Making Sense of Pensions

Brendan McLean

Markets performed very well in January with the MSCI World up over 7% in USD. This was driven by the US Federal Reserve signalling that it may not raise rates as fast as previously indicated. Also, US/China trade relations are improving, which resulted in the MSCI China Index being up over 11% in January in USD. However, even with the strong returns most asset classes have not recovered from last quarter’s negative performance.

Despite the improving US /China trade tensions assisting in boosting equity markets in January, the US economy is beginning to see effects of this trade war as leading indicators such as the ISM manufacturing survey reported its largest monthly decline since 2008. The tensions have had a greater effect on China, which has resulted in the monetary authorities having to provide stimulus to the economy. Europe has also been affected by the trade dispute, mainly caused by slowing Chinese demand for manufacturing equipment.

In the UK, Brexit continues to dominate the news in the run up to the exit from the EU on 29 March 2019. Throughout January, a number of votes held in Parliament indicated that the majority of MPs are against a no-deal scenario and would support May’s deal if she can re-negotiate the Irish border backstop, however, the EU have so far said this is not an option. If she can receive concessions from the EU regarding the backstop then it is possible that a version of her deal could pass in parliament. Sterling increased on the possibility of a deal being reached. There could be increased volatility in markets if there is no deal agreed by the March deadline, as markets seem to be pricing in some kind of deal at the moment.

In January, Italy officially went into recession, which is defined as two successive quarters of economic contraction. This result did not surprise markets, as over the last six months the new Italian government has been in a dispute with the European Commission over the size of its government’s spending budget.

Despite the bounce in markets in January, we expect them be volatile going forward and Trustees should continue to monitor their investments and speak with their advisors to ensure their investment strategy remains suitable.

Andrew Kerrin

Over the past weeks, living in the UK, you’d have been forgiven for thinking that there was nothing else going on in the world apart from Bre… well, you know what I was going to say – I’ll spare you from hearing the word for once.

Before ‘that-which-shall-not-be-named’ took over our lives, there were other news stories, other events, other happenings in the world that equally shocked us and exercised our opinions.  One of those other sources managed to do his best in the past weeks to grab back the news agenda – the 45th President of the United States.

January has been a tough month across the pond – particularly for the 800,000 federal employees who went without pay checks.  However the story that caught my eye was the initial refusal by the Speaker of the House, Nancy Pelosi, to formally invite the President to give the annual State of the Union address to Congress.  Like the size of a recent loss by the UK Government in a House of Commons vote on ‘that-which-shall-not-be-named’, this action by the Speaker was unprecedented.

“What has this got to do with this Quarterly Update?”, I hear you ask. Well, what this reminded me of was the wording of the clause in the US Constitution that the State of the Union Address stems from, namely that the President:

“shall from time to time give to the Congress Information of the State of the Union, and recommend to their Consideration such measures as he shall judge necessary and expedient.”

In that spirit (assuming that unlike Nancy Pelosi you have invited Spence to address you!) let us give to you this quarter’s Information on the State of the Pensions Union, along with our recommendations, for your consideration, of all the necessary and expedient measures you may wish to take.

We hope you find this useful and look forward to addressing you again in three month’s time… if ‘that-which-shall-not-be-named’ allows us!

Topics included in this quarter’s address include:

• The PPF’s 2019/20 Levy Rules determination
• Investment Market Update
• HMRC and The Pensions Regulator Warning over Member Tax Relief
• Master Trust triggering events
• The Supreme Court judgment in the Barnardo’s case
• GMP Equalisation
• PPF Purple Book
• And of course… an update on ‘that-which-shall-not-be-named’

Download the Quarterly Pensions Update Q4 2018

Dennis Mincher

Data quality

The Pensions Regulator (‘TPR’) has been highlighting the issue of data quality for years and continues to do so. Maintaining data quality requires scrutinising (testing for accuracy, completeness, reliability and consistency) the data set periodically and rectifying where needed. Various rectification tasks may include updating, standardising or de-duplication. Since TPR started pushing their data quality agenda there has been a reasonably positive response from pension scheme trustees, however, over the same period of time, the legislative environment across the UK pensions sector has experienced a rapid succession of changes. Whilst many pension scheme trustees have reviewed their schemes’ data quality and perhaps even taken steps to rectify the issues that exist, legislative developments are potentially creating a host of additional problems for pension scheme data and pension scheme administration operations. The only way to effectively manage this is through the use of dedicated systems.

A good example is the processes involved with pension flexibilities available to members with Defined Contribution (‘DC’) benefits introduced back in 2015. Various actions such as partial Defined Benefit (‘DB’) to DC transfers and flexible drawdowns may not be properly recorded on systems. The issue here is that the fields and calculations required for any potential new inputs may not currently exist and the necessary system development could be difficult or out-of-scope, the implications of this could be disastrous. If all this data is not properly recorded at the time of processing, it could be lost completely or issued with unchecked errors that could create problems for trustees and members alike. Inaccurate records will impact on the information provided to the member and consequently their understanding and application of the guidance and information available. In turn this may lead to the member choosing a retirement option that is not right for their circumstances and which could affect them and their dependents for the rest of their life.

The alternative to updating existing systems is to develop new systems; however the development cycle for a new pension scheme administration system is typically measured in years, with complex projects and high associated costs. Many insurers have been slow to offer new products and services to their customer following the advent of the pension’s freedom flexibilities. One of the reasons cited by insurers to justify the lack of greater flexibilities is that they have not received adequate support in order to develop systems that can deliver the proper information and protection that consumers should expect in making choices about their retirement options.

Beyond the software development world, users of third party systems are often faced with large scale implementation and data migration projects should they wish to upgrade or change their systems. As a result of this, there is a desire among system providers and system users alike to ensure that their pension scheme administration systems remain relevant and fit for purpose for as long as possible. The choice between switching to a newly developed system, or sticking with an existing system and pushing for functionality updates is fraught with risks on both sides. Making the wrong choice in the short term could have costly repercussions for both the long term operations of the scheme and the delivery of a quality service to scheme members, especially if more legislative changes occur in the future.

As always, the key is vigilance to ensure that the correct systems and processes are in place to guarantee good record-keeping now and in the future.

Brendan McLean

Market Volatility

Recent market volatility has created a lot of news headlines, as well as causing multiple asset classes to record some of the worst annual performance since 2008. The last quarter of 2018 was particularly painful with global equities returning -10.6%, UK equities -10.2%, oil -40% and 10 year treasury yields -19%. This was mainly driven by fears of slowing global growth and investor de-risking and moving into safer assets.  It is worthwhile noting that strictly speaking the definition of market volatility is markets moving a lot both down and up however, in periods in higher volatility markets tend to decline as investors panic and sell.

The cause of the volatility has not yet dissipated, and 2019 could be an even more volatile year due to a range of factors including tightening global liquidity because of the withdrawal of quantitative easing, rising interest rates, rising geopolitical concerns including Brexit, Italian politics, US political gridlock, and the ongoing trade conflict between the US and China.

But what does all this mean for pension schemes and their investments? 

I think pension schemes should not be panicking.  They are long term investors so should not be too duly influenced by short-term volatility.  That said such volatility does provide challenges (as well as opportunities) and it does alter market dynamics.  I mention below a few areas that I think pension schemes should be thinking about as follows:

  • Asset switching – with such volatility schemes need to be careful when switching.  The impact of market volatility can be reduced by trading over a number of days or trading on days when news announcements are not expected.
  • Active management – In recent years there has been a lot of capital flowing into passive funds, due to the low cost and better performance net of fees, versus active managers. However, active management may be able to reduce volatility and provide better returns by using their skill to protect against such volatility. Also they can hold more cash in falling markets than passive managers so protecting values. This could mean active managers could outperform the aforementioned passive index funds.
  • Diversified Growth Funds – If you look over the last 5 to 10 years these funds have often provided returns significantly less than equities during the bull equity market run, despite being sold as equity replacements.  Perhaps they can now in a more volatile environment prove their worth and provide equity like returns with lower volatility.
  • I believe that pension schemes should have trigger structures in place to benefit from any potential upside if it does occur. Given the current volatility with market movements occurring rapidly, having a robust process for implementation will benefit pension schemes and help them take advantage of these opportunities.

I am sure that there a lot more areas that pension schemes need to be thinking about and it is worthwhile that Trustees speak to their consultant about what is going on at the moment to seek their views as well as their managers’ views.

Adrian Campbell

Combating Pension Scams

I thought this was worthy of a mention in respect of how Spence and Partners as administrator to a pension scheme prevented a member from transferring her pension to a perceived pension scam.

The facts:

•    A member contacted our administration team to ask for a transfer quote.

 •    Appropriate due diligence was carried out and as a result we had concerns that the member was looking to transfer their pension to a suspect overseas entity.

 •    Upon contacting the member they advised  they had received a  cold call and that the Plan they were being  recommended  offered “significant growth potential”

 •    The member was advised that this could possibly be a Pensions Scam and that they should speak with the Pensions Advisory Service to obtain independent guidance/advice. 

 •    A letter enclosing the Financial Conduct Authority(FCA)/The Pensions Regulator (tPR) , Pensions consumer leaflet  on how to spot and avoid Pension Scams was also sent to the member: http://thepensionsregulator.gov.uk/brand- assets/16423_Pensions_consumer_leaflet_SCREEN.pdf

 •    Several weeks later the member contacted us to say that the company operating the plan had been suspended and therefore they would not be proceeding and expressed their gratitude for  our  due diligence.

Naturally, we were pleased to have saved the member from transferring her pension. This example demonstrates our commitment to ensuring that we apply the principles of the Pensions Industry Code of Good Practice Version 2 which was published in June 2018.

The steps that trustees, administrators and providers should take to protect scheme members from pension scams can be distilled into three core principles:

  1. Trustees, providers and administrators should raise awareness of pension scams for members and beneficiaries of their scheme.
  2. Trustees, providers and administrators should have robust, but proportionate, processes for assessing whether a receiving scheme may be operating as part of a pension scam, and for responding to that risk.
  3. Trustees, providers and administrators should generally be aware of the known current strategies of the perpetrators of pension scams in order to inform the due diligence they need to undertake and should refer to the warning flags as indicated in The Pensions Regulator’s Guidance, FCA alerts and by Action Fraud.

We also welcome the recent Scamscart Campaign advertising and information campaign, that was run by the FCA and tPR which was to help members of pension schemes to become more aware of scamming techniques and encourages them to report any they are aware of:
https://www.fca.org.uk/scamsmart

Hugh Nolan

Good News in Pensions

Christmas is allegedly the season to be jolly so it seems to be an appropriate time of year to remember the good things about the UK pension scene. There are a lot of them!

Firstly, there are currently well over 10 million members of Defined Benefit (DB) schemes in the UK private sector. This includes 1.3 million people who are still accruing benefits, not to mention all those in the public sector. The private sector is currently paying over 4 million pensions regularly and in full. Despite the impact of the credit crunch, low interest rates and increased longevity, these DB schemes are now estimated to be funded at 73% of the full cost of buying guaranteed benefits from an insurance company, up from 60% in 2006.

There are still inevitably some corporate failures where members have to rely on the Pension Protection Fund (PPF) for their benefits. There are less than 250,000 who have had to do so since the PPF started in 2005 though and their payments from the PPF are well-protected, with £6.7 billion reserves and an estimated probability of 91% of meeting their funding target. The PPF is funded by a levy on the other schemes and the total levy fell last year to £541 million, some way below the £725 million that the PPF was able to pay out. That’s a wonderful improvement from the bad old days when members could lose their pensions entirely if their employer went bust.

On the Defined Contribution (DC) side, auto-enrolment has been a huge success too. The statistics at the end of November 2018 showed that 9,958,000 people have been auto-enrolled into pension schemes, which is a massive number of new savers who won’t be solely reliant on the State pension when they retire. That’s particularly important when the State pension itself is under huge pressure due to an ageing population and austerity and it again shows the advantages of personal pension saving.

Finally, the pension industry keeps trying to improve the regulatory landscape to get the best results. Successive Governments have decimated DB schemes with excessive regulation and, more significantly, by imposing additional financial obligations on schemes retrospectively. We have been lobbying for years for more flexibility and it’s great to see that the Royal Mail and Communications Workers Union have got support from the DWP and politicians to try a new Collective DC arrangement. This isn’t a magical solution to the pensions issue but it has a lot of merit and it’s great to see the industry trying to make the best of a very muddled legislative background.

We’re very proud at Spence to be part of the industry that has delivered these opportunities for millions of people to have a better quality of retirement. The real stars of the industry though are still the sponsoring employers who have paid most of the money needed over the years for their staff to get decent pensions. We also need to recognise the diligent efforts and hard work from trustees, who give up their time and wrestle with the complexities of pension regulations to get the best outcomes for their schemes and members.

Well done everyone and a Merry Christmas to you all.

James Geen

Brexit. The fog of uncertainty. Political claims and counterclaims. Arguments between those with rose tinted glasses (both on the remain and leave sides of the argument) on what the Brexit outcome might be. Cutting through this there is a fundamental question. What, at the end of the day, does a pensioner living abroad have pretty high on his or her wish list? I might put a small wager that continuing to get their pension paid is not a bad guess at the answer.

So, what are the issues around pension payments?

Government alerts have flagged possible difficulties in making payments to EU based pensioners on Brexit, following the loss of access to the EU ‘passporting regime’.

As far as trustees are concerned, loss of access to the regime means that they face uncertainties over how payments will be made, potential delays in payments and increased costs of such payments. These issues need to be thought about by Trustees when considering the risks to the scheme and have been highlighted in the Government’s economic analysis.

If the payroll costs of paying EU based pensioners increases, then trustees will also need to consider who will meet the cost of these additional charges, the Scheme or the Member.

A further concern is an increase to the processing time and the potential issue of difficulties of EU based pensioners relying on a UK based bank account for accessing their funds.

So, with this in mind, what do trustees or administrators say to pensioners when they ask that very relevant question, will my pension payments be affected? To date, our experience is that Brexit has not created a rush of phone calls from pensioners living in the EU worried about their pension payments but, as we head towards 29 March 2019 and there is clarity over what might, or might not happen, being prepared for the question is important.

Perhaps saying nothing, or we don’t know, is the answer. However, given warnings from the Government on potential difficulties in making payments to EU member states, whether or not trustees decide it is appropriate to communicate with pensioners at this stage, they should at least consider the issue and have something in the back pocket. At least they will be prepared to explain why it is difficult to give a definitive answer. It may not be an answer that gives a lot of comfort, but it is an honest assessment of the situation.

A consideration, for trustees is whether there is sufficient information to add value to their pensioners by a wider communication now, or whether a communication should be delayed until they have more certainty on the issues. Whatever trustees decide, they should prepare a list of potentially affected members, so they are in a position to communicate quickly, if they decide to communicate with these members.

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.

Angela Burns

At the time of writing, on 29 March 2019 the UK will exit the European Union with or without a deal.

It is not possible to guess what will happen in the coming months and how markets will react. For Trustees with defined benefit pension schemes it’s an uncertain time.

The risks that Brexit poses are not new – they are the same risks that pension schemes face every day. Brexit just provides an increased chance of unlikely events.

So how should Trustees prepare?

In December 2015 the Pensions Regulator introduced guidance for Integrated Risk Management confirming that Trustees should consider risk at a holistic level. The three main areas of risk are ‘Funding’, ‘Covenant’ and ‘Investment’. Trustees should consider the main risks faced by the scheme across all three areas and more importantly how they interact. Trustees should also have in place contingency plans setting out actions that will be undertaken to limit the impact of risks should they materialise.

Brexit is effectively a ‘test’ of how well Trustees have implemented the Pensions Regulator’s proposals. A Trustee board with a robust IRM framework will be well placed to deal proactively with risks as they emerge.

It is important during times of volatility that Trustees have access to timely and accurate information to make quick, informed decisions. Trustees should ensure that their advisors are well placed to provide regular information in the lead up to, and after the 29 March 2019. Any delays in information provision will add to risk exposure.

Trustees should also have access to scenario analysis tools to determine the impact of certain events – for example a 1% p.a. fall in gilt yields. This will allow the Trustees to specify more robust and accurate actions when considering contingency plans.

Trustees with valuation dates on or around 29 March 2019 should consider the potential impact of this and may decide that the valuation date should be moved. In my view, there is sufficient flexibility in the funding regime to take a long term view on funding, and taking a snap shot of the funding position at a single point in time should not drive funding decisions.

In times of volatility, Trustees should monitor transfer value requests and any other member events where actuarial factors are used. If, for example, extremely low gilt yields result in high transfer values, the Trustees may choose to delay the provision of transfer values to see if the low gilt yield environment persists.

Trustees should also consider any employer exercises offering member options and when these options may be exercised.

Trustees may wish to disinvest funds in advance to allow for any ‘known’ payments on or around March to avoid disinvesting in inopportune conditions.

From an actuarial perspective planning is key, and a good IRM framework should result in quicker decision making.

Mike Crowe

I am sure that with the many aspects of Brexit that are occupying the minds of businesses around the country the impact on the company pension scheme might not be high up on the list for the sponsoring employer. Whilst I have every sympathy for this view it would be remiss of me not to suggest that companies don’t lose sight of this and to engage with their trustees for whom this is a very real issue.

Let me start with a question. If you asked your trustees what was the top risk on their scheme risk register what would they say? If it is not “Brexit” then ask them again until they get the right answer. (Yes, I gave you a hint there.) The current economic uncertainty caused by Brexit highlights the need for an effective integrated risk management framework for pension schemes. It is important that your trustees understand the risks that the scheme faces and that they are actively engaging with you. Effective contingency planning is key and that planning is needed now.

But, as the events of November 2018 have shown, no one knows what 29 March 2019 will bring or indeed who will be leading the discussions, so how can I plan? Will there be a deal? If there is a deal what will it look like – a hard Brexit, a soft Brexit or something in between? Maybe no Brexit at all? Will the date or the transition period be extended? All valid points, but, as I was always told, you hope for the best but prepare for the worst. So with that in mind what do you need to discuss with the trustees?

Employer Covenant

The impact that Brexit will have on the business of a sponsoring employer is critically important to the trustees. Conversations should be taking place so that trustees and their covenant advisers can understand the impact on the sponsoring employers business prospects given the uncertain economic climate and potential shifts in currency or other markets  which may impact on their support for schemes – either in terms of DB funding or contributions to DC pots. This is something that you will be very aware of for your business and open and honest dialogue with your trustees will allow them to effectively assess risk and plan.

Actuarial Assumptions

The impact of Brexit should be taken into account in setting assumptions for actuarial valuations and agreeing recovery plans. To enable the trustees to assess the impact on planned contributions to the scheme, they need to understand the impact of Brexit negotiation outcomes on the cashflows of the business.

The funding levels of DB schemes need to be reviewed as continuing low interest rates and quantitative easing means DB liabilities remain high. New market conditions will raise questions about whether the scheme’s valuation is still current. The funding level and the associated risk it poses to the employer needs to be considered and ways of mitigating this risk need to be discussed.

Buy out prices for DB schemes may be more attractive and trustees may be checking with the scheme’s advisers whether now is the time to remove some risk from the scheme.

For a sponsoring employer this is all relevant and relevant now. Being an active part of the process is crucial not just for the scheme but for your business too.

Investments

Trustees will need to consider whether the scheme’s investment strategy is still appropriate for current market conditions and take advice from their investment advisers. For a DC scheme, they will need to check to see if the default fund is suitably diversified so as to protect members from any shock to the UK or European economy. A check should be carried out to see whether there has been an impact on the value of collateral that the scheme posts or receives under derivative contracts. The scheme might need to post extra margin, or ask their counterparties to do so.

It will be some time before there is clarity on how Brexit affects schemes’ investments, contingent assets and investment yields in other countries – both EU and non EU. Trustees need to keep this under review.

Trustees will also need to check that their fund managers have a Brexit plan. They should.

Scheme members may well be worried about security of their pensions in the run up to 29 March 2019 and beyond.  It is imperative that you and the trustees prepare for whatever 29 March 2019 brings. As far as you can, protect the scheme and the members from the impact of Brexit. Communication will be key both with your trustees and your employees to manage the uncertainty that Brexit

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