Making Sense of Pensions

Brendan McLean

The annual Pensions and Lifetime Savings Association (PLSA) conference in Edinburgh brought together leaders of the pension industry from trustees to investment managers, and addresses the biggest challenges faced by the industry with the aid of key guest speakers and expert knowledge.

This year’s focus was on cost transparency, regulation, and diversity, and below are some of my personal highlights.

Gaining the public’s trust again

The pension industry gaining more public trust was a key theme of the conference, with reference to a focus on cost transparency. Costs are an obviously important issue for investors; however I feel there should be concentration on the best value manager, not the cheapest.

Remembering the financial crisis

Nick Clegg, former Deputy Prime Minster in the years of the financial crisis, was one of the key speakers and discussed the notion that people are already starting to forget the way that imbalances, exposures, and liabilities can brew in a financial system, as during the 2007/8 financial crisis, if left unchecked. I believe he was making reference to senior members of systemically important firms (such as banks) having left their businesses or retired from work, leaving people who did not experience the crisis in their previous positions in charge.

The impact of advances in technology

Advances in technology were also alluded to – firms now have access to blockchain technology to help reduce costs trading (although this isn’t yet widely used), however there is concern with this in that firms will need to share information which will probably cause a greater delay than getting the technology.

Ethical investing

Ethical/impact investing was mentioned often. Ethical investments are not just about ethical investing, but also about reducing the risk in a portfolio – for example, challenges facing tobacco firms due to increased regulation will reduce sales and therefore share price. Ethical investing is more aligned with long-term investing, allocating to things such as renewable energy.

Asset bubble

A panel discussion was held on asset bubbles because of equity markets being at all time highs. It was debated that given the high valuations of equities it would not be unimaginable for the US equity markets to halve in value based on P/E ratios, and counter-argued that other valuation techniques don’t consider them to be overvalued at all. I struggle to see the where the growth in equites will come from given the rise of interest rates in the US.

If you would like to discuss any of the topics or issues raised above you can get in touch with me by phone on 020 3794 0193 or email I’d love to hear from you.

 

David Davison

As the government announces changes to pensions regulations, David Davison explains what these mean for charities.

They say that good things come to those who wait but I suppose that depends on how long you have to wait. I’m certainly delighted after around 10 years of campaigning that it looks like finally the section 75 regulations relating to multi-employer defined benefit pension schemes (MEDBS), which have so negatively impacted on charities over many years, are to be revised.

The problem which many charities in these schemes faced was that the further build up of benefits could not be stopped without triggering an unaffordable cessation debt, therefore charities were trapped in schemes forced to continue to fund for ever rising liabilities as they couldn’t afford to exit. This was wholly inconsistent with the options available in other UK defined benefit pension schemes.

At the end of February, the Department for Work and Pensions (DWP) issued the The Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2018 with the expectation that these new regulations will be in place from 6 April 2018.

Key proposals

The regulations are a response to consultation carried out In April 2017 and the proposals comment on the findings of the consultation and how the government has chosen to respond.

The key proposal is the introduction of the Deferred Debt Arrangement (DDA). This will allow employers in MEDBS, whose only change is to cease to employ active members in a scheme, to retain an on-going commitment to the scheme rather than a cessation debt automatically being triggered.

It is envisaged that future contributions would be set on an on-going and not cessation basis similar to what would be the position in a standalone scheme or in the event that the scheme as a whole ceased accrual. This should offer charities really significant additional flexibility allowing them to control risk in an affordable way while focusing resource on paying down liabilities already built up rather than building further amounts.

In entering in to a DDA employers would continue to have all the same funding and administration obligations to the scheme as was the case prior to the agreement which will protect member benefits and indeed other employers.

‘The devil will be in the detail’

I don’t for a minute expect this to be the end of the story as we of course need to see how things play out in practice. As is ever the case, the devil will be in the detail, and we need to see how individual schemes react to the new flexibility and whether they seek to embrace it or look to put up barriers to implementing it.

There undoubtedly seems to be widespread consensus that change in this area is long overdue and along with these changes we’ll shortly witness similar changes to Local Government Pension Scheme (LGPS) regulation in Scotland and a review of Tier 3 employers in LGPS in England and Wales which will hopefully result in increased flexibility in these schemes as well.

Undoubtedly however this is a huge step forward and one can only hope the opportunity will be embraced by scheme trustees and employers alike.

If you want to discuss any issue raised in this article please feel free to get in touch. You can email me on david_davison@spenceandpartners.co.uk or give me a call on 0141 331 9942

This article was original publish on Civil Society website. You can read the original article here.

David Davison

The LGPS Scheme Advisory Board (SAB) is seeking the input of charities at a meeting in Birmingham on 28th February 2018. The SAB was established to encourage best practice, increase transparency and coordinate technical and standards issues.

It is currently undertaking a review of Tier 3 employers in the LGPS – details of the project can be viewed here. Tier 3 employers are all those with no tax-payer backing (i.e. colleges, universities, housing associations, charities and any admission bodies with no guarantee from a Council, academy or other tax-payer backed employer).

The aims of the exercise are to identify:

  • the duties, benefits, issues and challenges for LGPS funds, Tier 3 employers and their scheme members with regard to their participation in the LGPS.
  • options for change that would improve the funding, administration, participation and member experience with regard to Tier 3 employers.

As part of this exercise it’s vital that charities get their voices heard. A key element of this project therefore is to gather information and to facilitate this a listening meeting has been set up at 2pm on Wednesday 28th February 2018 at Colmore Gate, 2 Colmore Row, Birmingham, B3 2QD. The meeting will be an informal discussion and provide you with the opportunity to ensure your views are heard and taken into consideration as part of this review of the LGPS.

If you are interested in attending please contact Chris Darby as soon as possible at chris.darby.2@aonhewitt.com.

This is a unique opportunity to have your voice heard and facilitate the change that is needed within LGPS. Hopefully the content I have provided in previous Bulletins from ICAS will help everyone with content.

David Davison

It’s coming up to that time of year when participants in LGPS will be preparing for their year end accounting disclosures under FRS 102. The norm is that the Fund advisers provide an indicative set of assumptions, these receive a cursory glance, you await the results of your report at some time around May and then have this incorporated in your accounts.

Simple….but wait!

Did you realise that it is the Directors /Charity Trustees who have responsibility for these disclosure assumptions and not the Fund actuary?  You can therefore chose to use a different set of assumptions if those are more suitable for you and bearing in mind that one set of global assumptions issued by the Fund actuary can’t be specific to each employer, this is probably something worth considering, especially if your balance sheet position is important.

You may well be surprised by just how much of a difference small changes in the assumptions can make to your liabilities and therefore your deficit and balance sheet position.

I would therefore encourage employers already disclosing an LGPS pension liability to consider the assumptions used and whether or not they are appropriate.

The table below shows the potential impact of varying the assumptions used to calculate the FRS 102 liability.  Please note this will vary for each scheme and the figures below are provided as an example only.

Change in assumption Change in liability
+0.1% p.a. discount rate -2%
-0.1% p.a. inflation -2%
-0.5% p.a. salary increases -1%

Indicative results showing the impact on deficit and balance sheet position are shown below.

‘Standard’ assumptions
£000
Organisation specific assumptions
£000
Assets 2,000 2,000
Liabilities 3,000 2,850
Deficit 1,000 850

So a small change of 2% in liabilities as in this case could reduce the deficit by 15% and improve the balance sheet position by £159,000.

As you can see therefore, for organisations participating in LGPS, it is well worth considering the use of bespoke assumptions, particularly if you are looking to manage your balance sheet. If you would like an indication of how changes could have impacted your 2017 disclosures we would be happy to provide these.

If you are considering a change, you need to consider this now as Funds usually require some advance notice that a different process will be used. We provide this service for many of our clients so don’t hesitate to contact us if you need more information.

Neil Buchanan

This guide is intended to be a useful reference for companies preparing their 31 December 2017 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.

Download your report

To discuss these topics further, please contact Spence through your usual contact or connect with our Corporate Advisory practice associate, Angela Burns, or by telephone on 0141 331 9984.

Andrew Kerrin

Another year, another mixed bag for the pensions industry.  Looking back, with its final quarter now closed, 2017 was a year that threatened change (the Work and Pension Committee’s review and subsequent Green Paper on DB schemes, and the much-anticipated ban on cold-calling) but that ultimately saw pensions taking a back-seat to the political beast that has become the Brexit negotiations.

That’s not to say that pensions weren’t firmly in the headlines, with the collapse of schemes adorning household names, and some significant decisions coming from the courts (not least the Walker v Innospec decision on same-sex spousal benefits).  However, the final quarter of 2017 brought some significant announcements and stories that promise to keep trustees and sponsoring employers busy during the next 12 months.

So, we have collated all of the most important topics from the 3 months to 31 December 2017 into a bite size report, to let you sign off on 2017 and get ready for 2018. Enjoy your Quarterly Update!

The seasonal topics of this quarter include:

  • Anti-Money Laundering Regulations
  • Latest news from the PPF
  • VAT on DB scheme management costs
  • MIFID II and the regulation of investment firms
  • Bank of England interest rates
  • Transfer value redress
  • 21st Century Trusteeship

To download this report click here.

As always we love to get feedback from you. If you like what we do please tell us – it’s nice to get great feedback. If you would like things included, excluded or done differently please drop us a line too. The report is to help you, so help us tailor it to your needs.

And … if you find that you do have time to keep up with things, why not follow us on Twitter @SpencePartners and keep up to date as you go along.

David Davison

In past bulletins I have highlighted the lunacy of organisations in LGPS Funds being forced to continue to build pension liabilities beyond the point where they are affordable. Organisations are stuck, continuing to build more and more benefits for their staff, focussing contributions on new benefits rather than looking to pay down the legacy liabilities they’ve already built up.

Organisations have the Hobson’s choice of an unaffordable exit debt or continuing accrual driven by LGPS Regulations which are patently not fit for purpose.

At last there seems to be a glimmer of hope that the problem has finally been recognised and an acceptance that these Regulations need to be changed to better protect scheme employers as a whole, and indeed the Funds themselves.

In a previous Bulletin, I highlighted the work ICAS in Scotland had undertaken to encourage Scottish Government to review the Regulations and, as a result of this the Scottish Public Pension Agency communicated a commitment to review the Regulations and issue a consultation with their proposals. True to their word a consultation was issued on 6 November 2017 with a closing date of 15 January 2018.

The consultation proposes material changes to Regulation 62 (equivalent to Regulation 64 in England & Wales) which would allow ‘exiting employers’ to cease building up future benefits but without the imposition of a gilts based cessation debt, something which is unaffordable for most. This would be via the use of a ‘suspension notice’ where Funds could agree to let employers continue to participate, effectively on an ‘on-going’ basis, with a continuing contribution commitment to the Fund. Such an approach would assist in dealing with this ‘Hobson’s choice.’

I greatly welcome the SPPA’s approach although the detail still, in my view, needs some refinement.

ICAS has provided a response to the consultation which highlights some issues and makes further practical proposals how these may be resolved.

I can only hope that the proposals are implemented (with some pragmatic amendments) and that England, Wales and Northern Ireland look to follow suit. It can only be in everyone’s interests.

David Davison

I was reading through an LGPS annual report for 2017 this week (I know, I get all the fun jobs I hear you cry!) and was struck by a comment about the scheme membership continuing to grow and linking that to the health of the scheme and it’s relative attractiveness. This ‘positive spin’ wasn’t wholly in line with my experience so I decided to do a bit of digging to see if the statements actually held water.

Trawling through some old scheme records I identified that the scheme membership had indeed grown by about 50% over the 10 years to 2017. However, when you looked a bit more closely the increases were driven more by rising numbers of deferred members, which had more than doubled. The active membership had only increased by about 29% over the period.

So this meant that the active members, i.e. those actually contributing to the scheme, had fallen as a percentage of overall membership from over 52% in 2007 to less than 46% by 2017.

Over approximately the same period the pensionable salary roll for active members had increased by about 26% with deferred pensions increasing by around 80% and pensions in payment by over 88%.

This led me to look at a few other LGPS reports and the position is broadly consistent, demonstrating something of a trend.

So what this means is that the salary increase and active membership numbers have increased by a relatively consistent amount so the future accruing liabilities are broadly consistent. However it does mean that proportionately there’s a smaller number of those funding any deficit contributions related to deferred and pensioner members and paying for the costs of running the scheme.

So the picture isn’t quite a rosy as the statement would lead you to believe. It’s also a position that’s not wholly surprising.

Given that public sector pay rises were frozen for two years from 2010 and then 1% until this year the average annual salary rise in the public sector over the last seven years has been around 1.5%.

However, CPI over the same period has been 2.3% a year. So active member benefits (linked to salary have been going up at a significantly lower rate over the period than the increases on deferred benefits and for pensioners.

However, this isn’t the whole story. In 2014 in England, Wales & Northern Ireland and 2015 in Scotland the LGPS Scheme moved from a final salary basis to a CARE basis so this means that active participants are likely to have benefitted from higher increases on their pension benefits accrued after this date than they have their salaries, and this on a higher accruing figure (i.e. 1/49th per annum vs the previous 1/60th). So while salary benefits may have been losing value in real terms that’s not wholly the position in relation to pension benefits. A ‘healthy’ position for individuals but possibly not quite so healthy for the Funds! If we are to see salaries begin to rise in the public sector over the next few years then this will be something of a ‘double whammy’ for funds.

So, the claim of materially reduced costs as a result of the 2014/15 changes has proven to be something of a con, and indeed something that many admitted bodies will have witnessed first hand.

You may therefore not want to take the healthiness of your LGPS scheme funding from Fund comments about the growth of the membership as things are far from as simple, or indeed as positive, as suggested.

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.

Matthew Leathem

The European Insurance and Occupational Pensions Authority (“EIOPA”) released the results of their Europe wide Occupational Pensions Stress Test last week.

The results show that pension scheme deficits can have a detrimental impact on the economy as a whole when companies’ future growth prospects are restricted by the level of contributions that they need to pay to schemes to plug their deficits. Businesses can fail as a result, bringing unemployment.
In this situation, it is also likely that members will not receive their full benefit entitlement in retirement.

What do the results of the stress test tell us?

The UK was one of three countries that showed a funding deficit on their current funding basis. It was also the worst performing country when measured using EIOPA’s common balance sheet approach, a method that broadly measures the ability of the scheme to sustain itself. The UK also fared the worst under the stressed scenario. This showed a funding level of just 45% for UK schemes.

EIOPA estimates that sponsors would only be able to cover 80%-90% of this deficit, meaning that the remaining 10%-20% of the deficit would fall on the PPF and the reductions in the level of benefits that members receive under the PPF than their scheme.

The report also highlighted the size of deficits relative to scheme sponsors. For 25% of schemes, the estimate of value of contributions required by the sponsor in the balance sheet exceeds 42% of the sponsors’ market value. This rises to 66% when the stresses are applied. For many schemes, the value placed on sponsor support in the balance sheet is greater than the sponsors’ market value as a business.
Such high level of contributions required would likely place a huge strain on scheme sponsors. This could affect their ability to continue to trade and when considered on a national basis could have a detrimental impact on economic growth and employment.

How do we plug this deficit?

There is no magic solution to fixing the UK’s pension funding shortfall. It will likely be a long process that will take into account a number of factors including scheme funding, investment and sponsor covenant within an integrated risk management framework.

The most important of these factors is to ensure that the trustee board has the expertise to be able to monitor and understand the funding position of the scheme.

There are a number of key take-away points for trustees:

  1. Ensure that you monitor your scheme’s funding level closely. These can be used to enhance your understanding of your scheme’s funding volatility.
  2. Trustees should work closely with the sponsors of their schemes to develop funding plans that will ensure the security of members’ benefits and minimise the impact on the sponsors business.
  3. It is important to take care when setting and reviewing your scheme’s investment strategy. Techniques such as stress testing and stochastic modelling can be used to assess how robust the strategy is under adverse market conditions.
  4. Make sure to review governance procedures regularly to ensure that decision making is effective and allows the scheme to react quickly to a volatile and changing market.
  5. Trustees can consider other options to secure members’ benefits such as securing benefits with an insurance company. Alternatively, they can look at options that can provide members more flexibility to take their benefits whilst removing risk from the scheme. This may include giving members the option to transfer their benefits prior to retirement so they can avail of flexible drawdown options.