Posts by Alan

Alan Collins

Alan Collins

Head of Trustee Advisory Services at Spence he provides actuarial, funding and investment advice to trustees and sponsors of ongoing defined benefit schemes.
Alan Collins

20 years in pensions

Last week, I passed through the ‘20 years in pensions’ landmark. Year 21 is as busy as ever, but I did find some time to pause for some reflection.

1999 was my first year in a ‘proper job’. It was the year when people waited to party like Prince predicted back in 1982. It was the year when businesses were fixated by the impending doom of the Millennium Bug, which after greater preparation, pretty much came to nothing (see GDPR). In 1999, Scotland had recently qualified for a major football tournament and suffered its first of many glorious failures in attempting to qualify for Euro 2000. Ah, the days of glorious failure instead of just plain old failure.

I started work in Towers Perrin’s North of England Office (St Albans!) and so my quest for the actuarial fellowship qualification commenced. In the financial world of 1999, the Bank of England base rate was 5.0% a year (no I haven’t missed the decimal point). Long-term interest rates were expected to average at 4.5% a year for the next 20 years.

So, if you were to borrow £1,000 for 20 years back in 1999, you would be expected to pay back £2,412 i.e. £1,412 of interest. Today, the amount to pay back would only be around £1,220 i.e. only £220 on interest of around 1% a year.

The late-90s pensions industry was adapting to the post-Maxwell world of the Pensions Act 1995 (PA95) and the soon to be forgotten Minimum Funding Requirement (MFR). Amongst a raft of legislation, PA95 introduced mandatory pension in payment increases and enshrined in law the protection of pension benefits built up in the past.

It was also a time-period when it was becoming clear that the actuarial profession had significantly underestimated life expectancy. This was (and still is) another significant factor in past pension promises costing more than had been expected.

My years in pensions have sped past, now finding my home at Spence for almost ten years now. Fellowship of the actuarial profession eventually came in 2006 and I have been proud to advise many pension scheme trustees as their Scheme Actuary since 2008. I have seen the sad, but inevitable, demise of final salary pension schemes for most members. As such, my job in the main involves helping trustees and sponsors deliver the past benefits that have been built up.

To end this reflection, I mused about the most significant turning points in the pensions industry over my time. Several came to mind, but I would plump for the introduction of full buyout solvency debts on sponsoring employers and the introduction of the Pension Protection Fund (PPF).

From what I recall, the introduction of full buyout debt sort of snuck up on sponsoring employers. Of course, the vast majority want to provide full pensions for all members. However, with the huge challenges and costs of pension schemes, how many would turn back the clock and wind-up schemes with lower obligations? Very many, I am sure.

The mere existence of the PPF is often cause for celebration and rightly so. In the fifteen years since it opened its doors, it has given shelter to around 250,000 members and undoubtedly provided them with a much better financial outcome than would otherwise have been the case. So, to the next 20 years.

What will happen? Don’t ask me, I’m an actuary!

Alan Collins

The art of discretion

Discretion matters for pension schemes and their members. If you know your Shakespeare, discretion is ‘the better part of valor’ (Henry IV), meaning better to be cautious than make rash decisions. Also a consideration for pension schemes and members, but not the kind of discretion I want to discuss here.

When pension scheme trustees operate discretion over who receives pension benefits, the benefits will not be subject to inheritance tax (IHT). Discretionary benefits are usually lump sum payments on death in service (normally insured due to the amounts involved) and sometimes also death after retirement payments.

Members are given the opportunity to complete an expression of wish (or nomination) form where they can give the trustees a note of their preferred beneficiaries and the proportion of any benefits they would like paid to each. But these nominations are always (to the surprise of many) not actually binding on the trustees. The trustees have the freedom to choose to whom to pay the benefits – this decision is at their ‘discretion’. The nominations are for guidance only, otherwise the IHT benefit would be lost.

In most cases, trustees will ask for a copy of the deceased’s will and details of financial dependence so they can determine the circumstances of the case before making a decision.

Going against the grain

Sometimes the decision can be straightforward. In other cases, trustees can face a tricky task when there are multiple beneficiaries or the deceased does not nominate relatives. They may choose to follow the member’s expression of wishes. Or after considering all the circumstances available to them and exercising discretion with due care and attention, the trustees may make a decision that is not in line with the member’s nomination.

One area trustees may need watch out for is where direction is switched to discretion. The Supreme Court is ruling on a case (‘Staveley’) where HMRC successfully claimed that a transfer from a S32 policy (where benefits would be paid to the member’s estate) to a personal pension plan (where benefits are discretionary) was tax avoidance as the member was terminally ill. Occupational schemes could see similar cases.

Sometimes trustees may find that their decision is contested. This is becoming more and more common. In fact, death benefit decisions now account for 10% of the Pensions Ombudsman cases, a threefold rise since the advent of pension freedoms when compared to the same period prior to 2015.

Raising awareness

Perhaps this is simply a case that large sums of money make it more likely that there will be an aggrieved party who has not received what they thought they should.

Or maybe it’s a lack of understanding of the benefits of discretion over direction. Does the expression of wish form do enough to explain the need for discretion to ensure IHT benefits? Does it explain sufficiently the loss of control to the member over decision making? How many members read the caveat that the trustees will usually follow the member’s wishes but are not bound to and ignore the last part. The key element of the discretion.

It is important that scheme administrators take the opportunity of regular member communications, such as newsletters, benefit statements and summary funding statements to remind members to keep their expression of wish form up to date. A form can be enclosed with traditional print communications, members can be directed to a website to download a form or prompted to contact the administrator by telephone or email.

The more up to date the member’s expression of wish form, the less likely it is that the trustees’ decision will be challenged and the member’s wishes can be fulfilled.

Alan Collins

The ultimate goal of a defined benefit scheme is clear – to ensure that all members receive the benefits they have built up in the scheme. For most schemes, this will involve some form of insured solution at a point in the future where remaining benefits are secured and the scheme is then wound-up. For some that will come sooner; for others it is currently a very distant prospect.

The UK funding regime has historically “ignored” this ultimate end point – rather, we have the somewhat vague construct of technical provisions (ongoing funding basis). This is the liability target required in funding valuations which must be prudent, but need not remove all future risks. Typically, you might see this liability target sitting in the region of 60-80% of the cost of insuring scheme benefits. Therefore, even if a scheme is 100% funded on the technical provisions basis, it will not be able to insure the benefits without significant further investment returns or significant further contributions from the sponsor.

As most of us working in defined benefit pension schemes already know, a scheme’s technical provisions are only a stepping stone towards the ultimate goal. What happens once full funding on an ongoing basis is achieved?

Over recent years, to assist scheme trustees with forward planning, the Pensions Regulator has introduced the concept of the long-term funding target (LTFT). The LTFT is defined as “the level of funding the scheme will need to achieve in order to reduce its dependence on the employer”. To me, this translates as meaning the buyout level funding or a level of funding that can be managed towards buyout without material further contributions from the sponsor.

The LTFT is now a key part of valuation discussions for 2019 and beyond. This is particularly the case for rapidly maturing schemes where the journey time to end point is getting shorter and shorter. The LTFT need not (and in most cases will not) bring about a change to the ongoing funding target or any immediate changes to the investment strategy. What it should do is bring about discussions on journey planning (both in the short and long-term), managing and reducing risk over time and possibly setting triggers that will reduce risk as the funding level improves and/or as the scheme matures.

Yields are returning to very low levels resulting in higher and higher liability values. As such, the funding challenges for pension scheme trustees show no sign of getting any easier. However, I am confident that looking to the future and setting clearly defined long-term targets (and clearly planning for how they will be achieved) will serve trustees well over the years ahead.

Alan Collins

The long-awaited Competition & Markets Authority (CMA) investigation into investment consultancy and fiduciary management has been completed and its final decision has been published.

All in all, to me, the CMA seems to have reached a pretty balanced assessment of the market and put forward some helpful remedies to the perceived problems. It is not the “all out attack” on the big three (and soon to be bigger in the case of Mercer) that some were hoping for (but, was never going to happen). Nor is it a full endorsement of all current practises and so some things will change.

The investigation focussed on two areas – investment consultancy and fiduciary management. To be clear, we provide both of these services to a number of trustee boards of defined benefit pension schemes.

The main findings of the investigation are that there is a low level of engagement by some pension trustees in choosing and monitoring their provider. The CMA also found that firms (like us) which provide both investment consultancy and fiduciary management have an “incumbency advantage” when fiduciary appointments are made.
The CMA also found that there may be high costs of switching providers and that many trustees find it difficult to access and assess information in relation to the fees of their existing fiduciary manager. My own experience is that the cost of switching investment consultant is often much lower than the costs of switching other services in our market (such as pension administration). Switching fiduciary manager may well be expensive due the potential costs associated with buying/selling investments, so the costs for these need to be understood as far as possible, before any switch is made.
I have also found the investment services market one of the more fluid areas of our industry, and one which is relatively easily accessible by new providers. I am further confident that all of our trustee clients have complete visibility and transparency of the fees paid and the services we provide.

So, what is the CMA going to do?

Following its investigation, the CMA is proposing to:

  • Require competitive tenders for first-time fiduciary appointments (or within five years, if the appointment was made without a competitive tender being undertaken);
  • Require investment consultants to separate marketing of their fiduciary management and to inform customers of the above tendering requirements;
  • Require fiduciary managers to provide better and comparable information on fees and performance;
  • Require trustees to set objectives for their investment consultant; and
  • Require investment consultants and fiduciary managers to report on performance using basic minimum standards.

All of the above seem to be reasonable requirements of trustees and consultants/managers. Indeed many schemes will already meet many or all of these requirements. My main concern is around the belief that “performance information” can be comparable. As stated in our response to the consultation, given the bespoke nature of pension schemes and the strategies put in place, applying a standard will prove difficult.

The report asserts that there is substantial confidence that a common standard could be implemented, but we still believe that it will be very challenging to agree a transparent approach to measuring performance on a standard basis. There is a real danger that a common standard will fail to identify genuine outperformance (or underperformance) and that it will actually drive inappropriate behaviour, as some providers might be tempted to adjust their strategies artificially. We will, of course, work within the parameters that emerge while sticking to our principles to achieve the best outcomes for clients, and we will be very interested to see how a genuine “apples vs apples” comparison standard can be put in place.

Alan Collins

It did not take Holmes-ian powers of deduction to pick up the influence of recent corporate failures in the Pensions Regulator’s annual funding statement that was issued on 5 April.

The annual “state of the nation” address on funding of Defined Benefit Pension Schemes made clear the disquiet from the Regulator that dividend payments were increasing but deficit contributions were not. The statement stresses the need for trustees to ensure “fairness” for their schemes relative to corporate shareholders/stakeholders. Where employers are strong, trustees should be “looking to fix the roof while the sun is shining” if you like. The Regulator has (pleasingly) avoided the temptation to try and fix parameters against which trustees should judge fairness. The current regime is founded on flexibility and I do hope this continues. Recent implications (in the Government’s White Paper) that greater direction/restriction is coming has me fearing a return to the days of a set Minimum Funding Requirement. The last attempt at MFR didn’t work and was quickly swept aside. I suspect that any attempt to turn back the clock on this would meet a similar fate.

There was also a reminder that dividends are not the only target, with the introduction of what might become a buzz-phrase – “covenant leakage”. This is really a catch-all phrase to describe any route by which the security of the scheme’s position is damaged by corporate activity. For me, this points strongly towards trustees drawing up and monitoring some key indicators to monitor company performance and company strength and take action to prevent deterioration or react swiftly if there is a change. And remember, it can be just as important for trustees to react when their sponsor’s position improves, allowing the scheme to share in this success and put their scheme on to a stronger footing.

The statement contained further “hints” that some trustee boards are not sufficiently well-equipped to tackle complex funding and investment issues. Trustees are expected to seek appropriate advice, especially where the board does not have the sufficient expertise or where potential conflicts exist.

Many other themes in the 2018 statement were follow-ons from 2017, such as the prominence given to the importance of contingency planning.
One part I struggle with is the continued highlighting of “Brexit uncertainty”. Yes, we know there is uncertainty. However, if the Government doesn’t know what is going to happen, the markets don’t know what is going to happen, advisors don’t know what is going to happen, then what chance do trustees have? I fear that trustee resources could be diverted in speculative discussions about future scenarios rather than focussing on more measurable, controllable risks.

Alan Collins

My initial thought was to sum up the last year by describing it as being one where there was quite a lot of talk but very little action.  A sort of “Have I Not Got News For You” if you like.

Having reviewed matters further, I reminded myself of a number of issues that caught the headlines for justifiable reasons. There is also promise of some big stories as we look into 2018 and beyond.

Firstly, the quiet, quiet bit.

The political landscape was always going to be dominated by Brexit and so it came to pass. Things were “spiced up” when Theresa May called a snap election which took place on 8 June – her powers of predicting the future certainly made actuaries feel better about themselves. At least we can be fairly certain 2018 will be an election-free zone (if not, I imagine Brenda from Bristol will have something to say about it).

All the Brexit-ing gave rise to a pretty much pension-free political agenda.

The recommendations from the Work and Pension Committee’s BHS pensions review were converted into a damp squib of a Green Paper. Even the low-hanging fruit of allowing schemes to more easily adopt Consumer Price Inflation was not progressed.  I can imagine the Paper has since been gathering dust on a far-away shelve in the deepest recesses of the never going to happen cupboard.

The much-heralded cold-calling ban has been put into cold storage. First announced in September 2016, it had been expected that firms would be prohibited from making unsolicited sales calls on pension matters in an attempt to combat the prevalence of scams.   However, the packed parliamentary agenda prompted the government to announce that legislation will be delayed until 2020.

There was hardly a mention of pensions in Chancellor Hammond’s November budget. This was generally welcomed by an industry that has grown tired of tedious tinkering.

At the more technical end of the spectrum, the long-running saga of VAT on pension scheme fees finally drew to a close. The end result was….just leave it the same as you have all been doing, but with some possible extended areas for reclaiming VAT on investment services.  The problem was that, despite the industry being on tenderhooks for three years and with only eight weeks to go until the deadline for implementation, the HMRC forgot to tell anyone of the decision.

The Work and Pensions Committee strode forward again recently to announce an inquiry into Collective Defined Contribution schemes. After the early death of “Defined Ambition”, the industry is fairly split on this – many, like myself are in the “never going to happen” brigade while others sit in the “give innovation a chance” camp.

Now for the bang…

The standout legal judgment for 2017 was Walker vs Innospec, where the previous limitation of spouse’s benefits for same-sex partners to periods of service on or after 5 December 2005 was ruled to be illegal. The law is now clear and schemes are taking action where necessary to redress matters.

My inbox has been flooded this year raising questions about my “GDPR Readiness”. For the few of you who haven’t heard, GDPR stands for General Data Protection Regulations, which come into force on 25 May 2018 and is ramping up the level of scrutiny on the processing and treatment of personal data.  The implementation of GDPR is very much more stick than carrot, with fines for non-compliance and breaches being much higher than the current laws provide.  So, I have been getting ever more conversant in the language of legitimate interest, privacy notices, data mapping and subject access requests.  Much work has been done in this area and there will be plenty more of it in the coming months.

Despite the concerted and collaborative efforts of the industry’s “big three” (Willis Towers Watson, Aon and Mercer), the Competition and Markets Authority launched an investigation into the market relating to investment consulting advice for pension schemes. The probe, which will determine “if there are any market features which prevent, restrict or distort competition”, is expected to report back in 2019.

The year is ending with a flurry of consolidation in the advisory market. Firstly, Broadstone purchased Mitchell Consulting and their sister company 2020 Trustees Limited.  Then, the recently floated Xafinity deepened and raided their “war-chest” by purchasing the administration, actuarial and investment businesses of Punter Southall.  In the pension equivalent of a “player plus cash” deal, HR Trustees headed off in other direction to merge with PSITL.

So, an interesting end to the year with plenty of room for speculation on might come about in 2018. I can hope for a better balance between talk and action, but I fear the continued domination of Brexit is still likely to lead to more quiet than bang for pensions.

Alan Collins

The 2017 Purple Book, the Pension Protection Fund’s stat-fest on DB pensions, has landed.

The document, can be accessed here.

The main headlines for me are as follows:

  • The transition of schemes from “closed to new members” to “closed to future accrual” is continuing – if the trends continue, more schemes will be closed to accrual than closed to new entrants by 2018 or 2019. The number of fully open schemes is relatively stable (but only accounts for 12% of schemes);
  • The funding levels of schemes (as measured on a S179 basis and a buyout basis) rose over the year to 31 March 2017, in spite of significant market turbulence which occurred around the EU Referendum Vote in June 2016;
  • The average length of recovery periods for valuations submitted to the Regulator dropped slightly, from eight years to seven and a half years;
  • The average insolvency rate of companies who sponsor DB schemes is around 0.3% a year – this has been relatively stable over recent years having dropped from around 0.8% in 2013/14). So, if you are a member of a scheme, your employer is (on average) significantly less likely to become insolvent than was the case four or five years ago;
  • Asset allocations to equity and property are relatively stable. There is a modest switch from cash and “other investments” to “bonds”.
    • I have a hunch some of this may be a re-classification of assets rather than a sign of strategic shift towards bonds.
    • The relative steadiness of allocations indicates little evidence of asset allocation changes during a year which contained some shocks.
    • It will be interesting to see if there is a greater shift towards bonds in 2017/18 as funding levels have improved and as there may have been some profit-taking from equity stocks. I suspect those hoping to have seen “peak bond” will be disappointed.
  • The number of schemes in assessment for PPF entry has continued its steady decline, both in terms of the total number of schemes and as a percentage of the DB universe. 78 schemes were in assessment during 2017/18 (around 1.4% of the total number of schemes); and
  • There is a large concentration of liabilities for schemes in assessment (around 80%) amongst schemes whose liabilities exceed £100m.
Alan Collins

I read an interesting comment piece by Peter Smith in the ever-reliable FTfm section of yesterday’s Financial Times.  It concerned a possible upcoming change in the investment strategy of the Bank of England’s own defined benefit pension scheme.

So, what have they been doing and what might be next?

Around 2007, the fund switched investment strategy from one with a mix of gilts and equities to a “portfolio exclusively focussed on index linked-gilts”.  Having checked the most recent fund report and accounts (as at 28 February 2017), the actual split is around 60% index-linked gilts, 30% index-linked corporate debt (issued by the likes of Network Rail) and 10% fixed-interest gilts.   The point being is that the scheme has been wholly invested in debt-based securities for over ten years.  This has served the scheme very well over many years, with the funding level now reported to be 101%, an improvement from 96% in 2011.  I would take issue with the contention from Marc Ostwald of ADM investors who rather uncharitably suggested that the scheme has “been an OK performer more through luck than judgement”.  Many schemes will look back and wish they had achieved the same “luck” over the last ten years.

The really interesting bit is what might come next.

According to recent meeting minutes, the Scheme’s Chair of Trustees (John Footman) has stated that the Scheme was considering “alternative approaches” and “taking more investment risk”.  This is being taken as a sign that gilts are “relatively less attractive” and that “defined benefit pensions are not necessarily best served by gilts”.

Gilts may not be hugely attractive, but they remain an important tool (perhaps the most important tool) in a trustee’s armoury for tackling the biggest pension scheme risks of interest rates and inflation.  While many of our clients are rightly seeking higher yield where they can get it (through multi-asset credit, illiquid assets and other growth assets), gilts (and instruments such as Liability Driven Investments) will remain core to a scheme’s investment strategy.

In my view, this potential change in tack may actually be more about dampening the expected cost of future benefits than managing the risk of benefits built up to date.  With ongoing accrual costs at an eye-watering 50%+ of pensionable salary, perhaps it has been decided that more investment growth is needed to mitigate this (broadly speaking, the more investment growth that is assumed, the lower level of contributions are expected to be needed to pay for future benefits).

There is no suggestion that wholesale change is on the horizon.  I would expect the vast majority of the £4 billion plus fund to remain invested along current lines.

So, what can we learn from the Scheme’s approach:

  • It is important to regularly review your Scheme’s investment strategy – a strategy that is right today won’t be right forever;
  • Diversification (and here I agree with Mr Ostwald) should be an important consideration for scheme trustees –even the smallest of funds should be considering how different asset classes can add to overall performance and reduce risk;
  • The nature of defined benefit pensions means that the ongoing build up of benefits is hugely expensive if the investment strategy is wholly gilt based.  To sustain benefit accrual (where the risk can be sustained), growth-seeking assets are likely to be a necessary part of the portfolio; and
  • The search for yield in the current environment may point towards alternatives to government bonds.

For more information or to discuss the content of the blog please get in touch.

Alan Collins
t:/ 0141 331 9970
e:/ Alan_Collins@spenceandpartners.co.uk

Quick Summary

Alan Collins

Spence & Partners latest blog for Pensions Expert:

Back in the day, actuarial valuation results contained an element of surprise. The actuary would be sent the data, it would be processed, the numbers would be crunched and many months later, the results would appear.

There was often limited fore-knowledge among the recipients, be that trustees or the sponsoring employers, about what the results would show.

An actuarial valuation was a lengthy, time-consuming process, which is one of the main reasons why a valuation was only deemed necessary once every three years, and why the timescale for completion was set at 12 months and later extended to 15 months. Read more »

Alan Collins

If they had a competition to name this Green Paper, they’d call it Dampy MacSquibface.

The much-anticipated pensions Green Paper in response to the demise of BHS dropped into the industry’s inbox yesterday.

It contains many more questions than answers, saying no to lots of things and yes to nothing.  If this was a squib, it would be very much of the dampest kind. Dampy MacSquibface if you like.

The bluster of the Work and Pensions Committee is nowhere to be seen.  The Paper is littered with phrases like “we do not feel there is sufficient evidence”, “all of these options have significant drawbacks”, “we would need to be certain” and “it would not be appropriate”.  The world of pensions is slow enough to change – do we really need yet another agnostic consultation? Read more »

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