owed by the employer to the scheme and cannot be revoked without trustee agreement. These are referred to as 'look through' guarantees.
157. Where trustees benefit from a look through guarantee, when assessing the strength of the employer covenant, trustees should assess the guarantor’s financial ability to support the scheme as if it was a statutory employer.
158. However, if a guarantee doesn’t meet the criteria of a look through guarantee, trustees should determine the level of support a guarantee can provide by considering the following:
     • The guaranteed amount (including whether the amount is capped and, where the amount is calculated by reference to the scheme’s funding position on a particular basis, how that funding position may develop over time).
     • The circumstances in which a claim can be made under the guarantee (or, where the guarantee provides for a variety of triggers, the most likely scenario in which the guarantee would be called upon).
     • The guarantor’s financial ability to provide that support at the time it may be required.
159. Generally, we expect the level of reliance trustees place on a guarantee that can only be triggered by an unexpected future event such as employer insolvency to reduce with time, unless trustees can demonstrate with reasonable certainty what value would flow to the scheme.

Multi-employer schemes

160. Schemes frequently have more than one employer. Trustees must consider the extent to which it is appropriate to analyse the financial ability of every sponsoring employer to support the scheme and how to reach an overall view on the covenant provided by the pool of employers as a whole.
161. Where trustees determine it is not proportionate to review all employers, they should determine if alternative approaches are appropriate. For example, this could include pooling employers into sub-groups with varying levels of review for each.
162. In considering which employers to assess in detail and the weight to be given to each, trustees should consider the following:
     • The number of members of the scheme attributable to each employer, and an estimate of the size of each employer’s liability to the scheme. This should be based on an understanding of each employer’s share of the scheme’s liabilities, including orphan liabilities (ie those that are not attributable to any specific employer).
     • The position of the scheme in the event of an insolvency or withdrawal of an employer, for example whether the scheme has segregation provisions and/or ‘last man standing’ arrangements.
     • The trustees’ powers under the trust deed and rules to impose contributions.
     • The likelihood of employer withdrawal and its impact and the treatment of any orphan liabilities.
     • Any restrictions that might apply under the trust deed and rules to the allocation or payment of contributions due to the scheme, for example where member contribution rates constrain the level of overall contributions to the scheme.

Not-for-profit covenant assessments

163. Not-for-profit organisations are organisations:
     • where some (or all) of their activities are of a non-commercial nature
     • that rely on donations (or other discretionary income or subscriptions) to fund their activities.
164. Where not-for profit organisations have material commercial operations, these operations should be analysed in accordance with the general principles set out above in determining the strength of the employer covenant. The non-commercial operations of a not-for-profit should be assessed in accordance with the modifications below.

Assessing cash flow

165. Where a not-for-profit organisation’s cash flow is generated largely from donations, when assessing the employer’s covenant visibility, reliability and longevity, trustees should recognise that the cash flow may be volatile and subject to reputational risk.
166. Trustees should ascertain the extent and nature of any restrictions on the use of the employer’s cash flow (restricted funds) and consider the extent to which restricted funds are permitted to be used as contributions to the scheme.
167. To the extent that an employer’s restricted funds are not permitted to be used as contributions to the scheme, those funds should be disregarded when assessing the financial ability of the employer to support the scheme.

Assessing prospects

168. When assessing the outlook for the sector and the position of the employer within the sector, trustees should, in addition to considering the factors set out in section (C) above, specifically consider:
     • the reputation and public profile of the employer and the impact of any changes to that on future donations
     • the quality of governance of the organisation including its efficiency, management of reputational risks, and contingency plans for potential shocks to income (for example reputational damage), or demand for services
     • the competition for income from other organisations
     • the demand for the services it offers, including the impact of government policy and/or social factors (for example demographic assumptions) on potential revenue
     • the macroeconomic environment

Contingent assets

169. Where a contingent asset is provided by a not-for-profit organisation, trustees should consider whether the entity is subject to any restrictions that would prevent the trustees realising value in relation to the asset.

Chapter 7 - Journey planning

Introduction

170. The second element of the funding and investment strategy is the trustees’ plan to bridge from the current funding position to the long-term funding target set in the funding and investment strategy (the 'journey plan').
171. Trustees must decide the investment strategies they intend to adopt as the scheme moves towards the relevant date. The level of investment risk that corresponds to these investment strategies should be dependent on the strength of the employer covenant and, subject to that strength, the maturity of the scheme.
172. The journey plan should reflect the circumstances of the scheme and the employer. The approach that trustees take when assessing the level of risk that can be supported over their journey plan should be proportionate to these circumstances. Trustees of schemes that have one or more of the following characteristics will more easily be able to conclude that the risks being run are supportable:
     • The size of the employer is very large in comparison to the size of scheme.
     • The scheme is already well-funded on a low dependency funding basis and/or solvency basis.
     • The journey plan relies on only a small amount of funding and investment risk being taken in the period before their relevant date.
     The trustees of such schemes will not need to undertake as detailed an assessment of the covenant or as much analysis on their risk-taking over their journey plans.
173. Where those circumstances don’t apply, trustees will need to carry out a fuller assessment of the covenant and a more detailed analysis of the level of risk to allow for in the journey plan. Further details of how to assess the covenant are provided in ‘detail of the journey plan’.

Detail of the journey plan

174. The journey plan forms part of the funding and investment strategy. It will therefore be reviewed (and, where appropriate, revised) whenever the funding and investment strategy as a whole is reviewed.
175. The funding and investment strategy is subject to employer agreement.
176. Trustees should determine their plan to transition from the scheme’s existing investment portfolio to one that would meet the standards of a low dependency investment allocation. Trustees should also plan for how the scheme will reach a position of being at least 100% funded on a low dependency funding basis on and after the relevant date^[2].
177. This plan should set out:
     • the date at which they intend the scheme’s investments to meet the standards of a low dependency investment allocation (which may be the scheme’s relevant date, or before that date);
     • the shape of their de-risking strategy; and
     • a qualitative description of the intended future approach to the actuarial assumptions for the technical provisions over time as the scheme moves from its current funding position to the relevant date.
178. When determining this plan, trustees must take into account the principle that the level of risk should be:
     • dependent on the strength of the employer covenant (so that more risk can be allowed for where the employer covenant is stronger, and less risk can be taken where the employer covenant is weaker)
     • subject to the above, dependent on how near the scheme is to reaching the relevant date (so that, subject to the strength of the employer covenant, more risk can be allowed for where a scheme is a long way from reaching the relevant date and less risk can be allowed for where a scheme is near to reaching the relevant date)
179. Granular detail relevant to the journey plan must be recorded in Part 2 of the statement of strategy. These details do not form part of the funding and investment strategy and are subject to the requirement to consult with the employer, rather than reach agreement.
180. The details of the journey plan to be recorded in Part 2 of the statement of strategy include:
     • the current level of risk in relation to the investment of the assets of the scheme
     • the level of risk the trustees intend to take in relation to the investment of the assets of the scheme as it moves along its journey plan
     • the proportion of assets intended to be allocated to different categories of investments as the scheme moves along its journey plan
     • the discount rate or rates and other assumptions used in calculating the scheme's TPs in the actuarial valuation to which the funding and investment strategy relates, and how the trustees expect the discount rate(s) to change over time

Supportable risk

181. When considering the level of risk that is appropriate for the journey plan, trustees should consider separately the following two periods of time:
     • The period during covenant reliability; and
     • The period after covenant reliability and up to the relevant date.
182. The following sections ('Journey planning – period of covenant reliability' and 'Journey planning – Period after covenant reliability') set out our general expectations for how trustees should approach these two periods of time for their journey plan.

Maturity

183. The supportability principles set out that, subject to the strength of the employer covenant, more risk can be taken where a scheme is further from the date of significant maturity.
184. In deciding on the appropriate level of risk, more immature schemes will be able to justify holding risk for longer. This additional period of risk-taking can be reflected in the de-risking journey plan of more immature schemes. Trustees should ensure that this is still set in the context of the strength of the employer covenant.

Journey planning – period of covenant reliability

185. During this period, trustees should consider both the likelihood and monetary impact of risks crystalising and the ability of the employer or any contingent assets to repair any deficit.
186. We expect trustees to analyse these aspects in reaching any conclusion about how they have satisfied themselves that the risks inherent in the de-risking journey are supportable by the strength of the employer covenant.
187. To assess the investment risk and the impact this would have on funding, schemes should carry out scenario analysis of alternative economic conditions to determine the estimated impact on the scheme’s asset and liability values, as well as that of the employer covenant. The level of complexity within that scenario analysis should be proportionate to their scheme and employer’s position.
188. This analysis should be compared to the trustees’ assessment of the strength of the covenant.
189. All trustees should carry out some form of stochastic or deterministic analysis to help them understand plausible outcomes from risk events. Trustees should identify the actions they intend to take in the event of a stress scenario to repair any deficit.
190. We would expect that a scheme considers an asset and liability Value at Risk (VaR) of at least 1-in-6 downside level event and the ability of the employer to repair any additional deficit from that event.
191. Trustees should be confident that the employer covenant can support the impact of this downside analysis and additional risk from the recovery plan.
192. If trustees are relying on the employer to make future payments to the scheme to mitigate these risks, then the trustees should assess the employer’s available cash after deducting DRCs to the scheme and other DB schemes the employer sponsors.
193. The level of affordability from that assessment should only be assumed over the period of reliability, as described in the above section.
194. If trustees are relying on a contingent asset or other form of tangible support that will provide additional funding to the scheme, then they should ensure it satisfies the relevant criteria set out above.
195. This will allow the trustees to understand whether the employer has sufficient affordability over the period of reliability to remedy any deficit from the downside scenario.
196. This approach can be used to determine the maximum risk (known as the maximum risk test) trustees should assume will be run during the period covered in the journey plan, ie test the largest deficit increase the employer could afford to remedy in line with the above approach. In practice, trustees may prefer to assume a lower level of risk.
197. This approach is illustrated in the below graphic
     
198. We expect trustees to determine a de-risking journey which is consistent with these parameters (or such other parameters as the trustees adopt) during the period of covenant reliability.
199. If the end of the period of covenant reliability is after the relevant date, then the journey plan must reflect that the scheme will be assumed to adopt the low dependency investment allocation at the relevant date.

Calculating the stress test

200. Trustees should use, as a minimum, the TPs as the basis for the liabilities for the purposes of this test and not adjust the expected return assumptions post stress. The rationale for the assumptions used and model description for calculating VaR should be documented.
201. For small schemes, using our stress test as set out in Fast Track as a proxy for a 1-in-6, 1-year downside scenario would be an acceptable approach.
202. Trustees should include any allowance for investment outperformance being made in any existing recovery plan as part of this stress test. To do this, trustees should calculate the outstanding TPs deficit after only giving credit for the monetary net present value of the cash contributions promised in the future (net present value calculated using the assumptions consistent with those used to calculate the TPs).

Journey planning – Period after covenant reliability

203. After the period of covenant reliability, trustees will need to consider what level of risk is appropriate and to what extent they need to allow for the scheme to de-risk before the relevant date.
204. These considerations will depend on the level of risk being taken in the period of covenant reliability and include the timing and pace of any de-risking planned to be undertaken in the investment strategy.
205. When considering the appropriate level during this period, the trustees should consider the impact of adverse changes and the likely actions they can take to mitigate them. This will depend on the level of risk in the investment strategy and to what extent this is reflected in the TPs.
206. This analysis of risk should also consider the extent to which the covenant is likely to be able to support risk in the future. This does not mean that we expect risk can only be taken where it is possible to forecast covenant with reasonable certainty. However, the trustees should understand the impact of a future deterioration in covenant.
207. Where adverse changes in covenant are likely in future, we would expect the trustees to allow for those.

Investment de-risking considerations

208. If a scheme’s existing portfolio means that a de-risking plan is required, trustees should consider the type of assets they plan to disinvest from and those they plan to invest in. Actions associated with de-risking may include:
     • reducing the level of risk associated with the growth assets
     • decreasing the overall percentage of assets held in growth assets
     • increasing the level of matching assets and reviewing the level of duration and inflation matching between the assets and liabilities
     • increasing the cashflow matching more generally
209. These plans should reflect a converging of the investment strategy to the principles of the low dependency investment allocation.

Choice of de-risking strategies

210. If a de-risking plan is required, trustees should plan a de-risking approach that suits their scheme-specific characteristics bearing in mind the principles discussed in this section. Common de-risking strategies include the following:

Linear de-risking

211. The assumed level of investment risk and return reduces progressively over time as the scheme matures. The rate of progression is linear, creating a smooth path towards low dependency.

Horizon (or ‘lower for longer’) approach

212. Under this approach, there is one level of assumed investment risk and return in the period before the scheme reaches the relevant date and a lower level of assumed investment risk consistent with low dependency funding thereafter. Typically, this entails the scheme taking a lower level of risk than under the linear approach but maintaining the same level of risk over a longer period.

Stepped de-risking

213. The time before the scheme reaches its long-term objective is split into a number of periods with a constant level of investment risk, which reduces as the scheme transitions from one period to the next.
214. Other strategies might be a combination of the above. This is not an exhaustive list and further strategies, for example de-risking based on funding level are also possible. Other strategies might be a combination of these. There are many different combinations and, providing the principles outlined here are adhered to, all are potentially acceptable.

The journey plan and choice of relevant date

215. In determining their journey plan, the trustees should bear in mind that the choice of relevant date will affect the risk inherent in the journey plan.
216. For example, where trustees choose a relevant date well in advance of the date of significant maturity, they will have flexibility to push back the relevant date in the event of adverse experience. The trustees will then have longer to reach full funding and the risk of not being fully funded by the time of significant maturity is reduced.

Journey planning for open schemes

217. For the purposes of journey planning, open schemes can assume an allowance for future accrual and new entrants, which will delay the time the scheme reaches significant maturity.
218. This means we would expect that open schemes can allow for taking investment risk over a longer period of time than an equivalent closed scheme with an equivalent employer.
219. We expect any allowance for new entrants and/or future accrual to be reasonable. We discuss this issue further and our expectation of what reasonable means in this context in the TPs section.

Other considerations

220. Trustees should ensure that that their de-risking plan will be practicable. For example we would expect the trustees to consider the following:
     • Their investment governance model and whether it can support the planned de-risking strategy, for example the frequency of reviews and changes to asset allocations incorporated in their plan.
     • The timeframes for significant de-risking. We would not expect the trustees to assume significant de-risking to occur instantaneously or over a short time period where in practice they would expect this to take longer to minimise risk. This is especially true of any de-risking that is assumed to occur at significant maturity. Specific consideration should be given to allowing sufficient time for illiquid investments to be disinvested in the journey plan.
     • The duration-based measure for significant maturity. As the requirement is for a scheme’s relevant date to be assessed using duration, we would expect the journey to reflect this measure in a proportionate way. Therefore, we expect that de-risking in the journey plan should be measured, to some extent, against duration.
221. Many trustees currently choose to have de-risking 'triggers' which are engaged when a scheme reaches a particular funding level. These strategies can remain in place, however we expect them to be in addition to the de-risking triggered by reference to change in duration. The journey plan should therefore, as a minimum, plan for de-risking no later than the relevant date regardless of the scheme’s expected funding level. In practice, we expect most journey plans to plan extensive de-risking in advance of the relevant date.
222. There is one exception to the duration-based principle referenced above. We would expect covenant reviews to occur at least in line with the schemes valuation. Where the period of covenant reliability is more than three years, it would be reasonable to assume no change in investment strategy during the three-year period between valuations, regardless of changes in duration. However, if the trustees become aware of a material deterioration in covenant during this short timeframe, it should prompt a more urgent review of the funding and investment strategy.
223. At a future valuation, even if the assessment of covenant does not change (for example the period of covenant reliability remains constant), for closed schemes this means the end point of covenant reliability will be closer to the relevant date. This assumes the relevant date has not changed because of changes to market conditions and/or the scheme membership. Therefore, it might be reasonable for the trustees to conclude at a review that it is appropriate to take more risk in its journey plan in future by extending the period before de-risking even if their assessment of covenant is unchanged.

Our expectations of the maximum risk strategy that can be taken

224. The principles below outline the maximum level of risk we believe is appropriate in deciding on a journey plan. We expect many schemes will choose to adopt a journey plan with less risk since employers may want to limit volatility in the journey plan and/or the trustees consider that a lower risk approach is more appropriate.
225. If trustees are taking this maximum level of risk, our expectation is that the trustees will assume that the level of investment risk will reduce by at least linear de-risking, measured over the period starting with the end of covenant reliability and finishing at significant maturity.
226. This would reduce the level of risk assumed in the journey plan from the level considered to be the maximum supportable by the employer covenant, to that derived from the low dependency investment allocation.
227. This approach is represented in the diagram below:
     
228. This linear approach may not be appropriate where, for example, trustees have concerns about the longevity of the employer covenant, particularly where the period of covenant longevity ends before relevant date. In these circumstances, trustees should consider whether a more rapid de-risking should be assumed in the journey plan.
229. The trustees do not have to assume that investment risk will reduce by linear de-risking. However, in determining the level of risk that is appropriate in a maximum risk strategy, we would not normally expect this to be greater than assuming linear de-risking.
230. These principles set out our general expectation for the maximum risk strategy the trustees might take. If the scheme assumes less risk than that determined under the maximum risk test during the period of covenant reliability, then the trustees may wish, for example, to plan to hold that lower level of risk for longer (horizon method) or have a slower de-risking path.
231. Overall, broadly, we would not normally expect the overall risk assumed in the journey plan to be greater than that assuming maximum risk at the start and then linear de-risking after the reliability period has ended. We would expect any analysis required to check this level of risk to be proportionate to the circumstances of the scheme and the level of risk taken.
232. The approach described above means that, for schemes with identical employers, a more immature scheme will have a slower pace of planned de-risking than a more mature scheme. In this way, more immature schemes can be assumed to be able to take more risk than a mature scheme.

Chapter 8 - Statement of strategy

Introduction

233. Trustees must prepare a written statement of strategy made up of two parts:
     • Part 1, which records the funding and investment strategy.
     • Part 2, which records various supplementary matters, including various details in relation to the journey plan, how well the funding and investment strategy is being implemented, the main risks to the strategy and how they are being managed.
234. This statement must be prepared as soon as reasonably practicable following a determination or revision of the scheme’s funding and investment strategy.
235. The statement of strategy must be submitted to us with every valuation submission or revised valuation.
236. The statement of strategy must be signed on behalf of the trustees by the chair of trustees. If the scheme does not have a chair, the trustees must appoint one. A chair must be:
     • an individual who is a trustee of the scheme
     • a professional trustee body which is the trustee of the scheme
     • where a company which is not a professional trustee body is a trustee of the scheme, an individual who is a director of the scheme or a professional trustee body which is a director of that company, or
     • for a scheme established under section 67 of the Pensions Act 2008, a member of the trustee corporation

Funding and investment strategy

237. Trustees will have to set out how they will achieve low dependency on their sponsoring employer by the time they expect to reach their relevant date. They must provide information on the scheme’s assets they intend to hold at the relevant date in line with a low dependency investment allocation. They must explain how they expect to be at least fully funded on a low dependency funding basis by their relevant date.
238. Within the statement of strategy, the trustees must explain how well the funding and investment strategy is being successfully implemented, reflecting on past actions and lessons learned, as well as any remedial action they plan to take to rectify divergence from the intended course.

Key themes in the Funding and Investment Strategy

239. Trustees must record their funding and investment strategy in the statement of strategy in a number of key areas including the following:
     • The way in which the trustees or managers intend pensions and other benefits under the scheme will be provided over the long term, for example through a buy-out or run-off with low dependency on the employer. The trustees must aim to be at least fully funded on a low dependency basis by their relevant date but could target being more than fully funded on this basis, for example if they want to reach buy-out by the relevant date.
     • The trustees’ chosen relevant date. If that relevant date is in the future, the expected maturity, expressed as the duration of liabilities calculated on a low dependency funding basis, at that date.
     • The low dependency asset allocation the scheme intends to hold at the relevant date.

Supplementary matters

240. Trustees must provide an assessment of the main risks faced when implementing the funding and investment strategy. We expect trustees to outline these risks, detail how they are being monitored and explain how they intend to mitigate the risks if they transpire. Trustees should evidence objective –risk-taking, explaining in detail how risks are being managed.
241. Trustees should monitor the scheme’s progress towards their long term objective and explain the actions they will take to ensure they achieve it, should the scheme’s journey plan not progress as expected.
242. Trustees must set out their assessment of the strength of the employer covenant, informing how much risk the covenant can support. See the covenant assessment section for more details on how to assess covenant. We expect the description of how the employer covenant supports risk to be proportionate to the level of risk being taken and to reference the employer’s cash flows, prospects and contingent asset support. We expect trustees to provide cash flow and liquidity information, the covenant visibility and reliability period, covenant prospects with an estimate of the covenant longevity.
243. For the scheme’s investment strategy, the trustees must explain the current level of risk in relation to the investment of the assets of the scheme. As a minimum, we expect the trustees to provide a full breakdown of the current strategic asset allocation.
244. Trustees must demonstrate how they intend to comply with the requirement to have a low dependency investment allocation by the relevant date. Trustees must provide evidence of how investments comply with the liquidity principle and the evidence this is based on. Trustees should explain how the scheme’s asset allocation is expected to change over time, so the scheme’s investments are compliant with requirements for low dependency asset allocation by the relevant date.
245. Trustee must provide the assumptions used to calculate their TPs, including their discount rates. Trustees must describe how discount rates are expected to change over time so that, by their relevant date, the discount rates are consistent with a low dependency funding basis.
246. The trustees must include the actuary's estimate of the maturity of the scheme, calculated as the duration of the liabilities on a low dependency funding basis, as at the effective date of the actuarial valuation to which the funding and investment strategy relates. For a scheme that has not reached the relevant date, the trustees must explain how the maturity of the scheme is expected to change over time.
247. The trustees must include the funding level calculated on a low dependency funding basis of the scheme as at the effective date of the actuarial valuation to which the funding and investment strategy relates. They must also specify the assumptions used in the actuary's estimate of that funding level
248. For schemes that have not reached the relevant date, the trustees must:
     • specify the assumptions used in the low dependency funding basis to estimate the funding level as at the relevant date
     • explain how these assumptions are different to the TPs assumptions

Footnotes for this section

• [1] Sec 121 of Pensions Act 2004.
• [2] Paragraph 3 of Schedule 1 of the Occupation Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2023.

Application

249. In the long-term planning section of this code, we set out our expectations of trustees in relation to their funding and investment strategy, and statement of strategy. In this part of the code, we set out our expectations of how trustees should approach other aspects of their valuations and how the elements in the long-term planning section should be integrated into their funding solutions.
250. Many of our expectations across these areas are linked and overlap. Where there is overlap, we have not repeated our expectations but referenced the relevant sections in other parts of this code.
251. The valuations section of the code covers the following:
     • TPs
     • Recovery plans
     • Investment, risk management and liquidity

Chapter 9 - Technical provisions

Introduction

252. At each valuation the scheme’s Technical Provisions (TPs) must be determined. This is the amount required, on an actuarial calculation, to make provision for the scheme’s liabilities.
253. The assumptions to be used for the purpose of calculating the TPs are determined by the trustees, which must be consistent with the scheme's funding and investment strategy. The extent of this requirement is set out below.
254. The scheme actuary will determine the TPs using those assumptions and the scheme data.
255. The trustees and actuary should discuss any concerns they have over the quality of the valuation data.
256. In the actuarial valuation, asset and liability measures should be consistent. For example, where the expected payments from an insured asset matches the expected benefits in the TPs the value of those insured assets and TPs must be the same.

Role of the scheme actuary

257. The trustees must take advice from the actuary on the assumptions to be used.
258. The actuarial valuation must incorporate the actuary’s certification of the TPs calculation. The actuary is not responsible for choosing the method and assumptions or certifying that they are appropriate.
259. The trustees should have good reasons if they decide not to follow the actuary’s advice. If they instruct their actuary to certify the TPs using an approach the actuary considers a clear failure to comply with Part 3 of the Pensions Act 2004, we expect the actuary to report that certification to us.

Setting the assumptions for TPs

260. The economic and actuarial assumptions used to calculate the TPs must be chosen prudently, allowing a margin for adverse experience. The mortality assumptions and demographic assumptions must be chosen using prudent principles.
261. The TPs must be calculated in a way that is actuarially consistent with the funding and investment strategy^[3].
262. Where the effective date for the valuation falls after the relevant date, the assumptions used for the TPs should be the same as or stronger than those in the low dependency funding basis.
263. Where the effective date for the valuation falls before the relevant date, the TPs must reflect the funding and investment strategy in two ways:
     • In relation to the period following the relevant date, the assumptions must be calculated in a way that is consistent with the low dependency funding basis assumptions as determined in the funding and investment strategy.
     • In relation to the period before the relevant date, the assumptions must be consistent with the planned investment transition, as set out in the journey plan element of the funding and investment strategy
264. This does not limit trustees adopting more prudent TPs that adopt the low dependency funding basis at a point before the relevant date.
265. The individual assumptions used should be chosen consistently with the overall level of prudence targeted for the TPs. The trustees must consider whether, and to what extent, account should be taken of a margin for adverse deviation when choosing individual assumptions.

Individual assumptions

266. The economic assumptions assumed in the TPs may include:
     • discount rates
     • RPI and CPI inflation
     • Inflation-related pension increases (ie pension increases related to inflation but with a maximum and/or minimum level)
     In addition, assumptions for pay increases in open schemes are often linked to the RPI or CPI assumptions.
     The factors that need to underlie these assumptions are almost entirely independent of the scheme. They are driven by the return on risk-free assets or broader economic and financial factors.
267. The economic assumptions must be set consistently with each other.
268. Our general expectation is that yield curves should be used for economic assumptions. This applies particularly before the relevant date where the journey plan expects gradual de-risking over time, and this is reflected in the discount rates.
269. Where the inflation assumption is derived from market expectations of future inflation, the trustees may adjust the market derived value to set the future inflation assumption, for example by using an 'inflation risk premium'. The level of such an adjustment should depend on the investment strategy and the extent to which the liabilities are matched against movements in inflation.
270. The principles used in setting salary increases, CPI inflation and pension increases in the low dependency funding basis (see Appendix 2) may also be relevant for the TPs, although the assumptions themselves may be set differently. Therefore, the trustees may also want to refer to Appendix 2 on setting these assumptions.
271. In addition, we would expect that many of the demographic assumptions used in the low dependency funding basis will also be used in the TPs. Therefore, the trustees should also consider our guidance on setting demographic assumptions in Appendix 2. Trustees should pay particular attention to assumptions about future mortality.

TPs for open schemes

272. This section applies to valuations for open schemes with an effective date falling before the relevant date. For valuations with effective dates after the relevant date, the assumptions used for TPs should be the same as or stronger than those in the low dependency funding basis.
273. In setting the TPs, the trustees should comply with the principle that past service in an open scheme should have the same level of security as an equivalent closed scheme. However, this does not mean that the same level of TPs is needed for an open and equivalent closed scheme.
274. It could be appropriate to make reasonable assumptions for the period of future accrual and/or the level of new entrants in determining the TPs before the relevant date.
275. Such assumptions will mean that an open scheme can be expected to take longer to reach significant maturity than an equivalent closed scheme. This extra time can be allowed for in the de-risking plan set out in the journey plan, and reflected in the TPs assumptions.
276. Therefore, it can be assumed that risk will be taken for a longer period of time, compared to an equivalent closed scheme. When this is reflected in the discount rates, it will mean that the TPs assumed for an open scheme can be lower than for an equivalent closed scheme of the same maturity.
277. We would expect the trustees to robustly consider the extent to which it is reasonable to make allowance for this continued accrual and new entrants when projecting the development of the scheme’s duration.
278. The period of future accrual and, where appropriate, the allowance for new entrants should not be assumed to continue beyond where the trustees have reasonable certainty over key aspects of covenant such as cash flow. We would not normally expect any period of allowance for future accrual and new entrants to continue beyond the point of covenant reliability.
279. In addition to considering the period for which they will assume future accrual and new entrants, the trustees should consider to what extent it is reasonable to assume that the DB pension will continue to be offered. In doing so, they should consider, among other elements, contractual entitlements and any statements or commitments made by the employer.
280. The assumptions for new entrants, like other demographic assumptions, should be evidence-based and prudent. Past experience could be relevant, but the trustees should consider any general trends or plans by the employer. Where allowance is being made for future occurrences that will lower the value of the TPs (for example an increase in the number of new entrants to the scheme), the trustees should be satisfied that making such an assumption can be justified and is prudent.

Future service

281. We expect the trustees to consider the risks to the scheme in allowing for future service, noting that once earned, accrual becomes additional TPs. When considering this risk, the trustee should be satisfied that the level of contributions paid for the provision of future accruals should not compromise the security of accrued benefits.
282. The trustees should be satisfied that the overall risk of the scheme is supportable, considering the level of future accrual being earned. We would expect that, after considering the provision of future service, the trustees would be satisfied that the scheme would still be expected to be compliant with legislation and continue to meet the principles of this code for funding and investment in the future
283. For open schemes in surplus, the surplus may be able to be used to fund future accrual in the scheme. However, we would expect the trustees to consider carefully whether allowing the surplus to be used in this way is appropriate, noting their powers and what is allowable under the scheme rules and considering the equitable treatment of their membership.

Chapter 10 - Recovery plans

Introduction

284. When the scheme is in deficit on a TPs basis as at the effective date of a valuation trustees must put in place a recovery plan (or review/revise the existing plan) to restore the scheme to full funding on a TPs basis, setting out the period over which this will be achieved.
285. Recovery plans must be appropriate and have regard to the nature and circumstances of the scheme. In determining whether a recovery plan is appropriate, trustees must follow the principle that funding deficits must be recovered as soon as the employer can reasonably afford – this is discussed in more detail in the section Reasonable affordability and the pace of funding below.
286. Trustees must take account of certain matters, namely:
     • the asset and liability structure of the scheme
     • its risk profile
     • its liquidity requirements
     • the age profile of the members
     • in schemes where (i) the rates of contributions payable by the employer are determined under the scheme rules in accordance with the advice of a person other than the trustees (for example, the scheme actuary), and (ii) the employer’s agreement is not required, the recommendations of that third party must be taken into account.
287. Although these matters must always be considered, trustees may apply different weights to the various factors depending on the scheme’s circumstances. They are subject to the overriding principle that deficits must be recovered as soon as the employer can reasonably afford.

General principles and expectations

288. When determining the appropriateness of their recovery plan, trustees should consider:
     • the employer’s reasonable affordability
     • whether to allow for investment outperformance
     • whether to account for post-valuation experience
289. In practice, these factors should be considered in reverse order:
     • If the trustees allow for post-valuation experience, this may change the deficit the recovery plan has to address.
     • If the trustees allow for investment outperformance, this may reduce the deficit the trustees need to be made good via contributions from the sponsoring employer.
     • The deficit (or remaining deficit, if both or either of the above steps have been taken) is subject to the principle that deficits must be recovered as soon as the sponsoring employer can reasonably afford.

Post-valuation experience

290. Post valuation experience refers to the experience that has already happened between the valuation date and the date of finalising the recovery plan (which may be up to 15 months later). Actual changes in financial markets and their impacts on both investment returns and scheme liabilities will be known and measurable by the date the recovery plan is finalised, as well as other aspects of the scheme’s funding.
291. Trustees can take post-valuation experience into account in the recovery plan. If they choose to do so, they should:
     • take account of favourable and unfavourable changes
     • consider changes to scheme assets, scheme liabilities and covenant, including any changes to the assumptions that should be used to calculate the liabilities
     • assess changes over the bulk of the period since the effective date of the valuation
     • be prudent in the amount of post-valuation experience to take into account
292. Trustees should consider whether it is appropriate to take a different approach to post-valuation experience than that adopted in the previous valuation.

Investment outperformance

293. Trustees may make allowance for investment outperformance in the recovery plan, ie they may assume higher investment returns over the recovery period than has been assumed in the discount rates used to calculate TPs. This has the effect of reducing the part of the deficit that has to be made good via DRCs.
294. If the scheme assets fail to achieve the higher return assumed, the deficit will not reduce as expected and higher DRCs than planned for may be required in the future. Allowance for investment outperformance in the recovery plan could therefore remove some or all the prudence in the overall funding strategy, increase funding risk and reduce transparency around how much risk is being taken/ assumed.
295. Investment outperformance should only be allowed for to the extent it is supported by the employer covenant (ie where the scheme could rely on covenant support in the future above that committed as DRCs), or where a suitable third-party enters into a legally binding contingent funding arrangement to provide cash support directly to the scheme. Trustees should ensure that they do not double count the support provided by a contingent funding mechanism, particularly where the arrangement is with the employer, whose cash position will already be factored into the trustees’ covenant assessment.

Reasonable affordability and the pace of funding

296. The deficit shown in the valuation (subject to post-valuation experience and investment outperformance adjustments, where relevant) must be recovered as soon as the employer can reasonably afford.
297. There are three steps in determining what contributions the employer can reasonably afford:
     1. Assessing the employer’s available cash.
     2. Assessing the reliability of that available cash.
     3. Determining whether any of the available cash could reasonably be used by the employer other than to make contributions to the scheme (known as reasonable alternative uses).

Assessing available cash

298. Trustees should assess an employer’s available cash by aggregating:
     • the employer’s free cash flow (see the covenant section for details on how to assess an employer’s free cash flow), and
     • its liquid assets
299. Liquid assets for these purposes are balance sheet assets, after reasonable working capital requirements, that can be readily converted into cash. For example, cash, intercompany debtor balances that relate to pooled/ swept cash, proceeds of debt or equity raises to the extent that these are on the balance sheet and not already factored into cash.

Assessing the reliability of available cash

300. See the covenant section for details of how we expect trustees to assess the reliability of an employer’s available cash.
301. When considering the reliability of an employer’s available cash in the context of recovery plans, trustees may find it useful to think of it in terms of triennial valuation cycles. For example, if an employer’s available cash is only reliable in the medium term, trustees may consider that available cash is reliable within the next two triennial cycles – ie a maximum of six years. The reliable period is key in determining an appropriate recovery plan length.

Determining reasonable alternative uses

302. The legislation does not necessarily require the entirety of an employer’s available cash to be used to pay down the deficit. The extent to which available cash may reasonably be used for purposes other than to pay down the scheme’s deficit depends on the circumstances of the scheme and the employer.
303. Trustees will typically have to consider three types of alternative uses for an employer’s available cash:
     1. Investment in sustainable growth
        • This involves the employer using available cash to finance investment in its business.
        • Sustainable growth refers to the growth a business could realistically achieve and maintain without creating a heightened risk of running into difficulty.
     2. Covenant leakage
        • Covenant leakage occurs when available cash leaves the employer in situations where no return of value is due or expected.
        • Examples of covenant leakage are distributions to shareholders, or intercompany loans that are unlikely to be paid back.
     3. Discretionary payments to other creditors
        • Discretionary payments are made when the employer elects to make payments to creditors other than the scheme, at a time when those payments aren’t due. An example of a discretionary payment is the early repayment of a loan.
        • Discretionary payments may be balance sheet neutral, however they likely favour other creditors over the scheme (by exposing the scheme to the risk of available cash not being as reliable as expected).
304. A fourth, less common type of alternative usage for available cash is making contributions to other DB schemes sponsored by the employer. Although these payments are not technically discretionary, if available cash is not allocated fairly between DB schemes, one scheme might be favoured over another.
305. When considering whether the potential alternative uses for available cash are reasonable, trustees should pay particular attention to:
     • the maturity of the scheme
     • the scheme’s funding level
     • the level of prudence in the TPs
     • the reliability of the level of available cash in the future
     • the fairness of treatment between the scheme, other creditors and shareholders
306. When these factors are considered, we would expect trustees to adopt the following principles when considering alternate uses for available cash.

The lower the funding ratio, the less reasonable it will be to use available cash for discretionary payments or to effect covenant leakage

307. Where a scheme has a low funding level, the risks to the scheme are increased. We therefore expect the scheme to receive more of the available cash by way of DRCs rather than for discretionary payments or to effect covenant leakage. If the scheme is running risks that are not supportable, then we would not expect any discretionary payments or covenant leakage. As the funding level improves, the use of available cash for those purposes is more likely to be reasonable (subject to the following applicable principles).

The more mature the scheme, the greater the need for available cash to be paid to the scheme in the near term

308. As a scheme approaches significant maturity, the use of available cash to make discretionary payments or to enable covenant leakage is less reasonable.
309. Once the scheme has reached significant maturity, DRCs should be prioritised over the use of available cash to make discretionary payments or to enable covenant leakage or investment in sustainable growth, where the trustees are not confident that this investment will result in growth within a period consistent with the schemes liability profile.

Available cash should not be used for discretionary payments or to effect covenant leakage where this would require DRCs to be paid after the period in which available cash is considered reliable

310. Trustees cannot be certain that cash will be available to pay DRCs beyond the period in which available cash is reliable. Covenant leakage and discretionary payments are less likely to be reasonable alternate uses of available cash if that would result in DRCs being required outside this reliable period.
311. Trustees may consider the use of available cash to make such payments to be reasonable if a suitable contingent asset is provided. The value of the contingent asset should be at least the expected remaining deficit at end of the period in which available cash is reliable.

Allocation of available cash between DB schemes sponsored by the employer should be fair, considering the position of those schemes

312. Each scheme sponsored by the employer will have a particular need for cash contributions, considering the respective funding levels and proximity to the respective relevant date.
313. Trustees should request information in relation to the other schemes sponsored by the employer to understand the extent of other schemes reliance on the covenant and to assess fair treatment. In particular, trustees should seek details of the respective scheme actuary’s estimate of:
     • the date on which the scheme is expected to (or did) reach significant maturity
     • the funding level of the scheme on a low dependency funding basis
     • the funding requirement and investment risk

Investment in the employer’s sustainable growth will be a reasonable use of available cash where the trustees are confident of resulting benefit to the scheme and employer

314. Where the employer is proposing to use some of its available cash to finance investment in sustainable growth, trustees should ensure they understand the risks and benefits to the employer’s business.
315. The complexity of the trustees’ assessment should be proportionate to the amount of available cash to be utilised in the investment, and the level of risk and underfunding in the scheme.
316. The use of available cash to enable investment in sustainable growth will generally be reasonable, provided that:
     • the benefits of doing so to the employer and scheme are reasonably certain, or other appropriate protections such as contingent assets are obtained, and
     • payments to effect covenant leakage are minimised during the period where DRCs are reduced as a result of the investment in the employer’s business.
317. The use of available cash to enable investment in sustainable growth may be reasonable even if this results in a recovery plan that extends beyond the period where available cash is reliable. However, the use of available cash in this scenario will become less reasonable the longer the extension to the recovery plan is, or where no contingent asset is provided.

Guarantors

318. Where a third-party has provided a look through guarantee, trustees should additionally assess the reasonable affordability of DRCs to the guarantor.

Employers’ obligations

319. We expect employers to provide trustees with the information they require to enable an assessment of reasonable affordability.
320. This is particularly important where the employer wishes to use available cash to invest in sustainable growth. In that situation, the employer should provide sufficient information to the trustees so they can make an informed assessment of the risks and potential benefits to the employer and the scheme.

Chapter 11 - Investment and risk management considerations

Implementing an investment strategy

321. For the purposes of their funding and investment strategy, trustees must plan to be invested in accordance with the requirements for a low dependency investment allocation from the relevant date. They must also formulate a de-risking journey plan.
322. While those elements of the funding and investment strategy do not limit trustees’ discretion over investment matters, our expectation is that investment decisions by trustees (and fund managers to whom decision making has been delegated) will generally be consistent with the strategies set out in the funding and investment strategy.
323. That is because the rationale behind the requirements for the funding and investment strategy should also underpin trustees’ actual investment decisions , ie:
     • when the scheme is significantly mature, there is less time to make good investment losses; therefore, a low-risk investment strategy will generally be appropriate to mitigate against sudden and unexpected investment volatility
     • trustees need to plan how they will transition to that low-risk investment strategy over time (therefore requiring consideration of de-risking strategies, as with the journey plan element of the funding and investment strategy); and
     • investment risk should be dependent on the extent to which the employer covenant can support downside risks on the path to significant maturity
324. The funding and investment strategy must be reviewed and, if applicable, revised whenever an actuarial valuation is undertaken under Part 3 of the Pensions Act 2004. The legislation envisages this happening every year, but permits it to be done every three years^[4]. We expect trustees to review their investments at more frequent intervals than that (see ‘Risk management and governance’ section below), so investment decisions in practice may differ from the funding and investment strategy over the short term. For example, opportunities in the markets might arise that would enable the trustees to accelerate their plans for de-risking and take advantage of advantageous market opportunities such as increased bond yields.
325. Other circumstances where investment decisions may not mirror the funding and investment strategy are:
     • A sponsoring employer refuses to agree to changes to the investment strategy set out in the funding and investment strategy, despite the trustees considering it appropriate. Employer agreement is required for the funding and investment strategy^[5], but not for the investment elements in the statement of strategy (where consultation with the employer is required).^[6] However, the power to take actual investment decisions lies with the trustees^[7] (subject to the scope of their powers in the scheme’s trust deed and rules). While we would expect trustees and employers to work collaboratively in agreeing the funding and investment strategy, where agreement cannot be reached this does not inhibit the trustees in exercising their investment powers; or
     • The scheme may have a material surplus (on a low dependency funding basis) after their relevant date. While trustees are still required to set their low dependency investment allocation and low dependency funding basis according to the relevant requirements, they may wish to invest differently in practice. For example, investing an increased amount in growth assets in order to meet their long-term objective (for example, to buy out with an insurer) sooner.
326. Although the examples set out above show that there might be good reasons in the short term to move away from the investment strategy in the FIS, as stated above, our general expectation is that investment decisions by trustees (and fund managers to whom decision making has been delegated) will be consistent with the strategies set out in the FIS.

Employer stress scenarios

327. Even if a scheme’s actual investment strategy differs from that outlined in the funding and investment strategy, trustees should generally ensure that downside risks can be supported by the employer covenant. There are two exceptions to this general position; short-term employer stress, and long term incompatibility with the funding regime.
328. In some situations, an employer might experience a deterioration in covenant strength. An example of this for some employers was the COVID pandemic. Trustees should consider whether the stress is likely to be short term or permanent. If they consider that the deterioration is permanent, investment decisions (and investment planning in the funding and investment strategy) should be revised appropriately.
329. However, if they consider that the deterioration is likely to be short-term, trustees could decide to preserve their existing investment strategy. Trustees may choose to make this preservation contingent on the employer providing additional support to the scheme, for example:
     • provision of contingent assets
     • transfer of non-cash assets
     • contingent cash funding
     • negative pledges
     • improving the insolvency priority of the scheme
     • ensuring the scheme is treated fairly
     • wider group support
     • third party guarantees
     • use of escrow accounts
330. If trustees subsequently form the view that the deterioration in covenant is not likely to be short-term, they should revise their investment strategy accordingly.
331. The above example applies to schemes where trustees can comply with the requirements of the funding regime. However, we recognise that there are a likely to be a limited number of schemes where the situation is fundamentally incompatible with the funding regime – ie the level of risk which could be supported by the employer covenant is such that the scheme would severely limit the chances that the scheme could pay full benefits to members.
332. Unsupported investment risk may be appropriate in these circumstances since it has a potential reward for the members . In these circumstances, we would always expect the trustees to seek to maximise the support that the covenant can provide to the scheme through:
     • limiting the flow of value away from the employer (for example, through covenant leakage, including dividend restrictions)
     • preventing detriment to the scheme’s claim on the covenant caused by any employer debt financing
     • improving the scheme’s security (for example through contingent assets being provided to the scheme by the employer)
     • securing formal group support
333. Other actions we expect the trustees to consider include the following:
     • Stopping accrual of future service benefits. In these circumstances, we think it is unlikely to be appropriate for the trustees to allow new, additional, liabilities to be built up when the level of security provided to the existing accrued liabilities is inadequate.
     • Winding up the scheme. This approach could crystalise a loss to members and would need appropriate advice and careful consideration of the extent to which the employer might be expected to continue in the longer term, which could allow the scheme more time to recover.
334. If trustees take unsupported investment risk in this scenario, the scheme’s technical provisions should nonetheless be calculated in accordance with this code – ie no allowance should be made in their technical provisions for the investment returns which are inconsistent with this Code.
335. Trustees should document their considerations and be able to justify their reason as being in the best interest of members. When performing their duties under Part 3 of the Pensions Act 2004, trustees should not take into account the potential for the PPF to provide compensation to members of the scheme.

Risk management and governance

336. Good governance, including risk management, is a central tenet of managing a scheme.
337. Trustees must consider the main risks to implementing the funding and investment strategy successfully and how they plan to mitigate these risks. As the scheme progresses along the journey plan, they should monitor its progress to identify instances when corrective action may be needed to put the scheme back on track.
338. By the time the trustees are required to prepare their first statement of strategy, our new code will detail the expectation for DB trustees to have written policies on their risk management, the necessary governance to embed them into their decision-making, to carry out regular reviews to assess their effectiveness, and to take remedial action as necessary. More specifically, the new code will require all schemes to have an effective system of governance, and, for schemes with 100 or more members, to carry out an own risk assessment.
339. The trustees’ strategy for delivering member benefits in the long term is a key aspect of scheme governance and covered by the requirements of the new code . The expectations set out in this code will help trustees focus on the risks from a funding perspective and assist them in complying with the governance and documentation requirements of the new code. It should also enable the chair of trustees to give us the assurances we will seek in the statement of strategy on the effectiveness of the scheme’s risk management.

Integrated risk management (IRM)

340. Trustees should adopt a proportionate integrated approach to risk management when developing an appropriate scheme funding solution. The resources committed to this should be commensurate with the benefits the approach is expected to deliver for the scheme and employer.
341. Schemes face many risks to achieving their funding plans. Although inter-connected, the risks broadly fall into these categories:
     • Employer covenant-related. This includes the risk that the employer covenant supporting the scheme deteriorates over time (or, in extreme scenarios disappears due to the employer’s insolvency) resulting in the employer being unable to provide sufficient support to the scheme when it is needed.
     • Investment-related. This includes the risk that the investments do not provide the returns expected.
     • Funding-related. This includes the risk that the scheme experience is materially different to that assumed, for example in relation to inflation or mortality.
342. Trustees should understand the risks across each of these strands and define acceptable parameters within which they seek to manage the scheme.
343. Trustees should then put in place appropriate policies to mitigate and manage the risks of most concern. These can include contingency plans, which should set out specific actions for employers and/or trustees to take and may include requirements to:
     • provide additional funding to the scheme
     • strengthen the employer covenant (for example improving access to employer assets or through legally binding support)
     • re-align investment risk for consistency with the support available from the employer
     • re-align other elements of the funding and investment strategy
344. Trustees should regularly monitor the key risks they have identified and ensure that their funding and investment strategy remains appropriate and that the journey plan is on target.
345. We expect trustees to develop suitable risk metrics to monitor, agree the frequency with which they will monitor them, and decide on appropriate thresholds and triggers for action. Trustees may find it helpful to develop a dashboard showing the performance of the key metrics against their risk thresholds and to discuss these regularly at trustee meetings or with individuals and committees to whom appropriate decision-making has been delegated.
346. This process should enable effective decision-making a nd will help the chair of trustees to give the necessary assurances in the statement of strategy about how the key risks are being managed by trustees, and the quality of the governance they have in place to accomplish this. This should include statements about what the key risks are and how they have been factored into the scheme’s monitoring systems, including:
     • what trustees do with the monitoring reports
     • who is responsible for them
     • how trustees determine their responses to the risks

Security, quality, liquidity and profitability

347. The Investment Regulations^[8] require trustees to exercise their powers of investment to ensure the security, quality, liquidity and profitability of the portfolio as a whole.
348. An appropriate investment strategy should balance the investment risk (security & quality) and return (profitability) considering the scheme circumstances and objectives and how these evolve over time over time.
349. The key considerations in how trustees should approach this balance are discussed in the implementing an investment strategy and employer stress sections. These sections highlight our expectation that trustees’ investment decisions will generally follow their FIS and the expectations set out in this code for a schemes journey plan and low dependency investment allocation.
350. It is also important to consider liquidity as a separate (although related) consideration. Below are the key aspects we expect trustees to consider in relation to liquidity.

Benefit payments and collateral requirements

351. It is important that trustees ensure there are appropriate levels of liquidity to meet their expected benefit and expense payments, ie pensions in payment and cash commutation lump sums on retirement, as well as keeping an appropriate amount of liquidity for more unpredictable cash flows, for example cash equivalent transfers out (CETVs), lump sum payments on death, or collateral calls for derivative instruments.
352. These issues will be more prevalent for more mature schemes as benefit payments increase where members approach retirement age and start to take their pensions or consider their options.
353. Trustees should undertake forecast cash flow needs over three to six months, including an allowance for new retirees or transfer value requests. The cash flow forecast should make allowance for contributions to the scheme and investment income paid to the scheme (as opposed to being reinvested).
354. In smaller schemes, the trustees should be aware of the idiosyncratic risks where a few members might account for a significant proportion of the liabilities and assets. For these schemes, understanding the retirement plans for these few members will be key in cash flow planning.
355. Liquidity issues in relation to benefit payments will be of greater concern as schemes mature. More immature schemes will have less liquidity issues as the majority of their benefit cash flows are further into the future – although trustees should be aware that cash flows may be accelerated where members may exercise the option to transfer out or, depending on the scheme rules, retire early .
356. More immature schemes may therefore have greater scope to invest in illiquid assets. However, more mature schemes can also invest in illiquid assets as they can, for example, be a useful investment to cash flow match the expected benefit payments. Trustees will have to manage these issues closely to minimise the risk of needing to sell assets to raise cash should there be events that cause an unexpectedly high number of transfers out or early retirements.
357. Immature schemes might have greater exposure to leveraged liability-driven investment (LDI) funds as they seek to manage their interest rate and inflation risks with regard to the longer duration of their liabilities. The use of leveraged LDI will bring additional liquidity risks and requirements due to nature of collateral demands over short periods when interest rates change.
358. Trustees should ensure there is sufficient liquidity to meet margin payments and cash calls following re-collateralisation events in relation to their allocation to leveraged LDI funds.
359. In ensuring sufficient liquidity trustees should consider the impact of changes in key variables such as real and nominal interest rates, currency and credit spreads. For example, this could be that the trustees will hold enough liquid assets so that liability hedging can be maintained following a rise in long-term interest rates (real and nominal) of 300-400 basis points (bps ). TPR may issue guidance on relevant benchmarks as appropriate.

Interaction with schemes’ long term objectives

360. A scheme’s long-term objective will also impact on the appropriate asset mix and balance of liquid and illiquid investments.
361. For example, a scheme with a long-term objective to buy-out will likely need to start to better match their asset portfolio with that of an insurers as they approach their planned date or timeframe for transacting with an insurer. This can put them in a better position both in terms of being a more attractive prospect for the insurance company (since the assets they won will be desirable to the insurer) and also to better hedge the buy-out price to limit significant differences due to market movements leading up to the transaction.
362. Schemes with high allocations to illiquid assets, which are not desirable for insurance companies, may find that they need to unwind their position earlier than planned if they had not factored in these issues within their planning.
363. These issues are also prevalent when considering a transfer to a DB consolidation vehicle, including a master trust or superfund, although these vehicles may have differing requirements or preferences to those of an insurer when it comes to the investment strategy and asset portfolio of a scheme transferring.
364. For schemes planning to run on, then the focus should align with the cash flow requirements of the benefits under the scheme.

Liquidity governance

365. Trustees should keep aside a bank float to meet benefit payments. A bank float has an opportunity cost, but too little cash also creates operational risks of not being able to meet payments as they fall due. Therefore, trustees should consider how much float is kept in the bank account, for example three months of pension payments plus any allowance for other expected payments such as cash commutation lump sums or CETVs out .
366. Where liquidity needs change at short notice, for example due to changing interest rates leading to collateral demands, trustees should also consider the protocols to meet cash demands.
367. These protocols can be documented in the statement of investment principles (SIP). The protocols can cover the order in which assets need to be sold to meet cash needs, whether the trustees have pre-agreed or not to meet cash demands, how long it would take to sell the investments for cash and if the cash call process is different to the cash distribution process.
368. As part of this process, it will be necessary for trustees to assess the liquidity of their investments.
369. If trustees use third-parties such as fiduciary managers, outsourced chief investment officers or investment platforms, they should regularly review the operational processes for meeting the required cash demands. These operational processes can include ensuring the SIP is up to date, the level of delegation is appropriate, signatory lists are up to date, and signatory processes are understood.

Assessing liquidity

370. To assess the liquidity of investments, trustees should monitor how liquid their investments are. This can be done in a number of ways and will depend on the importance of liquidity for the pension scheme, including their long-term objective and level of investment in leveraged LDI or other exposures involving collateral.
371. Trustees should quantify the supply of liquidity under normal and adverse market conditions. Under adverse market conditions, some investments are likely to become less liquid and asset valuations may deteriorate. By quantifying liquidity in normal and adverse market conditions, trustees can assess the resilience of the investments to meet cash flow demands from, for example, benefit payments, margin payments, and re-collateralisation events in LDI funds.
372. An example of this is in relation to property funds. In normal market conditions, property funds may deal monthly. However, under adverse market conditions, property fund managers can stop withdrawal of investments if the demand for disinvestment is significantly higher than expected. In such situations, it will take longer to obtain cash for the investments as the investment manager will need to use discretion and liquidation processes to meet investor demands.

Footnotes for this section

• [3] S. 222(2A) Pensions Act 2004.  That general consistency principle in s.222(2A) is supplemented in relation to the time the scheme reaches the relevant date and thereafter by virtue of regulation 5(4)(e) of the Occupational Pension Schemes (Scheme Funding) Regulations 2005.
• [4] S. 224(1) Pensions Act 2004.
• [5] S.229(1)(za) Pensions Act 2004.
• [6] S.221B(5) Pensions Act 2004.
• [7] S.35(5) Pensions Act 2004.
• [8] Regulation 4(3) of the The Occupational Pension Schemes (Investment) Regulations 2005.  This requirement does not apply to schemes with fewer than 100 members.

Appendix 1: Responsibilities and roles

373. It is the trustees who are responsible for taking the decisions on a scheme’s funding position and who must be comfortable certain statutory tests are met. However, trustees are required to seek advice or agreement with other key entities, including the sponsoring employer and scheme actuary.

Trustees and employers

374. Trustees must normally reach agreement with the sponsoring employer on the contents of the funding documents before finalising the funding approach and submitting documents to us. We set out our expectations for trustees and employers below.

Collaborative working

375. Trustees and employers should work together in an open and transparent manner to strike the right balance between the needs of the scheme and those of the employer.
376. Trustees should engage with and obtain relevant information from the employer at an early stage in the valuation process.
377. Employers must provide trustees and/or their professional advisers with information reasonably required to perform their respective duties. This includes information to assess the covenant.
378. Trustees should not be refused information to which they are entitled because of concerns over stock exchange requirements or other confidentiality issues. They should be aware of the potentially sensitive nature of the information. Employer concerns can be overcome by trustees entering into a confidentiality agreement with the employer and/or using trustee sub-committees.

Managing conflicts

379. Managing conflicts of interest and duties properly is vital. Trustees should have a process in place which effectively identifies, documents, monitors and manages conflicts and potential conflicts. Our expectations are set out in our new code of practice.
380. Where conflicted trustees should consider withdrawing from negotiations – for example where the trustee is also the finance director, member of the scheme, or hold trade union representative roles.

Agreeing a funding solution

381. It is important that trustees are always able to demonstrate they have acted in line with their fiduciary duties in an impartial, independent manner when complying with the requirements of Part 3. In the unlikely event those requirements are not met, the trustees should not agree the actuarial valuation as they would compromise the scheme’s funding position.
382. A limited number of schemes may not be able to put in place an adequate scheme funding solution (ie one that is appropriate in the context of the employer covenant without an unacceptable level of investment risk being run). The trustees of these schemes should be prepared to address the implications of this for paying benefits in the statement of strategy. Continued future accrual of benefits is unlikely to be appropriate. Other consequences might include consideration of whether the scheme should be wound up or how the scheme’s interests in the employer are protected or realised.
383. Trustees should document their considerations and reasons for decisions and should be in a position to be able to evidence and explain all decisions made – whether required for the statement of strategy or not - based on the interplay of the different information and advice strands they have received. We may request to see further information that is not required in the statement of strategy after the valuation submission.
384. When performing their duties under Part 3 of the Pensions Act 2004, trustees should not take into account the potential for the PPF to provide compensation to members of the scheme.

Consultation with the employer

385. Under the governing documentation of some schemes, the rate of contributions payable by the employer is set by the trustees without the employer’s agreement. Where that applies to a scheme, and where no person other than the trustees can reduce or suspend contributions, then the requirement to obtain the employer’s agreement under Part 3 of the Pensions Act 2004 does not apply.
386. Instead, trustees are required to consult.

Trustees and actuaries

387. Trustees are required to take advice from their scheme actuary in the following circumstances:
     • On the assumptions to be used.
     • Preparing or revising the SFP.
     • Preparing or revising the RP.
     • Preparing of revising the SoC.
     • Modifying the scheme’s future accrual of benefits.
388. The actuarial valuation must incorporate the actuary’s certification of the TPs calculation and the schedule of contributions. The actuary is not responsible for choosing the methods and assumptions or certifying that they are appropriate.
389. Where appropriate, we have set out expectations for the method and assumptions to be used when determining the funding and investment strategy, journey plan, TPs and, if in deficit, recovery plan.
390. Trustees should have good reasons if they decide not to follow the actuary’s advice. If they instruct their actuary to certify the TPs and/or schedule of contributions using an approach the actuary considers a clear failure to comply with Part 3 of the Pensions Act 2004, the actuary should report that certification to us. We would then consider if the failure was materially significant.

Appendix 2: Key documents, reporting requirements and intervaluation requirements

This appendix does not include the late payment reporting requirements or requirements for provision of information to members.

For the purposes of submitting any of the funding documents or reporting to us:

• any failure by the trustees and employer to agree an appropriate actuarial valuation of the scheme, funding and investment strategy, and deficit recovery plan if required, in line with the scheme funding and investment strategy requirements contained in Part 3 of the Pensions Act 2004 (ie funding and investment strategy, TPs, a recovery plan, the content of the statement of funding principles, or the content of the schedule of contributions) or
• any failure by the actuary to certify technical provisions or a schedule of contributions

The reasonable period is usually 10 working days from the relevant submission, agreement or certification deadline.

Document/action	Responsible parties	Deadline	Frequency and circumstances	Reporting requirements
Actuarial valuation	Trustees	Within 15 months of effective date. Effective date to be no more than three years from the effective date of previous actuarial valuation, where actuarial reports obtained for intervening years. If no actuarial report is obtained for an intervening year, then the effective date will be no later than the anniversary of the effective date of the last completed actuarial valuation.	Triennially where actuarial reports are obtained for intervening years. Otherwise may be more frequent.
Statement of strategy	Chair of trustees	Trustees or managers must prepare a written statement, setting out the funding and investment strategy and supplementary matters as set out in the Statement of Strategy section.	Depends on frequency of actuarial valuation. To be prepared as soon as practically possible after agreeing the scheme’s funding and investment strategy.
Certifying the calculation of the technical provisions	Actuary	Within 15 months of actuarial valuation effective date.	Depends on frequency of actuarial valuation.	Any failure to certify by 15 months of actuarial valuation effective date must be reported by the actuary to us within a reasonable period.
Actuarial reports	Trustees	Within 12 months of effective date. Effective date is no more than one year from that of the last actuarial valuation or, if more recent, the last actuarial report.	At trustee choice but usually for the years between actuarial valuations.	N/A
Review and revise statement of funding principles	Trustees	Within 15 months of actuarial valuation effective date.	Depends on frequency of actuarial valuation if other circumstances do not apply.	N/A
Review and revise statement of investment principles	Trustees	Within 15 months of actuarial valuation effective date.	Depends on frequency of actuarial valuation if other circumstances do not apply.
Review and revise recovery plan	Trustees	Within 15 months of an actuarial valuation effective date.	Depends on frequency of actuarial valuation if other circumstances do not apply.	Trustees to submit recovery plan to us within a reasonable period after: (i) its preparation or revision together with the valuation summary and statement of strategy; or (ii) its revision between actuarial valuations with an explanation for the revisions.
Review and revise schedule of contributions	Trustees	Within 15 months of an actuarial valuation effective date.	Depends on frequency of actuarial valuation if other circumstances do not apply.	Trustees to submit schedule of contributions to us within a reasonable period after its preparation or revision.
Certifying the schedule of contributions	Actuary	Within 15 months of actuarial valuation effective date.	Depends on frequency of actuarial valuation.	Any failure to certify by 15 months of actuarial valuation effective date must be reported by the actuary to us within a reasonable period.
Reporting failure to agree	Trustees	N/A	N/A	Any failure to agree by 15 months of actuarial valuation effective date must be reported by the trustees to us within a reasonable period.

Intervaluation actions

Actuarial Reports

Appendix 1 sets out the circumstances and frequency for actuarial reports. The purpose of the actuarial report is to provide an update of the funding position of the scheme since the last actuarial valuation. Actuarial reports prepared using a quantitative or a purely narrative approach may be acceptable to the trustees. In either case, trustees should question the actuary to understand the factors taken into account in preparing the report. While we do not expect this report to be submitted to us, we may ask to read the report in certain circumstances and expect trustees to provide this within a reasonable period.

Changes in circumstances

Trustees should be alert to material changes which may lead them to review and, if necessary, revise their scheme funding and investment strategy. Where, having taken advice from the actuary, it seems to the trustees that these material changes make it unsafe to continue to rely on the chosen assumptions used in the funding documents most recently submitted, they should review and, if necessary revise, those documents (bearing in mind that they would usually need to agree a revised recovery plan with the employer). Commissioning an early actuarial valuation is one technique for doing this, but may lead to unnecessary cost and delay when a revision of the existing recovery plan can achieve the necessary results. Trustees should adopt a proportionate approach when deciding how to proceed.

Summary funding statements

Trustees must issue a summary funding statement to all members and beneficiaries of their scheme (who are neither excluded persons nor persons whose only entitlement to benefits under the scheme is, or will be, to money purchase benefits) within three months of the trustees receiving the valuations or reports.

Reporting of breaches

Trustees have duties and obligations to:

• monitor the payment of contributions payable under the schedule of contributions for the scheme, and
• report materially significant payment failures to the regulator and to members within a reasonable period

Appendix 3: Low dependency funding basis – expectations for setting assumptions

The table below sets out our expectations for trustees setting the individual assumption in the low dependency funding basis.

Assumption	Principles and expectations
RPI inflation	Under the risk free + approach, the RPI assumption should be based on a market-derived assumption for inflation using an approach consistent with that used for setting the discount rate. For example, where a gilt yield curve is used to derive the discount rate, we would expect a yield curve approach based on gilts to be used to derive the inflation assumptions. As the scheme is expected to be broadly matched at the relevant date, our expectation is that no adjustment, such as an inflation risk premium, would be made to the market implied assumption. If an adjustment is made, we may require further information to understand the justification for it. For the dynamic discount rate approach, an appropriate assumption should be made consistent with the value of the matching portfolio.
CPI inflation	The CPI assumption should be based on the RPI assumption, adjusted to reflect the expected difference between RPI and CPI, having regard to both historical trends and the planned changes in RPI expected to apply from 2030.
Inflation-related pension increases	The assumptions should be based on the relevant measure of inflation adjusted to allow for caps and floors based on a recognised method, such as, for example the Black or Black-Scholes, SABR, Jarrow-Yildirim, or Truncated Gamma models, and an appropriate inflation volatility and other assumptions where required by the model. In determining the appropriate assumptions, consideration should be given to past experience and as to whether this provides a guide to the future, given current market conditions, or how that experience should be adjusted to derive an appropriate assumption.
Cash commutation	Members may be assumed to commute part of their retirement pension for a cash lump sum. The proportion commuted should be no higher than recent experience and any projections should allow for any decreasing trend. The assumed commutation factor should be no lower than current factors and, where appropriate, consideration should be given to making an allowance for future improvements in mortality. For example, where the trustees have the sole power to set cash commutation factors and those factors reflect the actuarial value of the pension commuted, we would expect an allowance for future improvements to factors to be made consistent with the trustees expectations for how mortality will improve in the future.
Mortality base table	Based on current expectations of mortality using appropriate mortality tools. For example: a 'postcode' analysis and/or experience to adjust standard tables where recent credible information is available, or a bespoke mortality table based on experience We expect many schemes will want to commission such analysis and would generally expect all schemes to have considered doing so. If this analysis is not done, standard tables may be used and consideration should be given to choosing a table reflecting the size of the pension where this might be appropriate as a guide to the socio-demographic status of the membership. However, where such a standard approach is taken, we would expect the uncertainty of experience to be reflected in a more prudent set of rates being chosen. Different groups of members can have different base mortality tables where there is evidence to justify their different treatment. For example, those qualifying for an ill health pension might exhibit different mortality to those retiring with standard benefits
Mortality improvements	We expect appropriate assumptions for future mortality improvements should be chosen prudently allowing for the uncertain nature of future mortality improvements. Consideration should be given to socio-economic factors specific to the scheme and how this should be reflected in the assumptions chosen.
Salary increases	The salary increase assumption can be a single rate or more complex for example making allowance for promotional increases. Where not constrained by the rules of the scheme or an established policy communicated to employees, we would expect salary increase to be at least as high as an appropriate inflation assumption.
Withdrawal assumption	A scheme-specific table of withdrawal rates could be used where statistically credible analysis of recent experience is available and the expectation is that the past remains a good guide to the future. Alternatively, a table relating to more general pension scheme experience is acceptable but we would expect the uncertainty relating to scheme-specific factors to be reflected in a more prudent set of rates being chosen.
Proportion married	Where the scheme provides for survivor pensions, trustees should make appropriate allowance for the proportion entitled to survivor benefits. Where there is reliable and statistically credible scheme specific evidence available, we would expect the assumptions to be no lower than that implied by recent experience. Where such evidence is not available, we would expect the assumptions: based on generic statistical tables, adjusted where necessary to allow for the rules of the scheme determining eligibility for survivor benefits, or be consistent with PPF guidance on assumptions to use when undertaking a valuation in accordance with Section 179 of the Pensions Act 2004
Age difference	Where the scheme provides for survivor pensions, trustees should make appropriate allowance for the age difference between partners. Where there is reliable and statistically credible scheme-specific evidence available, we would expect the assumptions to be no lower than that implied by recent experience. Where such evidence is not available, we would expect the assumptions used to be: based on generic statistical tables adjusted where prudent to allow for the scheme-specific nature of the assumption, or at least as strong as that provided by the PPF guidance on assumptions to use when undertaking a valuation in accordance with Section 179 of the Pensions Act 2004.
Retirement ages	A scheme-specific table of expected retirement ages can be used where statistically credible analysis of recent experience is available and the expectation is that the past remains a good guide to future experience. Where there is limited evidence available and the choice of retirement age has a significant effect on the liabilities, we would expect more prudence to be adopted in the assumptions chosen, for example assuming each tranche of benefit is taken at the earliest age the member has the right to draw that tranche of benefit unreduced.
Discretionary benefits	Where there is a reasonable expectation that discretionary benefits will continue in the long term, trustees should consider whether it is appropriate to make reasonable allowance for these benefits in the low dependency funding basis.
Other options	Appropriate allowance can be made for other options granted by the scheme. Scheme experience can be used to project the probability of options being taken in future, where statistically credible analysis of recent experience is available, and the expectation is that the past remains a good guide to future experience. The less credible the information available, the more prudence we would expect to be used in determining the impact on the liabilities for these options.
Other assumptions	There may be some assumptions needed as part of the valuation where we have not given specific guidance, for example an allowance for children’s pension or for an ill health pension. In setting assumptions where we have not given guidance, the following principles should be applied: Assumptions can draw on scheme experience where statistically credible analysis of recent experience is available, and the expectation is that the past remains a good guide to future experience. If this information is not available, standard tables or estimates may be used but the level of uncertainty in respect of scheme-specific factors should be reflected in additional prudence in the assumptions chosen. The impact on the liabilities can be considered when choosing assumptions, so for example a more approximate method would be reasonable where the choice of assumption will not significantly affect the liabilities. More generally, if it is an assumption not specific to the scheme and we have provided no guidance we would expect, where relevant, the derivation to be consistent with the derivation of other assumptions where guidance or specification has been provided.

Appendix 4: Allowance for expenses in low dependency liabilities

Principles and expectations
Schemes where there is no requirement under the rules for the employer to pay expenses	All schemes	We expect the low dependency basis to include a reserve for expenses. That expense reserve should be the value of all non-investment related expenses of the scheme, including annual levies and adviser fees, expected to be incurred on and after the relevant date (the relevant date expenses). The expenses should be consistent with the long-term strategy adopted by the scheme. For example: if the strategy assumes the scheme will run on until all benefits are paid, it should be all the expenses associated with this for a scheme that is targeting buy-out, it should include the expenses associated with that strategy
	Immature schemes	The reserve will be the value of those expenses at the relevant date discounted to the present time. It should be calculated assuming the projected position at the relevant date which should be a fully funded scheme on a low dependency basis with a de-risked investment strategy fully implemented. The scheme’s size at the time of the relevant date will also be smaller than the current position, possibly significantly so depending on current duration. Therefore, expenses as a percentage of current liabilities will be much less than the expected value of all current and future expenses. We recognise this will be an approximate estimate, but as the scheme matures and nears relevant date it should be possible to make that estimate more accurate through regular monitoring and updating.
	For schemes at or past relevant date	For schemes at or past the relevant date, this reserve will be the capitalised value of current and expected future expenses. This should be a more accurate estimate of expenses needed which we expect to be monitored and updated in line with experience.
Schemes where there is a requirement for the employer to pay expenses		We would still encourage the trustees to consider an expense reserve. If the scheme is relying on the employer to pay ongoing expenses in future this generates some dependency on the employer and the trustees should carefully consider if this is compatible with a low dependency basis. As a minimum, the trustees could consider whether to reserve for expenses beyond the period over of  covenant reliability and so a high likelihood of the employer being able to meet the expenses or consider establishing a side agreement and separate account for expected expenses. We recognise that funding for a reserve might lead to overfunding and the trustees might want to explore ways to reduce the possibility of this happening. For example, allowing a suspension of the requirement for the employer to pay expenses when the scheme is at or beyond relevant date and fully funded on a low dependency basis as set out in the statement of strategy. If a reserve is used, the guidance above, for schemes where there is no requirement under the rules for the employer to pay expenses, could be an appropriate starting point for determining the amount.

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