Archive for December 2010

Alan Collins

UPDATE : FRS17 has been updated to FRS102 follow the link to find out how this affects you


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:-

Change Reduction in liability
Discount rate increased 0.25% per annum* £1.8 million
Salary inflation less 0.25% per annum (assuming 50% of members are active) £0.5 million
Price inflation and salary inflation less 0.25% per annum £1.8 million
Life expectancy reduced by 1 year £0.8 million

*- 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.


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.

Greig McGuinness

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.

Brian Spence

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

Alan Collins

‘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.

Neil Copeland

Apparently the Baiji (Yangtze River Dolphin) is amongst the rarest mammals in the world. It may even be extinct. Clearly there’s a fine line between being very, very rare (i.e. only one left) or being extinct (none left). The last definitive sighting was in 2004. It was declared functionally extinct in 2006 but video footage of what might have been a Baiji was taken in 2007 raising the possibility that there was at least one survivor out there, wisely staying well clear of humans.

When it comes to pensions legislation common sense is nearly as uncommon, but we appear to have a confirmed sighting in the DWP’s response to the consultation on the abolition of contracting out on a defined contribution basis.

Now I have never understood why one of Margaret Thatcher’s most lauded sound bites was “You turn if you want to. The lady’s not for turning!” Not turning in the face of irrefutable danger or logic is not a particularly common sense position to adopt. Indeed history and experience teach us that a U turn is not necessarily a wrong turn.

If only the Titanic had been able to perform a timely U turn. Or Thelma. Or Louise.

So clearly I welcome the Government’s common sense U turn on the abolition of transfers from contracted out pension schemes. I had blogged previously about the iniquities of the original provision, sneakily hidden in the regulations regarding the abolition of DC Contracting-out, which could have outlawed such transfers. Respondents to the DWP’s consultation on these Regulations presented a factual and rational analysis as to why, for some people, based on their particular circumstances, transferring out of a contracted out defined benefit scheme is clearly in their interests. A lesson that the Pensions Regulator could usefully learn.  More importantly the DWP appears to accept that the decision about whether or not to transfer should be made by the member, having taken impartial advice, rather than be imposed in some crass one size fits all, we know what’s best for you, diktat from the nanny state.

As I previously noted the draft regulations did rather smack of an admission that the FSA was failing in its duty to regulate this particular area of advice. Rather than address that shortcoming they have tried to foist the responsibility for regulation of transfers onto pension scheme trustees through the Pension Regulator’s “guidance” framework. Some commentators had responded to this development by suggesting that it was wrong and possibly illegal for trustees to fully embrace the Pensions Regulator’s guidance on enhanced transfer value exercises. Given this, abolition may have seemed like an easy option, despite its inherent unfairness.

Yes members need protection from unscrupulous advisers but that is why we have the FSA and, from 2013, the Consumer Protection and Markets Authority. It is certainly not why we have pension scheme trustees, who have a difficult enough job to do without being forced to do the regulators’ jobs for them.

We have consistently argued that properly structured and funded enhanced transfer value exercises are a legitimate approach for employers to engage with their scheme members with a view to managing their liabilities. They also provide members with an opportunity to properly review their retirement planning with a professional adviser.

So credit where credit’s due, well done to the DWP for changing its mind on this one. It will be interesting to see if the Pension Regulator’s finalised guidance on enhanced transfer exercises will also be leavened with common sense.

Now if the DWP could only be persuaded to approach the question of GMPs in the same manner as it has recently dealt with Protected Rights – that is, just make them disappear – then that would be further evidence that, after years of languishing in neglect, common sense is unexpectedly back in vogue at Westminster.

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