High inflation is not always bad – it can encourage economy-boosting spending and more private investment in companies as many investors see stocks and shares as a better option than cash. Unfortunately, it also provides a lot of instability in the economy and the world of pensions. Over the last year, inflation has been the biggest issue on our radar, not least because of the contentious legislation to determine pension valuations based on Consumer Price Index (CPI) rather than the previous gauge of Retail Price Index (RPI) being introduced in the UK.

The recent announcement that CPI rose by 4.5 per cent over the last year compared with an increase in RPI of 5.2 per cent will have a direct economic impact on many pensioners. Those with pensions linked to RPI would gain by almost one per cent each year compared to those with pensions linked to CPI.  Assuming these inflationary rises continued at their present rates, the income of a pensioner currently earning £10,000 each year would rise to just over £16,600 per annum in ten years time under RPI compared with around £15,500 per annum under CPI.

Inflation as it impacts on pensioners is generally accepted to be currently relatively higher as the ‘basket of goods’ includes many items which have increased more rapidly recently, such as food and fuel costs. These tend to represent a greater proportion of income spend for a pensioner whereas other areas of expenditure which have been more stable or reduced.

The current high levels of inflation are highlighting the controversy over the move from RPI to CPI. We have already seen many public sector union leaders calling for a judicial review on this decision and the private sector is not exempt from this either. British Airways have seen three trustees of the pension fund in April resign because of the move from RPI to CPI. 

Future movements in CPI are very difficult to predict.  Even over recent years, there have been a number of occasions that CPI has exceeded RPI so it can therefore not be ruled out that CPI could on occasion give rise to higher increases than are currently paid under RPI.  The basket of goods for CPI could also change – if, for example, housing costs are included, this could substantially close the current gap between it and RPI.

Looking at the impact of inflation from a different perspective, it can also have a roller-coaster effect on pension scheme payments and funding levels.  Inflation caps on pension increases are often overlooked.  Pensions may become significantly devalued if this cap applies for an extended period (irrespective of whether the inflation measure is CPI or RPI). Pension increases are generally capped at a maximum of 5% per annum, and so with inflation at its current level, capping at the 5% level would currently apply under RPI and remain a distinct possibility for the future.

While it would be bad news for pensioners and possibly the wider economy, a run of higher inflation is actually likely to improve scheme funding. Providing the actual inflation level exceeds any cap that a scheme has in place, it will be providing its members below inflation increases which, assuming investment returns do keep pace with inflation, will improve the overall funding of the scheme. The worst possible scenario for scheme funding is likely to be in a period of deflation whereby they would need to effectively pay out increases in excess of inflation and reduce scheme funding.

Perhaps the fine balancing act and the cause and effect implications of rising inflation explain the apparent willingness of the Bank of England and the Government to live with this situation, at least in the short term. However, the longer Mervyn King is required to pen an inflation letter to the Chancellor, the greater impact this will have on UK pensioners.

This article featured in the Scotsman on 24th June 2011.

Government plans mean many pension schemes in both the private and public sector will not be in a position to implement pension sharing orders or even to issue transfer value statements.

“This is a very disappointing state of affairs” said Ian Conlon, Pensions and Divorce expert at Spence & Partners, Consulting Actuaries. “Peoples’ lives move on and they should be able to sort out their affairs and I am afraid this is an unintended consequence of government pension policy.”

The proposals announced by the Chancellor of the Exchequer, George Osborne, in the June 2010 budget state the Government’s intention to link future increases in public sector pensions to changes in the Consumer Prices Index (CPI) instead of increasing in line with the annual change in the Retail Prices Index (RPI).

Over a period of time it is expected that CPI will be lower than RPI and all public sector Cash Equivalent Transfer Values (CETVs) will reduce to take account of this, a reduction that could be around 20% or more in some cases.

As a result, it is understood that most if not all, public sector schemes have already stopped quoting CETVs and it is likely that this delay will continue until further guidance is published. This, in turn, will mean pension sharing orders issued will not be implemented until the position is clearer, and for those in the midst of divorce proceedings, whose calculations are put on hold, it could mean a considerable increase in costs.

Ian Conlon added: “Divorce proceedings are expensive and stressful enough without a log-jam of cases building up while pensions administrators, lawyers and actuaries debate the legal issues and amend software to deal with the changes.”

“Whilst a degree of uncertainty may remain, it may well be attractive for some parties to proceed having been provided with an estimate of the impact of the change.

“Here at Spence & Partners we have developed specific software which can help divorcing parties and their legal advisers with an estimate of the likely impact of the change and the potential change in value of a pension share which was in the process of being agreed which we believe we will be helpful in many cases”.

ENDS

For further information please contact Ian Conlon (07718 365129), Brian Spence (07802 403013), Rebecca McDonald (0141 331 1004) or email us at divorce@spenceandpartners.co.uk

Spence & Partners are a firm of Actuaries, Consultants and Pensions Administrators with offices in Glasgow, London and Belfast and experience of operating pension schemes in England & Wales, Scotland, Northern Ireland and Ireland.

Visit www.spenceandpartners.co.uk

Note:

In the June 2010 budget the Chancellor of the Exchequer announced the Government’s intention for future increases to public sector pensions to be linked to changes in the Consumer Prices Index (CPI). To date, such pensions were increased in line with the annual change in the Retail Prices Index (RPI).

The Pensions Minister subsequently issued a statement on 8 July confirming that the Government also intends to use CPI for determining statutory minimum pension increases which apply to private sector pension schemes.

Over longer periods of time it is expected that CPI will be lower than RPI. All public sector Cash Equivalent Transfer Values (CETVs) will reduce to take account of this; the position with private sector pension schemes is more complicated and the impact will depend upon the specific scheme rules. In the case of a member of a public sector pension scheme, the reduction in their CETV could be as much as 20% or more.

As this is such a material change, we understand that most, if not all public sector schemes have stopped quoting CETVs and it is likely that they will defer the implementation of pension shares on divorce until revised factors are in place. This will delay divorce proceedings and may increase costs for those in the process whose calculations are put on hold.

Spence & Partners Ltd have developed specific software which can provide divorcing parties and their legal advisers with an estimate of the likely impact of the change in the level of increases on the CETV, and the potential impact on the value of the pension share on divorce which was in the process of being agreed. Whilst a degree of uncertainty may remain, it may well be attractive for some parties to proceed having been provided with an estimate of the impact of the change.

• A simple step by step guide through the key issues.
• A unique on-line calculator which allows individuals to get an estimate of what their (or their spouses) pension may be worth covering both pensions in payment and prospective pensions.
• Case study examples highlighting key issues
• Useful document downloads to help obtain the information individuals will need.
• A link to our popular blog which will be regularly updated with topical comment.
• Access to a lawyer and financial adviser search facility
• A link to a life expectancy calculator to assist the clients financial adviser deal with likely future cash flow requirements.

Spence & Partners Director David Davison commented “ We hope this new service will provide useful support for individuals struggling with this difficult and complex issue and will evolve in to a useful forum to ask questions and obtain the information people need. We believe the calculator on the site will prove particularly popular as it is often difficult for individuals to get a feel for just how significant pension assets might be and also for lawyers to get indicative figures for clients with pensions in payment and this facility will deal with both of those issues.”

Now recognised as a leading industry commentator Spence & Partners have been successful in carving out an enviable niche in a highly competitive sector. The firm’s in-depth understanding of the complex issues involved in the modern pension environment has taken them from an initial staff count of eight to more than 50 people today.

Joining the pension consultancy team Ian brings 23 years experience and specialism in risk finance, expertise Brian Spence believes supports Spence & Partners’ client’s objectives, “We are delighted to welcome Ian to the company. Ian’s areas of expertise will bring a rich new dimension to the service we offer our clients and continue to enable Spence & Partners to provide tailored advice based on our clients specific needs”.

Ian, a qualified accountant, joins the company from Guy Carpenter where he led on all longevity-related business. Beginning his career as an actuarial trainee Ian spent eight years with ITT London & Edinburgh. Previously, Ian has held positions for JLT and has been involved in financial modelling for longevity based hedge fund as well as the origination, analysis, structuring and transaction of longevity-based business.

Ian’s role with Spence & Partners will include pension’s consultancy and advisory services and identifying business development opportunities. Brian Spence explains how the firm has adapted successfully to the major changes contained within the Pensions Act 2004, which had far-reaching consequences for the industry.

“This decade has seen major changes in the way the pensions industry operates and the way pension professionals have had to adapt to new circumstances. The tightening of regulation and scheme governance has created new challenges and the establishment of the Pensions Regulator and lifeboat schemes has altered the landscape.”

“The continued acquisition and retention of quality advisors and consultants is crucial in meeting the growing demands of the industry and our clients, and the inevitable emerging challenges of the next 10 years.”

Spence & Partners is a leading firm of actuaries, consultants and pension scheme administrators.  Through sister company Dalriada Trustees Limited we also provide independent trustee services.

A specialist in risk finance, Ian joined the company as a pension consultant on 9^th June from Guy Carpenter where he led on all longevity-related business.

Ian graduated from Reading University with a BSc in Pure Maths and has a diverse range of skills. Ian has an actuarial background and is also a qualified accountant. Ian has been involved in financial modelling for longevity based hedge fund as well as the origination, analysis, structuring and transaction of longevity-based business.

Ian will lead Spence & Partners consultancy efforts in London and the South and his role  includes pension’s consultancy and advisory services as well as identifying business development opportunities.

Brian Spence, managing director of Spence & Partners said, “Ian is highly experienced in his field and knows the industry exceptionally well. Ian’s areas of expertise will bring a rich new dimension to the service we offer our clients and further enable Spence & Partners to provide tailored advice based on our clients specific needs”.

Improving world stock market returns in 2009 will have helped the asset side of the pension balance sheet, particularly for those pension schemes with a meaningful equity exposure, albeit it has been a bit of a volatile ride. This may have given some finance direction a false sense of optimism.

However this good news is likely to be more than offset by a very significant reduction in bond yields since the 2008 year end. Pension accounting standards such as Financial Reporting Stadnard 17 (FRS17) and International Accounting Standard 19 (IAS19) require liabilities to be discounted using AA corporate bond yields of an appropriate duration to the pension scheme liabilities.

One common measure of this is the Markit 15 year iBoxx Corporates AA 15 year + index . During the course of last year, this fell from about 6.7pc per annum to about  5.5pc per annum.  This meant that figures produced at 31 December 2008 factored in a much higher risk of default than applies today, resulting in what may be viewed as an artificial reduction in the accounting liability disclosed, and therefore improvement in the funding and balance sheet positions, other things being equal. At the time it was a welcome offset to sick asset valuations, but it is likely to make the resultant impact of the 2009 figures all the more stark.

The impact that this will have on individual pension schemes depends mainly on the age profile of the membership. It will also depend on the extent of any margin that was deducted from the rate used at the previous year end to allow for the effect of the “credit crunch”. Assuming a discount rate of around 6.5% p.a. was adopted at 31 December 2008 and discouting other factors at play (for example changes in the inflation and longevity assumptions), for a young scheme with a typical benefit structure and average weighted age of say 45, this will increase the liability value by about 30%. For a more mature scheme, with an average age 55, the increase is about 20%.

How pension liabilities are valued in accounts is at long last being recognised by analysts and investors as being very significant. It is capable of distorting a company’s financial position and should be looked at closely, frequently with some degree of scepticism. Indeed the FRS17 basis has long since been discounted by the Pensions Regulator as too weak a basis to be credible for funding a final salary pension scheme. Funding on an FRS-type basis was in vogue when the new pensions funding regime came into play in late 2005, but it has now more or less been discredited.

Recent research has suggested that the Royal Bank of Scotland and Lloyds may have been underestimating pension obligations in their statutory accounts by in excess of £24bn combined. The survey by AlphaValue suggested that both organisations were using too high a discount rate in their accounting disclosures, therefore reducing their scheme deficits. This is an issue not just for the very largest companies but for any company disclosing pension liabilities in their accounts.

The UK’s Accounting Standards Board (ASB) in its January 2008 discussion paper “Financial Reporting of Pensions” proposed replacing the AA corporate bond discount rates used for calculating scheme liabilities with a risk-free rate of return, such bas government gilts or a swap rate.

A move to a risk-free basis would have an even more significant impact on the company balance sheet. Currently, this would result in an annual discount rate of about 4.3% in contrast to 5.5% mentioned above, and an increase in liabilities of 30% for the younger scheme mentioned above and 20% for the more mature scheme in addition to the increases referred to above.

In a supplementary report to its earlier report entitled “The Financial Reporting of Pensions – Feedback and Redeliberations”, the ASB confirmed its view on discount rates and stated: “The ASB, in considering concerns arising from the use of AA corporate bond rate in the UK at this time, affirmed its view that the discount rate should reflect only the time value of money, and therefore should be the risk-free rate. In its view, the risk associated with the size and variability is more appropriately addressed through disclosure”. However, it is believed that the International Accounting Standards Board (IASB) has at this stage decided not to provide additional guidance on how to determine the discount rate.

Never has it been more vital for finance directors to review the basis on which their disclosures are calculated. The company directors are responsible for the basis of the disclosures in the company accounts. FRS17/IAS19 requires the assumptions to be derived on a best estimate basis after taking actuarial advice. However, it is common for the pension disclosure calculations to be carried out using many of the same assumptions used by the pension scheme trustees for funding purposes. And yet the assumptions used for scheme funding are required to include margins for prudence such as the allowance made for longevity improvements of future salary increases – companies may have recently revamped their policy on the salary review process, resulting in lower expected increases than in the past, but this may not have filtered through to the pension funding plan. It could be argued therefore that these calculations are not best estimates and overstate the employer’s accounting liability as far as these assumptions are concerned.

Ensuring the use of best-estimate calculations based on the employers specific circumstances may be an area worth investigating as a possible way of mitigating some of the likely increase in the year-end liabilities and protecting the company’s balance sheet position.

For information regarding pension accounting computations and disclosures contact Ian Campbell on 0141 331 1004 or email ian.campbell@spenceandpartners.co.uk

Issued on behalf of Spence & Partners by Blueprint Media

This article was featured in the Your Money supplement of the Daily Telegraph on 27th Feb 2010

Date: February 2010

If, as industry figures increasingly tend to show, defined contribution(DC)  pension schemes are the way forward and defined benefit (DB) schemes are going to continue to wither on the vine, then it is time for some radical thinking about what the future should look like.

The marketplace is awash with new ideas and the government is falling over itself to come up with new initiatives, but the question has to be asked: why re-invent the wheel?

There are serious issues to be addressed, such as mandatory contributions from the outset of schemes, default retirement ages, means-tested benefits and the use of contract-based arrangements rather than introducing the National Employer Savings Trust (Nest).
This article examines many of the pressing challenges facing the pensions industry today and proposes some radical and innovative solutions.

If we accept that DC provision is likely to be the cornerstone for occupational pension provision ongoing, why has the government felt it necessary to establish an oversized, trust-based scheme at fantastic expense when we already have existing contract-based products in the marketplace that more or less fit the bill? And, especially as there appears to be some lack of enthusiasm to administer them.

Interestingly, Simon Richards, business delivery director at the Personal Accounts Delivery Authority (PADA) has said of PADA developing “a new system to administer personal accounts” (now known as NEST).
“This means that rather than buying a new IT system, PADA will use the technology and business processes of existing firms.” Is that the sound of pennies dropping a bit late in the day?

The government wants something “easy to understand and accessible” – companies (except for the very small employers) are already obliged to offer stakeholder schemes where no other provision exists. How much more access to employer-sponsored arrangements is necessary, and how is introducing yet another form of pension provision going to make it easy to understand?

A nice piece of joined up thinking might be to take the National Association of Pension Funds’ idea of kite marking but rather than focus on the employer, for contract-based arrangements focus on the provider. Review the provider communication, web based access, flexibility, fund choice, charges, performance etc. and kite mark that arrangement. That way, employers (particularly small-to-medium enterprises that don’t have self-administered DC arrangements and to which, it might be argues, Personal Accounts are targeted at) can pull a product off the shelf to use to facilitate compliance with “compulsion”. If they have an existing contract based-arrangement in place, it would be down to the provider to make sure that arrangement was able to be kite-marked and so the employer was able to comply.

On the issue of “compulsion”, procrastination is the thief of time or, in this case, future financial security – notwithstanding previous comments; lack of compulsion to contribute left stakeholder schemes dead in the water (except as a cheap and cheerful replacement for closed DB arrangements).

Let’s just bite the bullet and impose mandatory contributions from the outset. If there are concerns this will create a cliff edge increase in employer/employee costs, put in place some transitional tax reliefs. Making it ‘opt out’ rather than ‘opt in’ may result in inertia and, as such, some increase in those employees contributing to work based schemes. But while there is a get-out clause, those employees who are minded to maintain current spending power at the expense of the future will still do so.

Any form of means tested state benefit in retirement also needs to be scrapped. There are two issues: the first that pensioners don’t claim all the benefits to which they are entitled because the process is too complicated (for example, pensions credit); the second that they could end up paying into a scheme for nothing, because they believe that by having some form of private provision, this will impact of the amount of state benefit they may be able to claim. There needs to be a simple structure as to what any individual is entitled to from the state and this should not be impacted by any other legitimate post-retirement income they may have in place.

Finally, let’s scrap any idea for a default retirement age including a default state retirement age. The only test should be whether an individual can do the job? Does the job legitimately exist? Do they want to do the job? I accept that there appears to be some reluctance amongst employers to embrace this idea, but I suspect this is just a mindset – I have yet to see a reasonable explanation as to why a default retirement age is deemed necessary.

It must be recognised that, in the future, it will no longer be the case of work, retire and die – the edges will become somewhat blurred. Individuals should be free to plan their retirement and look holistically at all sources of revenue – pensions, savings, equity release, part time/full time working and state benefits. They should be free to mix and match to create the required level of income at any point in time. This should include the option to draw state benefits at any age, appropriately adjusted to reflect the length benefits will be paid, and/or to take part of any state entitlement and defer the rest – i.e. fully flexible retirement for state benefits.

The pensions landscape is changing. Financial security in old age has always been a three-way deal between the individual, their employer(s) and the state. Increasingly, individuals are taking on more of the responsibility and this message needs to be communicated both well and quickly. However, collectively we must also consider more imaginative solutions to the question of the country’s financial future and not rely on a re-hashed, unnecessary DC model?

Sean Browes is a project manager at Spence & Partners

For further information please contact David Davison at Spence & Partners (www.spenceandpartners.co.uk) on 0141 331 1004.

Issued on behalf of Spence & Partners by Blueprint Media

This article was featured in Feb ’10 issue of Pensions Management.

Date: February 2010

This further strengthens the team following the appointment of Ian Campbell as Actuarial Director in May 2009 as reported at: http://www.spenceandpartners.co.uk/archives/ian-campbell-becomes-latest-significant-recruit-at-actuaries-spence-partners/

Brian Spence, managing director of Spence & Partners, said: ”This is a great appointment and we are really pleased to have Alan on board. His broad experience and enthusiasm will add quality and depth to our actuarial team and provide invaluable support to our graduate recruits and part-qualified actuaries, as well as creating a skilled new resource for our clients. We are all really looking forward to working with him.”

Alan is a graduate of the University of Glasgow, where he attained an M.Sci First Class in mathematics and physics and the University of Edinburgh, where he attained a post graduate diploma in financial mathematics. Alan qualified as an actuary in December 2006 and obtained his practising certificate in November 2008.

Alan has particular expertise in buy-outs/buy-ins, accounting for pension costs, risk reduction exercises and mergers and acquisitions.

For further information please contact David Davison at consulting actuaries Spence & Partners on 0141 331 1004.

Spence & Partners are a firm of Actuaries, Consultants and Pensions Administrators with offices in Glasgow, London and Belfast and experience of operating pension schemes in England & Wales, Scotland, Northern Ireland and Ireland.

Issued on behalf of Spence & Partners by Karen Milne at Blueprint Media tel 0141 353 1515
Date:   January 2010

Firms cannot any longer have an open-ended commitment to final salary pensions, especially in the environment where deficits narrow or widen almost on a daily basis.

But closing a final-salary pension scheme is not an easy or uncomplicated option.

As a specialist adviser, I tell employers they have five serious issues to consider before consulting employees on a scheme closure. Firstly they should be ready for employees, trade unions or the pension scheme trustees to ask whether they have considered the alternatives.

They must be able to demonstrate that all options and their financial implications have been considered, and be able to communicate those clearly.

Advisers can “model” any common replacement benefit structure, including career average earnings, money purchase pensions, and the limiting of pensionable salary increases and cash benefit, with the aim of arriving at a “best fit” and financially-sustainable solution.

Employers must take legal advice on wording used in contracts of employment, because a final-salary pension may be considered to be legally contractual. Contract of employment can be changed, but the risks involved and the procedures that need to be followed are considerable more complex where there is a high risk that the pensions promise is contractual.

Pension scheme trustees can wield much power in thwarting or delaying an employer proposal. Closure is the most controversial decision that employers are ever likely to take in connection with a pension scheme. The trustees may be able to block a closure proposal and, at the very least, are likely to argue for concessions on scheme funding or other matters as a price for their cooperation. Employees must be given detailed information on how any proposal affects them as individuals.

We would normally recommend the provision of individual benefit projections for every pension scheme member, incorporating the impact of state benefits.

The quality of all the data required is very demanding, and we would say that rather than muddling along with the same set of advisers an employer should take independent actuarial advice.

Closure of a pensions scheme is rarely a cause for celebration and the consequences for individual employees can be very unwelcome.

However, by conducting the process properly and professionally, the consultation can be successfully completed without too much collateral damage to the hard-won relationship between employer and trustees.

For further information please contact Brian Spence at Spence & Partners (www.spenceandpartners.co.uk) on 0141 331 1004.

Issued on behalf of Spence & Partners by Blueprint Media

This article was featured in The Herald on 16th Jan ‘10.

Date: January 2010

Brian Spence is a founder of actuaries Spence & Partners Limited and a director of independent trustee Dalriada Trustees Limited.  You can follow him at @briandspence or @PensionsEndgame on Twitter or link to him on LinkedIn.  Dalriada provides professional trustee services and Spence & Partners can provide support to employers in appointing an independent trustee.  Brian has written a series of articles on appointing an independent trustee.

Follow @SpencePartners and @DalriadaTrustee on Twitter.

It also leaves many questions unanswered. Why was there such enthusiastic encouragement to participate in a pension scheme of this type? Why were these small organisations not given very clear guidance about the potential risks that they were exposed to as a result? Had they been, would so many have blindly taken part?

And the biggest question remains: what is going to happen to other similar schemes with participants all equally ill-equipped to deal with final salary liabilities?

David Davison is a Director at Spence & Partners, independent actuaries and consultants in Scotland and Northern Ireland.