Posts Tagged ‘Public Sector’

David Davison

It is amazing how quickly time flies. It seems like only yesterday that Scottish Housing Associations were absorbing the bad news about the funding position of the Scottish Housing Associations’ Pension Scheme (SHAPS) in late 2013 and getting used to their new higher contributions from 2014. Associations have now just received communication containing the initial results of the September 2015 valuation.

The great news, apparently, is that the ongoing funding deficit has reduced from £304m to £198m, representing an improvement in the funding position from 56% to 76%. The improvement has been attributed to a combination of investment performance, additional contributions and other experience. If this information is confirmed in the formal valuation it could all result in a reduction of the term of the deficit contributions of about five and a half years. This is all great news, isn’t it?

For those of you of an accepting nature then it is job done, issue parked and you would appear to be able to continue to fill your boots with defined benefit accrual without material concerns.  However, if you are of a slightly more sceptical disposition, perhaps built up over many years experience, you may want to dig a little deeper…

It is initially interesting to consider the backdrop of the results. The scheme ‘de-risked’ at the last valuation, investing in lower risk stocks which might have expected a lower return. The results demonstrate that the asset performance has been positive, so credit where credit is due on that front. The difficulty for the Scheme is that the investment return consistently needs to run very fast to keep up with the ever increasing level of liabilities and some difficult underlying membership and longevity issues that the scheme has to deal with, but more on that later.

On the liability side, the position is a bit more intriguing, and more difficult to assess, as unfortunately the report does not incorporate any of the underlying assumptions actually used (the assumptions were disclosed in the Trust’s presentation to employers in November 2015). The report suggests that over the period the value of the liabilities has increased by £112m from £698m to £790m, before changes in market conditions are allowed for.

In the table below I have shown the key changes in assumptions on a “like for like” basis, and their impact on the value of the liabilities.


So, we add £160 million to the £790 million to get an overall value of the liabilities of £950 million – easy, right?   No, this is where things take a sharp turn in a different direction.

Instead of adopting “like for like” assumptions, the Trust have decided that the Scheme no longer needs to hold as much assets to pay future benefits.

The report gives some explanation around this issue:-
“The fall in government bond yields between the 2012 and 2015 valuations together with the low interest rates, has led to a lower rate of discount adopted to calculate the present value of the future payments. This results in a higher value of liabilities.” Ah, so my assumption was right!

“However, the Committee has adopted valuation assumptions reflecting its overall view of the aggregate financial strength (the covenant) of the SHAPS employers. The assessment permitted the Committee to view with more confidence the long-term strength of the sector and therefore apply marginally less prudence to the assumption that investment returns would be realised.” Ah, so in other words we are going to change our approach and adopt a lower funding target (by assuming that investment returns are going to be relatively higher than before)…

OK, I accept that assumptions can change and this will alter the value of the liabilities.  Where I really, really struggle is with the claim that the Trust is applying “marginally less prudence”.  Marginally less – what 1%, 2% maybe?  No, the Trust is applying about 15% less prudence.  I don’t need to go scurrying for the latest Oxford English to realise that a 15% change is hardly marginal.

Since I first became involved in this Scheme, I have been worried about the lack of prudence in the actuarial assumptions.  The 2012 valuation increased the prudence in the assumptions and I welcomed this as a move in the right direction.  The 2015 results smack of a move back to the bad old days of crossing fingers and hoping everything will be OK.  This is how the Scheme got into such trouble in the first place and I urge the Trust to reconsider, even if it means participants paying deficit contributions for a longer period.

As a scheme sponsor, what I would want to know is, if we started with the funding principles agreed at the 2012 valuation, with no change in method, what would the results have been (i.e. confirmation of something around my £960 million figure)? I would also want to see the figures on a solvency basis, as this would provide for a more consistent and objective assessment of the Scheme’s liabilities.

From an employer future cost perspective I would also want to understand the likely impact of the increasing move towards defined contribution for employers and employees, likely to result in an increased average age of DB members. What sort of impact might this have on scheme funding over time?

Employers should also be considering the likely impact on their costs and liabilities of:

  1. the introduction of revised state benefits resulting in the abolition of contracting-out from 31 March 2016. The removal of these NI deductions will increase net contribution costs by 1.4% of band earnings for employees and 3.4% for employers.
  2. the proposed changes to the living wage could also have a negative impact on the funding costs for the scheme as lower earners salaries may increase more rapidly than projected and even employers who have made the move to defined contribution are not immune to this as the Scheme retains the link to future salary for active employees.
  3. the disclosure of these deficit amounts on balance sheet for the first time in 2016 which will make the issue much more visible than previously was the case.

Once all this information is available then its relevance to each employer can be assessed and organisations can decide if they’re happy with their future strategy or if some greater clarity is required.

David Davison

I’d been asked to draft some thoughts on the current, and likely future, state of public sector pensions for The Scotsman which I did in an article on the 4th April- Time Turned on Pension Attitude. Not surprisingly (well it was of little surprise to me at least) that the article received a prompt rebuttal from a leading trade unionist, Dave Watson of Unison, denying that any problem exists with public sector pensions – Contrary to Popular Belief Pension Costs are Falling.

This is undoubtedly the problem with raising the spectre of public sector pensions as it completely polarises opinion between those affected and those who are not and raises strong emotions on both sides. I could feel the irked indignation from Mr Watson in every keystroke. Read more »

David Davison

A major new research paper produced by Michael Johnson for the Centre for Policy Studies has highlighted that, despite reassurances from the Government to the contrary, the current round of public sector pension reform (even though still not completed) may not see time called on the issue for very long.

As has been suspected by many, myself included, the major concessions won by the trade unions from the government will mean that the changes will do little to improve the public finances, will merely further divide our public and private sector and will commit us to a cashflow deficit of over £15bn by 2016/17. That’s a 77-fold increase in only 11 years and will mean that the annual burden on tax payers will rise to £32bn – the equivalent of £1,230 for every household in the country. It also means that £4 out of every £5 paid in pensions to former public sector workers is paid by the tax payer. Read more »

David Davison

It is interesting to note, as we await the content of Lord Hutton’s report on public sector pensions, the amount of speculative material that is being produced on the subject.  It is already possible to discern that views and arguments are becoming to polarised and we have even had suggestions of a National strike over the matter.

Deputy PM Nick Clegg summarised the problem as a consequence of  the persistent under-estimatation of the value of the pensions promise  due to inappropriate funding methodologies and increasing longevity which in turn have given rise to insufficient contribution rates over an extended period of time.

A helpful contribution to the debate Read more »

Clare Caswell

Couples who are going through divorce proceedings, and their solicitors, will know that if there are pension assets to be considered then the Cash Equivalent Transfer Value (CETV) of these assets must be obtained from the relevant pension scheme. If you or your (ex) spouse is a member of a final salary pension scheme then beware the dangers of not knowing the definition of “Final Pensionable Salary” (FPS) within the scheme. This is of particular importance to those members who have been “acting up” to a position for a period of time where they receive a higher salary than usual for that period, but return to their normal salary after the period of “acting up”.

If the definition of FPS contains any reference to “the best” or “highest of”, for example, 5 years, and you are close to retirement and/or implementing a pension sharing order then pay close attention! Read more »

Alan Collins

I was in attendance on Friday at the first presidential address to the newly formed Institute and Faculty of Actuaries.

Mr Bowie’s speech was upbeat and set out an exciting vision for the future direction of the Profession. He was right to talk up the skill set that an actuary has to offer the wider business community, and reinforced that these skills are uniquely combined with a desire to act in the public interest and perform the role of a “trusted advisor”.

Innovation is not necessarily something we actuaries are renowned for, but the address included some promising signs. Tales of actuaries branching out into other areas such as banking, risk management and even electricity pricing were intriguing and should be pursued with vigour by the Profession. Spence & Partners will also look at the new Chartered Enterprise Risk Actuary (CERA) qualification with interest and see what the attainment of these skills could bring to our business.

All good, positive stuff, but my concern is: Who’s listening?

My reason for being in London was, in part, to meet up with three financial/pensions journalists. Not one was aware that the presidential address was taking place that day, and at least one did not recall who the Profession’s president actually was. Not a good start!

Rarely do we hear from the Profession on matters of great public interest, such as the ongoing debates around the ageing population and public sector pensions or the much talked about “inflation switch” from RPI to CPI. This void is filled by bodies such as the Pensions Policy Institute or the Office for National Statistics or even one-man bands such as Ros Altmann or John Ralfe. I long for the day that the Profession has the confidence to make its voice heard on important issues and fully support initiatives to make this happen.

On Friday, like most events at the Profession, I still qualified as “the young man sitting at the back”. This is a fairly worrying indictment of the Profession’s lack of engagement with younger members once the exams have been completed.

From the outside, I have always felt that the Profession has had the manoeuvrability of an oil-tanker when it comes to adapting to a fast-changing business environment – council for this, committee for that, with no clear agenda or purpose. Like Mr Bowie, I hope the recent merger of the Faculty and Institute can be a catalyst for change.

To sum up Friday’s event, I am confident that his message in the address was the right one, but am concerned that it was being delivered to the wrong audience (or worse still, no audience at all).

David Davison


Recent experience has suggested to me that many third sector bodies are missing out on perfectly viable out-sourced engagements because they are not adopting an effective approach to dealing with the associated pension risks.


With considerable pressure on public finances it seems inevitable that there will be a move to out-source increasing amounts of public services to the private sector. This undoubtedly represents a very significant opportunity for the third sector as their skills and specialisms would make them a very attractive home for many of these services.  However, organisations should not be attracted to the bright lights without having a full understanding of the risks and pitfalls which might await them.

Read more »

David Davison

The publication of John Hutton’s long awaited interim report in to the future of public sector pensions was not surprisingly met with some comment bordering on hysteria in certain quarters and some degree of entrenchment as various parties sought to lay out their stall for the future. The report provides a balanced and well thought through assessment of the position we find ourselves in with public sector pension provision and an initial consideration of what options might exist to provide a more sustainable solution for the future. In my view it needs to be viewed dispassionately (difficult I know!!) and without the level of rhetoric which has already begun to appear. Read more »

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.

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