Archive for January 2011

Alan Collins

I came across an interesting panel discussion in the current issue of Engaged Investor Magazine, where a number of industry experts were asked for their views on developments in pension scheme de-risking. My views on the questions addressed are as follows:

Q1 – Many companies are not able to carry out full buyout in one go. What multi-layered approaches can they take to de-risk their schemes?

The most important first step is for the employer and trustees to agree a common goal for the scheme. In almost all cases (especially closed schemes), the ultimate goal should be to secure all benefits with an insurance company and wind-up the scheme.

An agreed, transparent objective will then set the path towards the ultimate goal. There are many alternative partial de-risking measures that can be taken, most of which can work in parallel. These include employer led exercises such as:

  • a transfer exercise, offering members the opportunity to transfer their scheme benefits to an alternative arrangement via an incentive in the form of an increased transfer value, or sometimes a cash payment; or
  • a pension increase swap exercise, where members give up future pension increases in return for a higher initial pension.

These exercises can generate significant savings to the employer relative to the ultimate cost of buyout. They are unlikely to generate significant immediate savings on ongoing funding costs or FRS 17, though they do contribute to reducing the risk profile of the scheme.

These exercises can be run in tandem with providing opportunities to members to retire early from the scheme, which can generate savings on cash commutation and also insurers prefer the “certainty” of pensioners rather than deferred members. In conjunction with the company, the trustees can also move towards a lower risk investment strategy, using bonds or LDI type investments, and also consider partial insurance such as pensioner buy-ins. I would caution that for schemes with young pensioners or where the pensioner group makes up a small proportion of the liabilities, it may not be efficient to use significant resources of the scheme to obtain insurance covering only a small portion of the liabilities. There are also opportunities developing in the market to enter into a staged buyout process with insurers, where the terms are agreed up front but the whole premium is not required at the outset.

Nor should the trustees overlook the potential for non-cash funding, such as parental guarantees, contingent assets or “asset-sharing” with the company, such as the whisky-bond deal completed by Diageo .

Q2 – In what ways did trustees’ de-risking choices change during 2010?

The choices remained broadly unchanged, though it was a year of massive change in defined benefit pensions, particularly on the legislative front. The single largest issue was Steve Webb’s RPI/CPI summer bombshell, which is expected to have a significant effect on pension scheme funding. Most schemes are expected to see a reduction in liabilities of between 5-15% depending on the nature of the scheme rules.

This meant that larger exercises tended to be shelved as trustees waited for the full impact of the change in inflation measure to come through. I would say the introduction of innovative non-cash funding solutions and the focus by trustees on obtaining enforceable security was the other main development in de-risking.

The emergence of longevity swaps was supposed to be the big-ticket item for 2010, but this remains the preserve on the very largest of schemes and I don’t see that changing any time soon.

Q3 – What early steps, such as data cleansing, communications and legal considerations, should be undertaken before entering into a de-risking activity?

The quality of pension scheme data can be highly variable. It can be held in multiple formats, for very long periods of time and is often subject to major change (e.g. after mergers, systems migrations, legislative changes). When entering a liability management exercise and moving ultimately towards winding-up a scheme, every effort must be made to ensure that members have the correct pension entitlement. The key message on data is that full and accurate data will reduce the cost of staff communication and liability management exercises as well as ultimately buying annuities as it helps to reduce underwriters’ pricing for uncertainty.

The communication process is also vital, both between the employer/trustees and the member. Possibly even more important is the communication between a financial advisor and the member during an employer’s de-risking exercise.

The need for proper legal input almost goes without saying, but the emergence of the RPI/CPI issue and continued problems with sex equalisation and other scheme amendments, mean that assistance from your friendly pensions lawyer is a necessity, not a luxury.

Greig McGuinness

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.

Alan Collins

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.

Valerie Hartley

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.

David Davison

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. Read more »

David Davison

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? Read more »

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