Posts Tagged ‘Liability Reshaping’

Brian Spence

At the end of July by the Department of Work and Pensions published a consultation document entitled  “Abolition of contracting-out on a defined contribution basis: consultation on draft consequential legislation.

Hidden within the document (it takes some finding) and then cross referencing  the Contracting-out (Transfer and Transfer Payments) Regulations 1996 (what would we do without Pendragon Perspective!) and it becomes clear – no transfers of GMPs or of post 1997 contracted-out rights will be permitted from DB pension schemes to either occupational DC pension schemes or to personal pensions from 6 April 2012.

Who saw that coming?  The vast majority of DB pension rights are now locked into the DB pensions funding regime until the last member dies, a regulated buy-out is transacted or the sponsor goes bust.

Deferred pension scheme members who may have been thinking for some time about transferring to a personal pension will need to make their mind up soon.  There is a minority of people who would be well advised to take transfers, for example some of those in poor health or without dependents.  Schemes will undoubtedly have to deal with an increased incidence of transfer requests for 18 months and virtually none thereafter.

The whole new industry that has developed around transfer incentives will come to an end.  From the point of view maximising individual choice this is not a good development but there are a number of practitioners who have advised employers to conduct enhanced transfer value exercises in a manner that will in all likelihood result in many of those members who have been advised to transfer coming to regret the advice they have received.

The Pension Regulator’s recent consultation on the subject seemed a rather limp response to some very poor practices on the part of some advisers but maybe this latest announcement goes some way to explaining why.  If the Pensions Regulator and the Financial Services Authority cannot regulate Enhanced Transfer Value Exercises (and certainly over the last few years it is clear that they have failed to do so) then banning transfers seems a logical step.  Whilst we understand the move by the new Pensions Minister Steve Webb, it is a pity that the price of this regulatory failure is to deprive the minority of people who could gain by transferring of that option. It is a price worth paying to protect the majority from the detriment caused by the predatory and harmful practices that have developed.

The whole area of calculating transfer value equivalents to DB benefits has been fraught with difficulty – the mis-selling of the late 1980s and early 1990s having been improved on by some firms only a little in more recent years.

There does however seem to be a high chance of a firesale over the next 18 months as individuals take a final look at their affairs and decide once and for all on whether to transfer out to a personal pension or DC scheme and as employers contemplate making a final and best offer to incentivise deferred members to take their liabilities and leave the scheme.  Hopefully employers and trustees will take the proposed new Guidance from the Pensions Regulator to heart and conduct these exercises in an appropriate manner.  The appointment of an independent trustee in such cases to eliminate conflicts of interest would be good start.

We have argued several times that transfer incentives properly conducted are a legitimate and proper technique for employers to manage their liabilities and at the same time would be happy to advise any employers looking to achieve a fair win/win result in the limited time that now appears to be available or indeed any trustees seeking to meet the demanding new expectations of the Regulator.

Brian Spence is a founder of actuaries Spence & Partners Limited and a director of independent trustee Dalriada Trustees Limited.  You can follow him at @briandspence or @PensionsEndgame on Twitter or link to him on LinkedIn.

Follow @SpencePartners and @DalriadaTrustee on Twitter.

David Davison

Rarely a day goes by without some press comment on the use of Enhanced Transfer Value Exercises as a legitimate (or not!!) form of final salary pension scheme de-risking. So we thought we’d get some informed comment from someone who actually has experience advising members on these exercises. Our guest contributor, Matthew Smith, is a highly experienced and qualified financial adviser, with leading Independent Financial Advisers Argyle Consulting, who has carried out a number of these exercises and outlines here what he considers are the real issues and choices members face.

(Argyle Consulting Limited is a leading firm of Independent Financial Advisers based in Scotland.)

Sponsoring final salary schemes is a pretty thankless business, and with a limited number of options open to employers to manage liabilities, an Enhanced Transfer Value (ETV) exercise conducted in an open and professional manner with employer funded IFA advice, remains an option worthy of serious consideration.

This is despite the entirely valid opprobrium heaped by the Pensions Regulator (among others) on some reported exercises that have bordered on sharp practice by employers at best.

Apart from the criticism of patently poor procedural conduct, there’s an undercurrent of hand wringing which seems to based on 1) that members need to be protected from themselves (and the big bad employer!) and 2) that there’s no way Joe Average can really understand or assess the value of the guarantees they are giving up.

It’s certainly not an IFA appetite for reckless endangerment which is encouraging members out of schemes.  The pensions review of the 90’s may be a fading memory, but final salary transfers remain the highest risk business an IFA can conduct from a regulatory, reputational and business survival perspective.  Get it wrong and you won’t be around for long!

As an IFA it’s meeting the personal objectives of the individual, not the protection of the many that gives a different starting point to our view, ever mindful of the fact that all transfer advice must start from the FSA stance that it is not in a member’s best interests to give up any guarantees.

But if the prevailing message from regulators is ‘beware of employers bearing gifts’ which right thinking member would take such an offer anyway, and why?  How can these exercises be done effectively for the employer, with proper governance and protections, and be balanced and not misleading to members?

Despite what the actuarial modelling might forecast about the value of the guarantees implicit in a final salary pension promise, each member places an entirely different ‘value’ on the real benefit of these guarantees to them, depending on their personal circumstances.

A few (real life) examples that can be taken in conjunction with a fair transfer offer and sensible critical yield would include early access, for example, the redundant employee in his 50’s who has been unable to find another employment and has used his lump sum to fund a business start-up.

Members do tend to underestimate their own life expectancy but the single member who is not in robust health is another example where a transfer giving up dependents pensions and possible increases can make sense.  Conversely the married member with a large pension entitlement from their spouse may feel no need of the guarantees or dependents benefits.

The reality is most members who decide to transfer with the benefit of balanced professional advice make an entirely rational decision on the basis of control of funds and greater immediate or future access flexibility.  Retirement is changing and pension entitlements for many deferred members are small and inflexible in relation to their other earnings, assets and entitlements, and are valued as such.

Much of the unease seems to be that somebody out there is duping Joe Average into thinking he’ll get a better pension on the basis that it’s an enhanced offer, rather than the reality which is that members in properly conducted exercises are making an informed choice to opt to transfer out of schemes in most cases for greater flexibility and control.

It’s not all about the numbers, and members are quite capable of making the value judgement, as long as a sophisticated professional adviser is explaining the issues to them in a way they can understand.

For employers thinking of spending the money on an ETV exercise our advice would be:

1) Make a fair offer, this is not a cheap option and setting enhanced transfer values that don’t get past the first base of a low critical yield to allow members to have a chance to transfer is a waste of everyone’s time.  Don’t offer cash, it’s difficult to assess its real value and could be regarded as an unfair inducement.

2) Engage with and appoint an IFA firm that has the relevant depth of technical experience, staff with the right qualifications, a robust process, and crucially the individual member communication skills to engage members at a high level on what can be a complex decision.  This will be critical to the success of any exercise and also to help reassure your trustees.

3) The employer needs to fund properly for the communications and member advice, and allow the member sufficient time with the adviser for decisions to be made. Members won’t transfer if the advice is generic or feels impersonal.

Sponsoring employers should not shy away from considering the merits of an ETV exercise, but the involvement of an experienced professional IFA practice at an early stage is critical to ensure it is money well spent.

Neil Copeland

Thomas Aquinas apparently spent a large part of his life pondering the number of angels that could dance on the point of a needle. He also , apparently, could gravely debate whether Christ was or was not a hermaphrodite and, most crucially of all, whether or not there are excrements in Paradise.

Speaking of interesting digressions, this brings me to actuarial mortality assumptions and, in particular, the question of the most appropriate mortality assumptions to use for a particular valuation for a particular scheme.

I always think the key thing to bear in mind is that whatever assumption is chosen it will be wrong.

For example, I suspect any of the tables currently in use ignore the impact on mortality of future trends of Global Warming (or more likely Global Cooling, at least in the short term, as we appear to be 10 years into a cooling trend, although as with all statistics it depends on your starting point). Actually, Global Cooling is potentially a greater risk to humanity than Global Warming as a few degrees of Global Warming are projected to result in a net increase in food production (statistically at least, which I find tends to be shorthand for “not much better than guessing wildly”), whereas Global Cooling much more quickly results in a net reduction in food productivity, with dire consequences for the teeming millions.

But hey, the polar bears will be all right, which is the main thing, I guess.

Obviously if warming were to continue beyond a few degrees this would start to have a negative impact on food production also. And result in malaria in Notting Hill – such a development would be of great help to many final salary pension schemes. However, given the recent lessons of SARS, Avian Flu and Swine Flu, such schemes probably can’t rely on a Global pandemic to solve their mortality problems.

The good news is that,  in the long run, Malthus may eventually be proved correct. Studies of animal populations that grow at a rate greater than the potential food supply generally see catastrophic reductions over a very short period. Eventually.

And have the actuaries considered the risk of a meteorite strike? A direct hit in the greater London area would do wonders for the BT Scheme’s deficit. Just in case you think I’m being facetious, which of course I am, below is a summary of a news story that reports that such a strike is probable, statistically speaking. Eventually.

The story reported that a 13 year old whizkid from Germany corrected NASA scientists on the probability of a asteroid called Apophis striking earth. While NASA scientists took the probability calculations (which are far from easy) and estimated that there was a 1 in 45,000 chance of strike; the boy’s findings showed the chances to be 1 in 450. NASA scientists concluded that he was actually right since they had not considered the possibility of the asteroid striking with satellites , something that the 13 year old did.

Slightly disappointingly, NASA subsequently refuted this element of the story and claimed it had faith in its original calculations.

However, both NASA and the 13 year old agree that if the asteroid does collide with Earth, the resultant shockwaves would create huge tsunami waves, destroying both coastlines and inland areas, while creating a thick cloud of dust that would darken the skies indefinitely.

So what have we learned from our digressions  into climatology, demography and astronomy?

Well firstly, even 1 in 45,000 isn’t  a particularly comforting probability when it comes to possible armageddon and the extinction of human life. By some estimates the mass of the earth increases by about 40,000 tonnes a year due to extraterrestrial bits and pieces striking it. These are obviously pretty small meteorites, but conversely that’s an awful lot of actual collisions. It only needs one big one, and if it comes, Bruce Willis and Billy Bob Thornton probably aren’t going to be able to help.

Secondly, sometimes it’s worth getting an alternative view, but not necessarily from a 13 year old. Notwithstanding the uncertainty attaching to climate change and meteors, it’s important for trustees and employers to understand, as far as is possible, the latest thinking on mortality and how it is likely to develop in future.

Thirdly, it should be apparent from the above that the uncertainty inherent in final salary schemes poses real risks for many businesses. Also whilst attention to detail is important you shouldn’t lose sight of the big picture. The good news is that you can be pro-active in taking steps to manage and reduce the risks.

And finally, whilst I haven’t specifically quantified the direct effect of such a meteor impact on rates of mortality, I presume you can draw your own conclusions.

Neil Copeland

Interesting article on FT.com re the difficulties being experienced by the Church of England in relation to funding its final salary pension liabilities.

It’s not surprising that a body such as the Church of England appears to place greater store in faith than in reason. What is surprising is that it appears to be placing its faith in equities and Mammon, the false god of riches and avarice.

Actuaries will tell you that equities provide a poor match for pension scheme liabilities and we have blogged previously on the risks for both employers and trustees on relying too heavily on equities to save the day. Clearly they can have a part to play, but for the trustees of the Church of England Scheme, unless they are satisfied that the Church will be around at all times to underwrite the Scheme (okay, so it has been around since the time of Henry VIII which suggests a greater longevity than the average employer) this is a relatively high risk strategy.

According to Professional Pensions the Church of England does also appear to be taking some steps to try and address the liability side of the equation, and isn’t relying on blind faith alone. It is proposing to:

  • Contract the Clergy Scheme into the state second pension
  • Reduce the full pension from the Clergy pension scheme from two-thirds of National Minimum Stipend (NMS) to half of NMS for future service;
  • Limit the annual increase in the pensionable stipend to price inflation (RPI);
  • Chang the pension age for future service from 65 to 68; and
  • Move, again for future service, the accrual period for full pension from 40 to 43 years.

Whilst moving things in the right direction evidence from the private sector suggests that such limited reforms rarely deliver the desired results and more fundamental change is required to address the risks posed to any employer by a final salary pension scheme.

Employers need to understand that they can be proactive in managing their schemes’ liabilities and they have a range of options available to them  in dealing with their final salary schemes – which means they don’t have to rely on divine intervention.

David Davison

More on Trustees and ETVs

Interesting to read Fraser Sparks from Hammonds views expressed at the recent Professional Pensions Show that trustees should not be getting involved when employers chose to run an Enhanced Transfer value (ETV) exercise for their scheme members. His view is that getting involved exposes trustees to additional dangers and is outside their legal obligations. Read more »

Laura Cumming

Trustees and ETVs

I read with interest that trustees should not get involved in Enhanced Transfer Value exercises (ETVs). I would agree that it should not be the position of the trustee to question the reason for such an exercise (is there a reason other than de-risking?) however, I am in full support of trustees reviewing communications to members to ensure that the guidance from the Pensions Regulator has been followed and that the offer is fully explained to members with the necessary notes of caution included.

Without trustee review the ETV runs the risk of being overturned at a later date with consequent additional cost to review and ‘fix’ any problems.

Of course if a trustee does not have an opportunity to review the ETV offer a trustee could elect to send its own communication to members but quite frankly this could do nothing other than confuse an already complicated matter.

See UPDATE on ETVs reflecting the July 2010 Guidance.

Neil Copeland

Actuaries are only human

Can we get something straight? Final salary pension liabilities are not linked to the yield on AA rated corporate bonds. Nor are they linked to returns on equities. Nor are they linked to the yield on gilts, index linked or otherwise.

Final salary pension liabilities are the aggregate of the payments promised to members and their beneficiaries over the life time of a scheme. For closed schemes this is a finite amount, but the actual amount can’t be known until after the death of the final member and beneficiary. Add up all the payments to members, beneficiaries, advisers, the PPF and other parties, and that’s your liability.

So if you have been rash enough to promise your employees final salary pensions and had your original vague aspiration to ensure those faithful and loyal employees who stuck with you through to their retirement had a reasonable income in retirement,  Read more »

Brian Spence

We have provided actuarial advice to many employers in recent years on liability reshaping.  This is often financially motivated because by swapping a high rate of guaranteed pension increases for a higher pension now cash flows are brought forward which are easier and cheaper to fund than distant cash flows.  This can substantially reduce the cost of buying out pensions as employers reach the Pensions Endgame.  These exercises tend to have a high take-up rate because pensioners in their 60s and 70s have a preference for a higher income now “while they can enjoy it.” Read more »

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