This guide is intended to be a useful reference for companies preparing their 31 March 2019 pensions accounting disclosures, whether under FRS 102 or IAS 19.
In this guide, we will review the changes in the investment markets over the last 12 months and consider the impact these will have had on a typical pension scheme. We will also review recent developments in the area of pensions accounting, highlighting issues that you should be aware of.
With the wealth of corporate advisory experience available
at Spence, we are well placed to provide you with guidance in how to best
manage your pension scheme liabilities.
The implications of the recent developments should be
considered to help you avoid any surprises. Spence can help guide companies through
these complexities and have a proven track record in navigating to the best
outcomes for our clients.
We would be happy to discuss the options available to you
in reaction to the market trends discussed above, including:
- How to lock in asset gains;
- Decrease future risk;
- Reduce funding level volatility.
To discuss these topics further, please contact Spence through your usual contact or connect with our Corporate Advisory practice associate, Angela Burns, at email@example.com or by telephone on 0141 331 9984.
On the 8th May the Ministry of Housing, Communities & Local Government issued a policy consultation entitled “Local Government Pension Scheme: Changes to the Local Valuation Cycle and the Management of Employer Risk.” This comes following the publication in September of the “Tier 3 employers in the LGPS” research findings. The consultation closes on the 31 July 2019.
The first proposal is to change the actuarial valuation cycle in LGPS, from every 3 years to every 4 years, to coincide with the 4 yearly valuations of LGPS as a whole. I do have some concerns that for admitted bodies in the Schemes this will mean that they receive less information and ultimately the information provided will have to have a much longer shelf life. I suspect this is driven more by the inefficiencies in administration and a drive for cost savings than it is for any drive for valuation consistency.
I think to make this change work Schemes should be supplying annual updates on the funding and cessation position (perhaps linked to the provision of FRS102 information) which would allow organisations to be better informed about their position and options.
Of greater importance to charity participants are a series of proposals primarily aimed at looking to help employers better manage exits from the Schemes.
The document recognises that “for some employers a significant issue is the cost of exiting the scheme which can be prohibitive.” The consultation seeks views on two alternative approaches:-
- To introduce a ‘deferred employer’ status that would allow funds to defer the triggering of an exit payment for certain employers who have a sufficiently strong covenant. Whilst this arrangement remains in place, deferred employers would continue to pay contributions to the fund on an on-going basis. This is looking to broadly replicate the ‘deferred debt arrangements’ (‘DDA’) brought in by DWP to deal with Section 75 debts in multi-employer schemes and the suspension arrangements implemented in Scottish LGPS in 2018;
- To allow an exit payment calculated on a full buyout basis to be recovered flexibly – i.e. over a period of time providing this is deemed to be in the interests of the Fund and other employers. This is designed to put in to regulation a framework to provide flexibilities on a more formal and consistent basis to those being utilised ‘informally’ by some funds via alternative arrangements.
Whilst I welcome the sentiment and the objective to formalise any additional flexibilities offered the consultation proposals stop well short of fully recognising the issues and finding a full range of workable solutions to deal with them.
- The DDA legislation and the changes to the cessation position in LGPS in Scotland brought in in 2018 have both been damp squibs with schemes choosing to ignore the changes and to continue to plough their own furrow. The fundamental issue seems to be that schemes are using any request to use the new regulations as an opportunity to re-negotiate security arrangements with the participant. This is hugely short-sighted as it ignores the lack of security on the benefits already built up and that it cannot be in the interests of the organisation, or indeed the other organisations participating, to build further liabilities. This stance in most cases therefore forces organisations to stay in the Scheme which is exactly the result the changes were looking to avoid! The proposals in this Consultation just seem re-inforce this issue referring to employers who are “sufficiently strong” being the only ones who avail of the proposed funding flexibilities – exactly the employers who can probably afford to exit or even potentially continue in the Scheme;
- The proposals need to consider what options are available for less “sufficiently strong” employers. It cannot be sensible to force employers in to insolvency as a result of their pension liabilities but instead find a better way to manage these. In the interests of the impacted employer and others in the Scheme it would seem more productive to identify methods where the fund can obtain the maximum possible amount, even if this amount is less than the full cessation position. Some LGPS have already pioneered work in this area and the proposed changes are well behind the curve in terms of effective solutions;
- The gilts based cessation methodology is flawed. Over the past 10 years gilt yields have fallen from over 5% to well below 2% which means that exiting employers are subjected to something of a lottery in exit terms. Currently high cessation values based on low gilt yields make exits less affordable keeping employers tied to the scheme – again counter-productive. Funds feel their hands are tied in investment terms forcing them to either invest very long term liabilities in poorly performing gilt assets or some funds remaining invested in the same way effectively just taking the cross subsidy benefit from their charity participant to help fund public sector liabilities. A more equitable system could be to look at the rolling average gilt value over a period or based upon the expected local authority borrowing costs;
- There continues to be no recognition of the issue of legacy liabilities within LGPS. It is wholly inequitable for public sector bodies to expect admitted bodies in their Funds, often charities, to cross subsidise the public entity for benefits built up by staff while working for them. These liabilities should continue to be held by the public body in the same way as they were pre a transfer and new employers should be fully protected from these. Benefits reverting back to a prior employer for service linked to that employer just means that they continue to be dealt with on an on-going’ valuation basis (as they were initially) and not converted to a cessation basis. This is a solution which is also likely to make exits more affordable.
- The suggestion that the steps proposed are linked to protecting the remaining employers in the Funds and this is repeated here. This whole issue of residual risk has been over-egged. The risk is already there and rising – what is needed is an affordable way to minimise the associated risk with the accrued liability and limit any future accrual. How can it be sensible to have 2 employers where one has one active member and one has no active members and yet they are both treated in vastly different ways.
The proposals in this consultation paper are a hugely disappointing response to the issues and in my view provide a wholly inadequate range of options to address the major issues faced. You’d have thought having sat on its hands over this issue for such a long time that the response would have been more comprehensive and considered.
I will be preparing a more detailed response to the consultation which I will share in a future Bulletin. I would also suggest that if you are a charity affected by these issues that you also respond to the Consultation.
When a single issue starts to dominate headlines, it can become a little tedious. Whether we like it or not, Brexit will continue to be front page news for a while longer.
However, it’s important we keep Brexit in perspective. While Brexit may lead to a period of disruption, a number of economists believe that, in the long run, it’s unlikely to make a significant difference to GDP growth. For global investors there are bigger issues:
- the price of commodities;
- weakness in emerging market economies;
- concerns over the future strength of the Chinese economy;
- President Trump’s unpredictability;
- the USA trade war with China;
- and rising interest rates.
So, while turbulence, be it the result of Brexit (and there is near unanimity in a recent Centre for Macroeconomics survey that the Brexit question will increase financial volatility) or other factors, can be unnerving, it also offers opportunities. The key is to keep calm and remember that volatility is part and parcel of investing over the long term and a normal function of healthy markets. The moral of the tortoise and the hare story is that you can be more successful by being slow and steady than quick and careless.
Market volatility has undoubtedly caught out some over the years, causing them to panic and sell, losing money in the process. However, investors who have been able to stay the course are likely to reap the rewards. By way of illustration, over the past 30 years or so (incorporating Black Monday, Black Wednesday, the Dot.Com crash, Lehman’s collapse, the Global Financial Crisis and the like) £1,000 would have grown to over £18,000 if invested in the FTSE All-Share Index. Indeed, adding to existing positions at attractive valuations has been a cornerstone of Warren Buffett’s success.
Where does that leave trustees and sponsoring employers of DB pension schemes?
- Factor Brexit in as a managed risk, keep an eye on covenant and be mindful of members with EU bank accounts.
- When it comes to investing, don’t panic. Brexit is a known unknown. This means that it’s impossible to accurately predict how various scenarios will ultimately unfold. As a result, it would be prudent to consider exposure to a variety of economies and asset classes; as well as ensuring there is sufficient available cash to meet (potentially unpredictable) benefit outflows.