In the past couple of weeks “The NEST phrasebook” has been released to assist with the clear communication of pension issues and encourage public engagement in retirement savings by improving levels of understanding of the products on offer.

Far be it for me to question how public funds are spent or the need to make pension literature more user friendly. In fact, one of our aims, especially in our blogs, is to demystify the world of pensions. However, there are a few clear rules:

Firstly: the interpreter must understand the subject in the first place.

Secondly: the layman should be given some credit and not patronise him.

Thirdly: the cure should not be worse than the ailment.

Does changing the term “trivial commutation” to “Taking your retirement pot as cash” suggest an understanding of the finer details or the audience? The additional explanation is unlikely to be remembered and suggests that the only way to fully commute a benefit is on the grounds of triviality.

Does the layman need to be told that a “Fund” is usually made up of shares and other financial products? If so does this explanation tell him anything more? And would you expect the same layman to know what a gilt is? That’s a term that NEST thinks needs no further explanation.

Now whilst I support the effort and can see what is being attempted in the previous examples I see no reason why an employee should be redefined as a worker, auto-enrol should become automatically enrol, pension commencement lump sum should be re-named “cash lump sum taken when you purchase a retirement income” and probably most shocking the term pension should no longer be simple enough. A pension now needs to be described as “the regular income you receive when you open your retirement pot”.

Also, we must not forget to remove any potential age discrimination by referring to “on/approaching retirement” rather than “in later life”. Apart from the fact that people tend to retire in later life the very definition of retirement is much more fluid and therefore the term itself is quite complicated. Does retirement mean stopping work, reaching a particular age or, as should be the case, the time at which you “open your retirement pot” regardless of age or employment status? NEST either does not know the answer or thinks that everyone else does.

It’s not all bad; the phrasebook does include some positive suggestions. It is probably a good first step but needs to go further and should have benefitted from some further input from those within the pensions industry who specialise in explaining how retirement benefits work.

Unfortunately, pensions (not least because of the regulatory framework) are complicated and whilst any attempt by government to simplify things should be welcomed, a glossary of common terms, no matter how simple, is not the answer. Until we have a truly simplified regulatory system, which will probably be preceded by porcine avionics, appropriate professional advice is a must for both employers and employees (sorry, workers), NEST and auto-enrolment are on their way and responsible employers should seek advice on how they will be affected before it is too late.

Posted in: Blog
Tags: NEST, Retirement

Throughout my work in the pensions industry, I find myself continually being surprised by the effects of small print, either in scheme rules, insurance policies or in the legislative framework governing pension schemes. So you would think that I always check the finer detail.

And if you can’t remember to check the small print, at least remember “case law”.

But alas, before embarking on my return journey home to Glasgow from nearby York on Wednesday, I did neither.

To help control my employer’s expenses, I did some research and found that purchasing an advance single train ticket from York to Glasgow for my return journey was the most cost effective approach. On departure from the meeting, I was offered a lift by car to Darlington (heading in the right direction) where I could connect with my train. Good idea, yes?

On arrival at Darlington, I checked at the ticket desk – “My ticket is still fine, given that I’m catching the same train?” Simple answer, surely, but always polite to check. The response was a bit of a shock. The lady behind the desk, I didn’t catch her name – let’s just call her Mrs Jobsworth, said “No, that would count as a “broken” journey . You would need to go back to York to catch the train but you’ll be too late. It will cost £40 to change the ticket over.” I was then handed a leaflet containing said small print which confirmed I had to start and end my journey at the stations stated on the ticket. The fact that I was using their services for a lesser period didn’t seem to count.

Now in my mind, travelling back to York to try and catch a train which will shortly arrive in the station I was actually in struck me as possibly one of the most stupid suggestions I had ever heard. Mrs Jobsworth’s final suggestion was that I could just “chance my arm” to see if I got away with it. My predicament did eventually remind me of a staggering piece of “case law” – that of Professor Martyn Evans, who was charged an additional £155 by the same train company for getting off a stop early compared with the destination on his ticket (it was subsequently waived).

So chance my arm I did, and low and behold, an outbreak of common sense. I took my seat (which was no doubt unused between York and Darlington), I gave a truthful account to the conductor and he said “It’s the same train you are on, so no problem”. I didn’t try to correct him with Mrs Jobsworth’s small print.

Lessons Learned

1. Always check the small print;
2. Remember the case law;
3. Sometimes it’s worth chancing your arm; and
4. If you look hard enough, there are still pockets of common sense to be found.

Posted in: Blog
Tags: Actuarial, Legislation

Recently I read with some interest figures showing that different generations of women are witnessing an altering pension’s landscape, with many of today’s young adults not saving enough for their retirement. Tell us something we don’t know!  As most of us do know, the earlier they start, the better off they could be. However, by turning their backs on saving for a pension young people are increasing their chances of facing poverty in old age.Official figures also show that the number of women aged 22 to 29 in the UK who are signing up for a workplace pension has fallen for four years in a row, marking the most rapid decline of any age group.

It is apparent that people are often waiting for decades after starting work before they consider how to pay for retirement. It has since emerged that experts are now warning that a new scheme to ensure employees get into the savings habit will be insufficient and offer workers a false sense of security.

Latest figures from the Office for National Statistics show that currently more than half of the UK’s single pensioners have a pension income of less than £10,000 per annum, and the UK has an ageing population. By 2034, 23% of the population is projected to be aged 65 and over, up from 15% in 1984. An estimated eight million workers have no pension provision and face having to rely on the state pension and benefits to pay for 20 years or so of retirement.

The Survey shows that less than 40% of men and women aged 22 to 29 contributing to a scheme offered by their employer.  These workers are missing out on a pension provision that is generally the most generous of pension policies, compared to a personal pension plan where there is often no employer contribution.

For today’s 20-somethings, pensions have fallen down the priority list as they face up to more pressing financial concerns. In the past the pension system assumed that women did not need a pension, they needed a husband!!  One woman in particular was quoted in the Press as saying, ‘I am struggling to pay off my debt and so at the moment every penny of my monthly salary is needed for rent, living and debt.  After my debts are cleared I think the focus at my age is to start saving to invest in property. This seems more relevant and urgent than a pension at this point in my life.

Is it the case that the only people in their 20s who think about pensions are those who sell them?  Pensions Minister Steve Webb expressed his concern that complications, as well as poor awareness of the pension system, has turned many young people away from thinking about how they will fund for old age. Most young people starting in a job do not get around to thinking about pensions for years because when young you think you will live forever and a pension is something for your granny. Other people assume that their home will be their pension.

No-one is expecting 20-somethings to become pension geeks, but what we do want is to demystify it, make it simple and ask the question, what sort of standard of living do you want when you are old?.  A new system that will automatically enrol people into a workplace pension scheme will get young people into a savings habit and it will also tackle the dividing line between pension provisions depending on people’s choice of career. At present, workplace pension scheme take-up is more than 90% in public sector jobs such as public administration, defence and social security, compared with just 6% in shorter-term accommodation and catering work.

Some people argue that an entire change of culture is needed to make pensions affordable.  We are all expected to live longer, not such a great prospect if we are all going to be poorer. It doesn’t need to be that way but people do need to rethink the way they approach later life. Perhaps this could mean working part-time during pension years? Who knows, but one thing for sure is that without adequate savings many people may no longer have the choice other than to stay at work.

Posted in: Blog
Tags: Mortality, NEST, Retirement

I remember with some fondness Denis Norden and his clipboard each Christmas taking us through another collection of bloopers and mishaps. The strange thing was that the title was a bit misleading as it quite clearly never was alright on the night.

Early in 2010 I made some predictions about the likely outcome of the SFHA pension schemes actuarial valuation and unfortunately when the results were made public these proved to be all too accurate . As I mentioned in the later blog you really didn’t have to be Derren Brown or own a fully functioning crystal ball to arrive at the results.

Participants in the scheme now have some difficult decisions to take by the end of February about the basis on which they will accrue future benefits within the scheme from April onwards. Before taking that decision associations really need to look closely and completely dispassionately about the potential implications of their actions, as this decision is highly significant for the future of many organisations and the service level they offer.

The table below shows the growth in scheme assets and liabilities between 2003 and 2009 with a very broad brush estimate of the possible picture in 2012 shown for illustrative purposes. The 2009 cessation liability is also an estimate as at the time of writing this it has not been published by the Pensions Trust.

The key points to note are:-

• Liabilities grew by over 40% on an on-going basis from 2006 to 2009.
• Asset values only grew by around 10% over the same period (which is a pretty disappointing result relative to the growth in the liabilities and not something which can be wholly laid at the door of market conditions).
• This meant that the deficit increased from £53.5m to £160.1m equating to a funding reduction from 83.4% to 64.8%.
• The funding basis used is very aggressive. For example, the pre-retirement interest rate is set at around 3.5% per annum in excess of government bond rates (compared with 1.6% per annum in the 2008 valuation of the Strathclyde Pension Fund). If a more prudent basis was used the liabilities and therefore deficit would increase further.
• The cessation deficit was £339m in 2006. I have not seen an updated cessation figure for 2009 but if we allow for expected growth in cessation liabilities, the cessation deficit is likely to have risen to somewhere in the order of £500m.
• It is important to note that even if the scheme had been 100% funded on an on-going basis the cessation deficit would still be of the order of £350m and a funding position of only 56%. Clearly however it is not!!
• This is a relatively immature scheme so liabilities will continue to rise rapidly and the cessation gap is likely to widen, although it will be slowed to some degree if participants chose lower future accrual rates. The cessation deficit is important as although it would only be payable if someone exited, which is likely to be unaffordable for most, it represents the amount which would be due in the event of an organisation ceasing to trade or becoming insolvent or where a cessation event was triggered inadvertently. Whilst the sector is strong insolvencies could not be ruled out and unlike historically, another organisation is unlikely to assume responsibility for prior pension liabilities thereby increasing the level of orphan debt distributable amongst the remaining participants. Smaller organisations may struggle to keep participants within the scheme given rising member contributions, and if no active members participate this could trigger a debt which is unaffordable for the organisation. Organisations will either need to come up with convoluted structures just to avoid this happening or face insolvency.
•  The aggressive nature of the funding basis means that there is no guarantee that the basis would be accepted by the Pensions Regulator. I’m sure a number of other sponsoring employers wait with interest to see if such a basis is accepted!! If it is not there will be additional complexity and an inevitable further increase in contributions.

So what might happen in the future? If the funding basis is accepted then there is a very high probability of further contribution increases in 2013 following the 2012 review, with deficit contributions fully picked up by the employer given the proposed change to the contribution basis. If it’s not accepted then the higher contributions will come much sooner.

If we make an assumption that assets and liabilities both increase at the same rate over the next 3 years (I’ve assumed 40%) whilst the funding percentage would remain the same, the level of the monetary on-going deficit would increase to over £200m. Total cessation liabilities are likely to top £1.0Bn with a deficit increase to in excess of over £600m. Clearly, if liabilities continue to outstrip assets then the position will worsen further.

So before you take a decision to stick with the status quo, make sure you understand the implications for your organisation and staff as if it’s not alright now you’ve really got to ask yourself, is it likely to be any more alright in the future?

Posted in: Blog
Tags: Charities, Pension Funding, Scottish Federation of Housing Associations (SFHA) Pension Scheme, Third Sector

A wave of optimism broke out as I read a recent interview with Sarah Smart, the Chair of the Pensions Trust (“the Trust”) in which she quite sensibly highlighted the risks faced by charities from their final salary pension schemes.

However the optimism was short lived, as whilst finding it difficult to disagree with the sentiments expressed they struck me as being at odds with another recent article where Mrs Smart appeared to continue to promote the use of Defined Benefit schemes with the statement “Despite numerous and well-publicised assassination attempts on DB Schemes over the past few years, I remain hopeful that they may yet prove to be Rasputin-like in their resilience and stubbornly refuse to lay down and die.” In the same article she had confirmed that she had effectively turned a DC Governance seminar into a sales pitch for DB. Am I the only one who sees some inconsistency here?

Also an anology with Rasputin strikes me as slightly inappropriate and I’m sure on reflection that Mrs Smart will feel she could have chosen a better one. It is entirely her prerogative to associate her cause with an incontinent alcoholic ‘mad’ monk, but she also appears to have missed the fact that Rasputin did eventually “lie down and die” at the hands of an assassin, and that the consensus was that Russian society was a great deal better off without him.

And what are we to make of yet another article from Mrs Smart on the schemexpert website where she makes the point that “the public sector is kidding itself if it thinks it can afford to keep building up defined benefit liabilities.”? But employers in the 3rd sector can?

In the Third Sector article Mrs Smart also suggests that the Pension Trust have been “trying to improve the sectors’ awareness of these risks” as “too often, warnings fall on deaf ears until there is a problem.” Now these statements may well surprise many of the participants in her organisation’s schemes and indeed be comments that may greatly irritate and upset senior individuals within them.

I’m not aware, nor indeed are numerous of my clients that I have asked, of the Trust providing participants in their schemes with any risk warnings about how bad these schemes might be for their organisations future health and well-being. Mrs Smart’s comments seem to suggest that the ‘white knight’ that is the Trust has for a long time been supplying such information freely and frequently to its participants and, despite its best efforts, it has been consistently, wantonly and irresponsibly ignored by those participants.

However it is in my experience, and that of my clients who are participants, that the Pensions Trust as an organisation historically promoted and continues to promote the use of DB schemes to employers who, it is becoming increasingly apparent, can ill afford to participate.  Not only that, but in my experience, cumbersome decision making processes within the Trust make it time consuming and frequently expensive for participants to ask important questions about schemes. The Trust remains incapable of providing accounting disclosures for participants that would allow them, their auditors and advisers to quantify the level of risk exposure. This latter point was very forcefully posed to the Trust at the ICAS meeting which was also mentioned in the article – a meeting which highlighted the deficiencies of the Trusts approach. Crucially also its schemes also do not offer participants the necessary flexibility to allow them to deal effectively with legacy deficits already built up.

Interestingly the article also highlights the vulnerability of trustees of unincorporated organisations. Has this not been something which has been known for some time? Did the Trust adopt a more risk based approach with these types of organisations and highlight this risk prior to allowing them to join? Did the Trust contact such organisations participating in its schemes? Once these unfortunate charities are trapped within a scheme what support does the Trust provide to help them deal with the problem?

Hopefully Mrs Smart and the Trust can arrive at a clear and consistent message about the use of DB pension schemes in the charitable sector. As my colleague Neil Copeland has pointed out in a different context, a U turn is not necessarily a wrong turn.

Is it too much to hope that the Trust and its participating employers could get to a position where both are facing in the same direction and might that direction be away from defined benefit pension provision?

Posted in: Blog
Tags: Charities, Pension deficits, The Pensions Trust, Third Sector

As the year-end approaches, I thought it was worth taking a back-to-basics look at the underlying actuarial assumptions used in FRS 17 calculations and what flexibility exists to change the results depending on the specific circumstances of each organisation.

So what is FRS17?

FRS17 is an accounting standard used to assess the balance sheet impact and pension costs associated with the operation of occupational pension schemes. For defined benefit arrangements (e.g. final salary pension schemes), the balance sheet asset or liability for the organisation is calculated as the surplus or deficit of the scheme assessed in accordance with assumptions appropriate for FRS 17.  The pension cost is a combination of the cost to the organisation of providing benefits built up over the past year and an interest charge applied to the liabilities built up in the past, offset by a credit in respect of the expected return on the scheme’s assets.  The elements of the pension cost are again calculated in accordance with assumptions appropriate for FRS 17.  Some organisations who participate in multi-employer schemes retain an opt-out, whereby the pension cost is set equal to the amount of employer contributions and there is no balance sheet impact.  This opt-out continues to be placed under serious scrutiny by company auditors and is looking increasing untenable.

FRS17 Assumptions

The responsibility for the FRS17 assumptions adopted lies with the directors/trustees of each organisation.  The agreement of the auditor is required, and the organisation should seek the advice of an actuary on the assumptions.  There is a considerable degree of flexibility in setting these assumptions and the impact of small changes to the assumptions can be quite substantial (some examples are provided in the table below).

In many cases, the assumptions proposed by the actuary will be based on the “average” index values and mirror those assumptions used for the Trustees funding valuation and therefore may not be appropriate for the individual circumstances of each organisation.  As the assumptions are the responsibility of the directors/trustees, they are entitled to request that the actuary carries out their calculations on alternative assumptions which they feel might be more appropriate.

It is important as early as possible in the process for each organisation to consider whether the assumptions proposed are appropriate and take suitable action if not.  However, it is not appropriate to “cherry pick” assumptions on a year by year basis as directors/trustees need to ensure a consistent approach is used.

FRS17 requires a market-related approach, with assets being taken at their market value.  Liabilities are valued using the ‘discount’ rate equivalent to that available on AA corporate bonds.  The rate should be adjusted to make it appropriate for the maturity of the scheme’s liabilities (this will depend on the proportion of pensioner and active members in the scheme).   Other assumptions (e.g. pension increases, mortality) are on a best estimate basis.  The expected return on asset assumption is set independently of the liability discount rate.  The assumptions should be mutually compatible and lead to best estimates of the future cash flows arising from the Scheme’s liabilities.  The assumptions should also reflect market conditions at the reporting date.

How assumptions can change from organisation to organisation

As noted above, the impact of small changes to FRS 17 assumptions can have a significant impact on the organisation’s balance sheet asset/liability and pension costs.  The main assumptions driving FRS 17 disclosures are the rate at which future values are discounted to “present day” terms (the discount rate), the expected rate of future price and salary inflation and the life expectancy of members.  Taking a scheme with a total liability of £30 million, an indication of the impact of assumption changes on the balance sheet would be as follows:-

*- liabilities are reduced by increasing the discount rate and increased by reducing the discount rate.

There would be corresponding increases in the liability if the opposite changes occur (i.e. reduced discount rate, higher salary and price inflation and higher life expectancy).  Therefore, it is clear that setting assumptions can have a material outcome on the organisation’s balance sheet.  The impact on the pension costs are more difficult to quantify but pension costs are generally lower when liabilities are lower and assets are higher.

My earlier blog entitled “Throw your actuary a curve ball on FRS 17” discusses the impact of changing the underlying assumptions in further detail.

It is worth noting the potential move to using the Consumer Price Index (CPI) as the measure of price inflation for the purposes of regulating occupational pension schemes.  Given that historically, on average, CPI has been around 0.5% per annum lower than RPI, this change places a lower current value on future pension payments and so reduces the liability of organisations in respect of pension benefits.  Typically, this change could reduce overall pension liabilities by around 10%.  If you have year end FRS 17 disclosures coming up, this point should be addressed with your advisor as soon as possible.

Summary

It is worth remembering that the assumptions used for FRS17 purposes are no more than assumptions – the assumptions used for the ongoing funding of each scheme will be different and give rise to different costs and liabilities and the costs and liabilities associated with a cessation valuation (the amount an organisation has to pay if it leaves a scheme) will be significantly higher.

If you are part of a multi-employer scheme which makes full FRS 17 disclosures (i.e. the opt-out does not apply), actuaries will provide participants with a briefing note outlining the assumptions they will base the calculations on and these will be carried out on a consistent basis for all participants and will therefore, in most circumstances, not reflect the specific circumstances of the participating organisation and may be more conservative than the organisation might deem to reflect a best estimate approach resulting in higher liabilities, and therefore higher disclosed deficits. Independent advice at an early stage will allow assumptions appropriate to each organisation to be set and ensure that the ultimate results need be run only once.

Posted in: Blog
Tags: Accounting, Actuarial, FRS17

How many times have I dug out my drive-way this week? Each time I broke my back to dig down to the paving more snow appeared and the colourful language commenced.

Feel free to draw any analogies with funding a DB pension schemes still open to future accrual.

It couldn’t be worse, or could it? Well only if you’d:

• no option on shovel size
• no option to use grit or salt
• your neighbour kept pilling all his snow on your drive

Ah, that will be a multi-employer scheme.

Posted in: Blog
Tags: multi-employer, Pension deficits, Pension Funding

If we were to compare the developments in UK pensions in 2010 to a football match, it might be described as a classic game of two halves – with the half time whistle being blown a little early in May for the General Election.

Unlike most football games, there was a new coalition referee for the second-half who decided that some of the goals in the first half were under review. If fans were feeling a little cheated at this point, they soon got over it as the second half began with a flurry of events, announcements, consultations, surveys, opinions, discussions, guidance, strikes and so on – I even recall someone saying at a meeting in June that they were unable to offer an opinion on the market because they had been on holiday for a week.

With so much having happened in 2010, and as we begin the countdown to Christmas and the New Year, we thought it might be useful to look back, sort the fact from the fiction and offer a post match summary of what actually happened.

Please let us know if we have missed anything out, what’s affected you most or what is likely to go down as the big story of 2010 in years to come – there’s plenty to choose from.

A new Government
In the first four months of the year, under Gordon Brown’s leadership, the DWP published regulations for Automatic Enrolment and National Employment Savings Trust (NEST) and confirmed that the option to contract out of the additional State Pension into a Defined Contribution pension scheme would be abolished from 6 April 2012.

But did it all matter when, after 6 days of uncomfortable behind-the-scenes negotiations, the Labour Government was replaced by the newly formed Conservative and Lib Deb Coalition on 12th May.

With the new government came a new lineup under David Cameron: George Osborne as the Chancellor of the Exchequer, Iain Duncan Smith as Secretary of State for Work & Pensions and Steve Webb as Minister for Pensions.

Some strong statements and intentions followed soon afterwards. IDS was first up with his vision for improving the quality of life by phasing out the default retirement age, ending compulsory annuitisation at age 75 and, from April 2011, the Basic State Pension was to rise by the minimum of prices, earnings or 2.5%, whichever is higher. He also committed to making automatic enrolment and increased pension saving a reality.

Next it was George Osborne with the first Budget of the Coalition Government on 22nd June, which included a number of announcements on pensions:

• Pensions Indexation. From April 2011, the Consumer Prices Index (CPI) will be used for the indexation of all benefits, tax credits and public service pensions.
• State Pensions and Benefits. From April 2011, the basic State Pension will be uprated by the higher of earnings, prices or 2.5 per cent. CPI will be used as the measure of prices but the basic State Pension will be uprated by the equivalent of RPI in April 2011.
• State Pension Age. The Government will review the date at which the State Pension Age rises to 66.
• Pensions Tax Relief. The Government will restrict pensions tax relief through an approach involving reform of existing allowances, principally of a significantly reduced annual allowance in the range of £30,000 to £45,000.
• Public Service Pensions. An independent commission chaired by John Hutton, formerly Secretary of State for Work and Pensions, will undertake a fundamental structural review of public service pension provision by Budget 2011.
• Default Retirement Age. The Government will consult shortly on how it will quickly phase out the Default Retirement Age from April 2011.

Two days later, reviews were announced into the timing of the State Pension Age rise to 66 and how best to implement auto-enrolment.

We all caught our breath for a few months and then, in October, the Government announced that, from April 2011, the annual allowance for tax privileged pension saving will be £50,000 and from April 2012 the lifetime allowance will be £1.5million.

Soon after, the outcome of the independent review into auto-enrolment was published and, separately, the Government announced that the State Pension age would rise from 65 to 66 between December 2018 and April 2020 for both men and women.

The Pensions Regulator flexes its muscles
Bill Galvin became the new chief executive of tPR from 17 May, replacing Tony Hobman, after five years in charge.

Soon after, guidance was issued on record keeping, monitoring employer support, multi-employer schemes and winding-up. Consultations were launched on transfer incentives and single equality schemes.

From June to September tPR used its powers of enforcement, handing out the first Contribution Notice to the Bonas Group Pension Scheme and a Financial Support Direction to companies connected with the Nortel Group and Lehman Brothers Group.

After four years of operating the Trustee Register, tPR changed the way it assesses the conditions for registration. From 51 firms at the start of the year, it is expected that this number will be considerably less by the year-end.

and the PPF was busy too
January and November saw the PPF unveil not one but two Purple books as a revamp took place and those schemes currently in the assessment period were removed.

June was the month the PPF issued new guidance to actuaries completing section 143 valuations and in October a new formula was proposed for calculating the pension protection levy from 2012/13 onwards.

Finally, as the year approached its end, the first scheme (the Paterson Printing Pension Scheme) successfully transferred through the new Assess & Pay Programme, just under 18 months after the company went insolvent.

How 2010 is shaping up – end of year financials
As we write, the pound is up 4.5% in the year against the Euro and down 3.5% against the dollar, the FTSE 100 sits around the 5750 mark, up 6% on the year, and the benchmark government bond yield has hardly moved compared to a year ago. Wouldn’t it be great if these relatively moderate movements were the result of a number of small predictable steps in one direction throughout the year and we knew what was going to happen next year? If only it was that easy when we agreed our recovery plans.

No doubt many of us will end the year by looking to the future. Will 2011 be the year that EU regulation imposes further funding requirements on defined benefit schemes? How will the rpi/cpi debate play out? Will new rules allow early access to 25% of our pensions savings if we fall ill? How about an ETV mis-selling scandal? Like 2010, a lot could happen. Please let us know what your predictions and concerns might be.

But before you become too paralysed with fear about potential hyper-inflation, the break-up of the European Union, winning the Ashes or never hosting the World Cup, you may wish to consider the words of Mark Twain: “I’ve been through some terrible things in my life, some of which actually happened”.

With Seasonal Best Wishes,
Brian Spence and the team at Spence & Partners

Posted in: Blog
Tags: Legislation, Pensions Regulator, Politics, PPF

‘Ello, I wish to register a complaint.  Much like Monty Python’s famous Norwegian Blue parrot, private sector defined benefit pension schemes are dead.  They are not resting, stunned or even pining for the fjords – they’re stone dead.

I therefore believe the calls by the UK pensions industry to shield defined benefit pension schemes from the effects of Solvency II are somewhat misplaced.  If the only reason for not adopting Solvency II is to prevent the further closures of such schemes, then these calls do not stand up to scrutiny.  Schemes have been closing rapidly under the existing regime and will continue to do so irrespective of European legislation.

Many employers overburdened by regulation and the dawning realisation of the real cost of pension guarantees have called time on defined benefit provision. The adoption of Solvency II may well further hasten this inevitable demise. For a large number of schemes, accepting this now will be a good thing in the long run.

The closure of schemes leaves two main issues: (1) should defined benefits constitute a cast-iron promise to beneficiaries and (2) how do we best close the funding gaps to ensure all liabilities are met?

The magnitude of UK defined benefit obligations have grown over time, often beyond the sponsors’ control. Layer upon layer of legislation, primarily relating to guaranteed indexation, has left employers to fund obligations which were not present or intended when schemes were first set up.  In effect, this has hindered the private sector from delivering pensions which can be guaranteed.

Beneficiaries certainly believe a promise is a promise and fully expect employers to stand behind their obligations irrespective of the above problems.  This feeling is heightened by the fact that fewer and fewer beneficiaries have an ongoing mutual interest in the prospects of the sponsor. However, by allowing measures which rely so heavily on employers, it is also clear that the UK funding regime has never been set up in a way to match the understanding of the beneficiaries.  It is a structure based on hope rather than expectation.

As integration across member states continues and the workforce in the EU becomes increasingly mobile, I would expect that benefit promises made by companies in all EU states will face harmonised regulation and enforcement. UK residents who end up working in other EU states would fully expect benefit promises to be honoured just as our European counterparts would surely expect the same protection working in the UK.

The expectation of benefit promises being honoured seems to make it inevitable that there will be levelling up of pension legislation across the EU, whether by Solvency II or other means.

The National Association of Pension Funds claims that the UK system already provides a strong level of protection for its members through the employer covenant, The Pensions Regulator (tPR) and the Pension Protection Fund. While the current regime is undoubtedly more robust, any inference that the existence of the PPF is a justification for a lower funding target should be discounted.

In support of this view, the Association of Consulting Actuaries believes that the current directive with its requirement for the prudent funding of technical provisions is providing ‘an appropriate balance between protecting members’ benefits and keeping the cost to employers at an affordable level’.  While balance is appropriate, I believe it would be a mistake to retain a lower funding target because it is all that can be afforded in the short-medium term.  It is much better to aim for the right target, even if it is going to take longer to get there.

As well as possible directives on Solvency II, there are a number of additional factors which support stronger funding targets such as the views of the Accounting Standards Board; the ultimate legal obligation on employers is already set at buyout; and the dominance of solvency levels in pension related discussions during mergers & acquisitions, where FRS and technical provisions are cast aside.

For all but the very largest of schemes, the only realistic end game is to buy out all of the remaining benefits with an insurance company as soon as it is affordable and efficient to do so.  In the meantime, the need for employer flexibility and the reluctance of tPR to accept very long-term recovery plans have lead to the adoption of weaker funding targets which rely on the ethereal employer covenant.  However this is the system we must work within at the moment.

Whichever way we end up reserving for and funding schemes, the UK pensions industry needs to face up to the fact that its biggest task is dealing with legacy deficits and not propagating the virtues of future benefit accrual.  The private sector defined benefit experiment has failed and the best that can be done is to ensure that current obligations to members are met. It is time to admit that the parrot is truly dead.

Posted in: Blog
Tags: Actuarial, FRS17, Pension deficits, Pension Funding, Pension Protection Fund, Pensions, Pensions End Game, Pensions Regulator, Scheme Closure