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

Estimating life expectancy is an important part of an actuary’s job. Last month’s Office of National Statistics (ONS) report on the issue of life expectancy certainly brought a real focus to this important aspect of our role and, as a man who lives in one of the lowest ranked areas for longevity in the UK, it also cast a bit of an unwelcome shadow over my day.

Confronted by headlines such as ‘Scotland the Grave’ and ‘Increase in North-South Life Expectancy Divide’, the Scottish media highlighted how the recently published ONS survey showed how the average UK man will live until he is 77.9, compared with only 75.4 years in Scotland. The comparable figures for women are 82.0 and 80.1 respectively.

Somewhat worryingly for me, the average male in Glasgow will die aged 71.1 years. Unsurprisingly, given the health issues that continue to plague many parts of this city, this is the lowest for any area in UK. This is in sharp contrast to Kensington and Chelsea where the average man can expect to live for 84.4 years, exposing a staggering gap of over 13 years in life expectancy between two regions of the same country.

There are important lessons in the ONS study for actuaries, as well as for sponsoring employers and trustees of defined benefit schemes. For defined benefit arrangements, it is the scheme (and ultimately the sponsoring employer) who is exposed to the risk of how long each member lives. The longer each member lives, the longer a pension will need to be provided for and hence the cost of providing the pension increases.

The study reinforces the need to consider and manage the risks associated with life expectancy on a scheme-by-scheme basis. For each additional year of life expectancy, the reserves required – and the ultimate cost of the scheme – increase by around three per cent. So taking the extremes above, the reserving requirements could vary by up to 40 per cent!

However, we need to be careful on drawing conclusions from this study on two fronts. Firstly, members of pension schemes tend to live a lot longer than those with no pension provision – which gives me some personal comfort in relation to the above statistics. This is borne out of many studies on life expectancy by insurance companies and by analysing data from self-administered pension schemes. Currently, most pension schemes assume that current pensioners will live into their mid-late eighties and that future pensioners will live into their nineties.

Secondly, in my view – and this is where views in the actuarial profession differ – it is not geography but socio-demographic factors that matter where life expectancy is concerned. If geography alone was a significant factor, why would the gap in life expectancy between neighbouring areas such as Glasgow and East Dunbartonshire be over seven years, whereas the gap between Glasgow and Manchester is less than three years and only around four years between Glasgow and areas in London? This point was summed up by Duncan McNeil, Labour MSP for Greenock and Inverclyde, who said: “someone in my community can expect to live around 10 years less than someone else who lives just minutes along the road in a better-off area.”

This is why analysis at a postcode level is so important, where life expectancy is considered on a street by street basis. This is the most effective and accurate current method for assessing life expectancy for most pension schemes. I would urge trustees of schemes and sponsoring employers to ensure this area is given appropriate attention and that a postcode analysis is carried out at least every three years to coincide with the formal valuation of a scheme’s funding level. The only reason for departing from this is if your scheme is large enough to conduct its own mortality study. However, this would only apply to schemes with thousands or even tens of thousands of pensioner members.

Before I get completely morose about the ONS report and the implied implications on a Glaswegian male like myself, I can take some comfort that there are other factors at play in determining what ultimately accounts for the number of innings we are likely to be on this earth. It is important that these are also accounted for on a wider scale for those of us who manage pension schemes to ensure we have the appropriate funding levels in place.

Alan Collins

Following the recommendations of the Pensions Commission in 2006, the previous Government proposed the introduction of the National Employment Savings Trust (NEST), to address the lack of pension provision for employees who do not have access to workplace pension schemes.

From the perspective of employers, a major issue surrounding NEST is the likely cost of implementing the scheme, especially the associated administrative costs. An independent review has been carried out into the proposals for NEST – Making Auto Enrolment Work, which seeks to address the question as to whether the cost to employers imposed by NEST is necessary and proportionate.

Prior to the review, the proposed structure for NEST had the following key features:

  • Every business with at least one eligible employee must comply with the regulations.
  • An eligible employee is one who earns enough to pay National Insurance contributions.
  • All eligible employees must be enrolled immediately in the workplace pension scheme.
  • Employees are to be enrolled automatically, without need for application forms
  • Contributions are calculated from qualifying earnings (earnings in excess of the National Insurance Primary Threshold, currently £5,035 per annum, which include variable items such as overtime payments and bonuses).
  • Will be introduced in stages, commencing with employees of large companies, commencing in October 2012.
  • Minimum employer contributions commence at 1% of qualifying earnings from 2012 rising to 3% by 2017.
  • Minimum employee contributions commence at 1% of qualifying earnings from 2012 rising to 5% by 2017.

After consultation with business and the pensions industry, the authors of the report made the following key recommendations (which the new Government has welcomed).

  • Every business with at least one eligible employee must still comply with the regulations.
  • Contribution levels and phasing of contributions remain unchanged.
  • The earnings threshold at which an employee is automatically enrolled is increased to be equal to the personal allowance for income tax (currently £7,475 per annum). The threshold at which contributions are payable remains the National Insurance primary threshold.
  • An optional waiting period of three months should be introduced before an eligible employee is automatically enrolled. However, employees may choose to opt in at any time, and the company would then need to pay contributions.
  • The system by which employers can certify that their defined contribution schemes meet the required contribution levels should be simplified.
  • Further de-regulation measures should be introduced to ease the administrative burden on employers.
  • The current cap on contributions (£3,600 per annum) and ban on transfers in and out of NEST is to be reviewed in 2017.

The impact of the recommendations is to reduce the number of eligible employees by around 1 million, which will reduce the costs associated with NEST, especially for companies with a high proportion of low-paid workers. Further simplification and cost reduction is achieved by simplifying the certification process for businesses with current defined contribution schemes and by reducing the number of short-term employees who would be automatically enrolled. Clearly, the proposals surrounding NEST will continue to cause displeasure amongst small employers. There also continues to be a risk that contributions are levelled down in existing schemes to match the minimum requirements of NEST.

Employees may also choose to opt-out of their employer’s scheme. However, employers are not permitted to induce employees to opt out of pension schemes, and a company which did so would be fined from £1,000 to £5,000 (depending on the number of employees).

Please contact us for further information or visit the NEST website.

Alan Collins

Warning – your actuary could be overstating your FRS 17 liabilities by up to 10% or possibly even more!!

The maturity or ‘term’ of your pension scheme is becoming increasingly important in setting assumptions for actuarial valuations and hence determining the value of the liabilities. In particular, FRS 17 states that scheme liabilities should be discounted at “the current rate of return on a high quality corporate bond (generally accepted to be AA rated bonds) of equivalent currency (£) and term to the scheme liabilities”.

So what about the term? This is the interesting, though unfortunately slightly technical bit!! Until a few years ago bond discount rates were generally unadjusted for term in FRS 17 calculations. The liabilities were therefore wrongly assumed to be of the same term as the maturity of the bond index (usually 12-13 years). Pension schemes are normally of a much longer term nature, from around 20 to 30 years on average. Between 2006 and 2008 where long term interest rates were unusually lower than short term rates, there was a significant push by audit firms for schemes to discount the liabilities using these lower rates – this significantly pushed up the magnitude of FRS 17 liabilities.

Recent movements in the shape of the interest rate yield curve mean that medium to long-term interest rates are now significantly higher than the rates implied by the AA index. For those firms already using a “yield curve” approach to assumption setting, the discount rate appropriate for FRS 17 will now be higher than the index yield and so FRS 17 liabilities will reduce, all else being equal (assuming the auditor agrees of course!!). It may no longer be appropriate to continue using the unadjusted bond index value as the discount rate, as this would currently overstate the pension scheme liabilities. All very easy for me to say you might think but what does this mean?

I estimate that for an average scheme, adopting a yield curve approach now could increase the FRS 17 discount rate by up to 0.5% per annum (or even more at very long terms), which would reduce FRS 17 liabilities by around 10%. So, if you receive FRS 17 assumptions advice or disclosures which stick rigidly to the AA bond index for setting the FRS 17 discount rate, you may wish to ask your advisor to reconsider, or seek separate actuarial advice.

For further information on FRS 17 assumption setting or other matters surrounding your scheme, please contact myself or any other member of the actuarial team at Spence & Partners.

Alan Collins

I read a recent article on the investment returns achieved by the ICI pension fund . The ICI fund was one of the first funds to implement a Liability Driven Investment (LDI) strategy back in the year 2000.

The article was lauding the fact that the fund had returned an average of 5.5% per annum over the last 10 years compared to 3.7% per annum for the average UK defined benefit pension scheme, according to the WM All Funds universe. All good news you might say, but on closer inspection what is it actually telling us, other than that the 3.7% per annum achieved by the average pension scheme is lamentable?

As most readers of this article will recognise, the purpose of an LDI fund is to provide returns which match the timing and nature of the cashflows required by the scheme. In broad terms, the LDI fund should rise in value if interest rates fall, or inflation rises. This will “match” the rise in liabilities (if a number of other assumptions hold). The converse is expected if interest rates rise, or inflation reduces.

In my view the article is really telling us that the fund returns were positive because interest rates fell, (which is good, because that’s what it is supposed to do). It tells us nothing about the real success of the strategy, i.e. how did the fund return relative to the changes in liabilities which it was trying to match, or indeed would a simpler, less costly holding in long terms gilts be just as successful when set against the undoubted cost of this strategy?

Depending on the movements in interest rates and inflation, a very successful LDI strategy could be one which gives rise to negative returns, as long as it matches what it is supposed to match.

So while the article on ICI makes for interesting reading, would it have been more valuable if the apples it described had been compared to other apples rather than a wider selection of fruit?

Alan Collins

At Spence and Partners and Dalriada Trustees Limited, we have long been espousing the value of good recording keeping in relation to pension scheme administration, particularly in our call for action in relation to pension scheme data.

We therefore strongly welcome today’s consultation from the Pensions Regulator (TPR) entitled “Record-keeping: measuring member data“.  We endorse the view that “Trustees and those responsible for administering workplace pensions will need to improve standards of record keeping”.

I was certainly less surprised than TPR by the fact that only 19% of schemes surveyed had checked that they had all the fundamental common data and that over half of the surveyed schemes were missing more than one item of fundamental data.  My experience would indicate lower “success” rates than this.

We further support the proposal for TPR to set, monitor and enforce target levels of accuracy for the common data that schemes must hold and will be interested to see how this area develops.

We note further that TPR intends to work closely with the Financial Service Authority to monitor record keeping in contract based schemes.

Finally, we look forward to further developments in this area and would encourage all trustees to look out for and undertake the soon to be published e-learning module on this subject.

Alan Collins

If, like myself, the prospect of trawling through the 2009 Purple Book published by the Pensions Regulator and the Pension Protection Fund (the PPF) is a research step too far, you will most likely have turned to the Executive Summary.

Being short of time, I was then less than pleased to see the Executive Summary running to around 10 pages.

So having now briefly digested the aforementioned the following provides my executive summary of the Executive Summary –

– the end date for the reporting period was 31 March 2009 (the nadir of recent pension scheme funding dates with the combination of low gilt yields and pre-bounce equity markets).

– 37 percent of scheme members were members of open schemes at 31 March 2009, down from 44 percent at 31 March 2008;

– Aggregate Technical Provisions funding levels fell to 70.3 percent at 31 March 2009, representing a total shortfall of £329 billion;

– the level of corporate liquidations in Q3 2009 was over 50 percent higher than at the low-point in 2007, though not as severe as in the recession of the early 90s;

– average allocation in equity fell from 53.6 percent oto 46.4 percent (this may of course be due to the fall in equity values rather than any “tactical” shift);

– there was a marked rise in the long-term risk to the PPF between March 2008 and June 2009, as measured by the PPF’s Long-Term Risk Model;

– PPF expects to collect £651 million for the 2008/9 year. The average levy paid is unchanged at 0.08 percent of scheme assets.

– 564 schemes had their levy 2008/9 capped (it will no doubt be interesting to see how this figure changes in due given the reduction in the cap to 0.5% of scheme assets for 2010/11);

– the total number of contingent assets in place has risen by 30 percent from 452 in 2008/9 to 587 for 2009/10;

– Liability Driven Investment (LDI) strategies continued to take root. The National Association of Pension Funds (NAPF) survey data indicated that 26 percent of schemes had implemented an LDI strategy by 2009 up from 23 percent in 2008; and

– to end on a subject dear to our hearts here at Spence and Partners Limited as specialists in managing schemes during PPF assessment periods (and our sister company Dalriada Trustees Limited), there were 240 schemes (covering 201,000 members) in the PPF assessment period as at 31 March 2009. Also in the year to 31 March 2009, the PPF paid out a total of £37.6 million in compensation payments to eligible members.

Finally for a brief update of subsequent events (from a corporate perspective, though same could be said for scheme funding) –

While we spent late 2008 telling companies your FRS/IAS is not going to be as bad as you think (thanks in most part to sky-high corporate bond yields), we are now in the process of telling the same individuals the exact opposite. “Surely the funding level must be better this year?” – “Err, No” (thanks to higher expectations for long-term inflation and a correction in bond yields have more than offset the equity bounce in most cases). Further details of this were set in in an earlier article on the current state of play for accounting under FRS17 and IAS19.

Page 8 of 8« First...45678