Making Sense of Pensions

Rachel Graham

The Pensions Regulator (TPR) has now issued their 2017 annual funding statement (“the Statement”) for defined benefit (“DB”) pension schemes undertaking valuations with effective dates in the period 22 September 2016 to 21 September 2017. The statement focuses on the longer-term and emphasises some key principles from the TPR’s Code of Practice 3 for funding DB pension schemes, and their supporting guidance on integrated risk management (“IRM”), investments and employer covenant. These are all areas in which Spence & Partners Ltd (“Spence”) has the necessary expertise to assist trustees meet TPR’s requirements.

Schemes with 2017 valuations will be affected differently by market conditions. Generally, TPR expects that scheme liability values will have increased since their 2014 valuations and despite most major asset classes having performed well, this does not fully compensate the increase in liabilities and most schemes are therefore likely to have larger funding deficits than expected.

Spence’s Head of Investment Simon Cohen has provided investment advice to a number of scheme trustees. We have seen that schemes which have adopted interest rate risk hedging are in a better funding position than those schemes that did not over the last three years. The Statement refers to TPR’s investment guidance published recently which sets out what TPR expects of trustees when setting their investment strategy. Spence can assist trustees set an appropriate strategy for their schemes. This is very important as TPR will intervene and engage with schemes where they believe the scheme’s investment strategy is inappropriate or too risky.

Spence’s unique in-house actuarial and administration software, Mantle, has proven to be a useful tool for trustees when considering the impact of the extent to which changing market conditions impacts the level of risk in their schemes. Mantle has the functionality to illustrate how sensitive a scheme’s funding level is to the valuation assumptions used. This gives trustees and employers a much better understanding of how funding, investment and employer covenant strength interact, and assists trustees in making better scheme funding decisions, taking into consideration the longer-term impact of those decisions. Mantle can also be used as an ongoing risk management tool, trustees have direct access to their scheme on Mantle and can check the scheme’s funding level on a daily basis to determine if the scheme appears on track to meeting its long term funding objective.

TPR outline the ‘appropriate action’ they expect trustees to take with regards to funding; this is dependent on the strength of their scheme’s employer covenant. Spence provide scheme actuary services to a number of private pension schemes and have vast experience supporting trustees and employer in recovery plan discussions. Whether trustees wish to reduce or continue with the current pace of scheme funding, or whether higher contributions are required now, Spence’s actuarial team can provide the analysis and advice trustees and employers need during funding discussions, whilst considering employer covenant strength and the investments the scheme has.

The Statement specifically focuses on the expectations of trustees of stressed schemes. Spence can assist trustees in fully evidencing that they have taken the measures appropriate for their scheme, for example Spence can assist with the following services which TPR mention in their statement;

•    employer covenant analysis
•    scheme closure to accrual
•    scheme wind up services

The Statement can be thought of as a good practice guide for trustees. The continuing uncertainty over future economic conditions highlights the importance of effective risk management and collaborative working between trustees, employers and advisers. Trustees should regularly monitor risks and all schemes should have contingency plans in place in the event a downside risk materialises, in order to prepare to recover their funding level and mitigate against any further downside events.

Simon Cohen

You can see the headlines at the moment – FTSE hits an all-time high, DOW hits all-time highs, and the DAX joins in as well.  Add to that the VIX index (a market indicator of volatility), is at lows.

You wouldn’t be the first to think that global economies are growing strongly and corporate profitability is rising fast… there is nothing to worry about.

However, there are always two sides to every story, and I have my worries (especially being a glass-half-empty kind of person).  Read more »

Alan Collins

Spence & Partners latest blog for Pensions Expert:

Back in the day, actuarial valuation results contained an element of surprise. The actuary would be sent the data, it would be processed, the numbers would be crunched and many months later, the results would appear.

There was often limited fore-knowledge among the recipients, be that trustees or the sponsoring employers, about what the results would show.

An actuarial valuation was a lengthy, time-consuming process, which is one of the main reasons why a valuation was only deemed necessary once every three years, and why the timescale for completion was set at 12 months and later extended to 15 months. Read more »

David Davison

In my last bulletin I outlined the issues that charities are likely to face should they look to exit an LGPS. The cessation debt is calculated by the Fund Actuary in most cases using a least risk approach based on Gilts. For many employers in LGPS the dramatic reduction in gilt yields over the last 10 years has resulted in very significant increases in applicable cessation debts.

Based on the table above an admitted body with a cessation debt of a few £100,000 10 years ago could well now have a debt well in to the £millions.

This I believe highlights a fundamental flaw in the cessation approach adopted in LGPS. In a private sector standalone or segmented multi-employer scheme to manage risk it could be agreed that no further benefits would be accrued. The trustees and employer could then agree to continue to fund the scheme on an on-going basis only deciding to buyout / secure the liabilities when market conditions, and the scheme and employer financial position, merited it. Read more »

Richard Smith

Yes, it’s that time of year again. The start of a new quarter and, once again, the pace of change in the pensions world continues unabated. Your team at Spence has pored over the various legislative changes, reviewed in detail the consultations and kept their fingers on the pulse of current issues in order to bring you a condensed summary of the highlights from the first three months of 2017.

As such, you can see at a glance the key issues you need to be aware of from the last quarter, and we’ve even put together a handy summary of what topics and dates to keep a look out for in the next quarter.

Topics covered in this quarter’s update include:

  • News from the PPF;
  • Consultation on the future of defined benefit pensions;
  • Highlights from the investment markets;
  • The ever-increasing value of scheme liabilities;
  • with many other highlights besides.

So what are you waiting for?… Click here to download your copy of the Spence Quarterly Update!

Hugh Nolan

With ever more people falling into the “Just About Managing” category as inflation increases faster than many pay packets, pension saving is likely to feel the pinch. Employees and employers both need clear and simple guidance on the choices to get the best outcomes.

In the infamous Jam Experiment (the psychological study rather than the jazz quintet of the same name), ten times as many customers bought some jam when offered a choice of six flavours rather than 24. Similarly, sales of Head & Shoulders went up 10% when the brand range reduced from 26 to 15 varieties. What on earth was Mr Heinz thinking when he decided to advertise a whopping 57 varieties? He could have taken over the whole world if he’d stuck to plain old baked beans in tomato sauce!

One of the authors of the Jam Experiment (lyengar) turned her hand to pensions later, finding that US plans offering just two investment options had a 75% take up rate – falling to 61% where they had 59 choices, which is even more than Mr Heinz. Back in 1999, Baber and Odean found that the least active traders got an 18.5% return compared to 11.4% for the most active traders. The average investor who switched stocks lost out by 3% over the following 12 months. Nowadays few people would object to a return of 11.4% but we’d all definitely want to get a little bit extra if it’s available given the current low expectations of future returns. Read more »

David Davison

We are delighted at Spence to be able to support a further two publications launched over the last week.

  • The 4th Edition of Charity Finance Group (‘CFG’) “Navigating the Charity Pensions Maze” was published in London on Thursday 23rd March. Spence were pleased to sponsor this invaluable publication and our Director and Head of our Charities Practice, David Davison, provided technical input on the Guide content. The Guide contains an excellent section on “Navigating the Local Government Scheme” compiled by leading legal firm Charles Russell Speechlys. This covers the benefits and risks of membership and provides a list of helpful questions charities should be asking about their participation. The CFG accompanying blog can be found here.
  • Leading representative body the Pension & Long Term Savings Association (‘PLSA’), formerly the NAPF, have launched the third of their guides covering Best Practice for Employers in LGPS with David Davison again providing technical input on the content. This was launched on the 28th March and a link to the launch information can be found here.

We believe these documents, and those published previously, will provide an excellent resource for charity trustees and senior personnel to assist them in dealing with the issues associated with LGPS membership.

David Davison

An Amicable Divorce

The question I’m asked about most often is about the cost of exiting a LGPS, as for most charities the costs can come as a bit of a surprise. One organisation I worked with recently had a small surplus at their last actuarial review and in their accounts, but when a couple of their staff left unexpectedly they were immediately hit with a bill from the fund in excess of £500,000, pretty much wiping out all their assets and placing them on the brink of insolvency. So what do you need to know?

Should you run out of active members in your LGPS fund (and not be in a position to add any new ones, for example if you have a closed agreement or a local authority contract has come to an end) under the LGPS Regulations the fund must commission the Fund Actuary to complete a cessation valuation. Whilst the Regulations do not prescribe how this calculation should be carried out, the actuaries undertaking the calculation will use very prudent ‘least risk’ assumptions based on gilt yields. This will result in liabilities being much higher than is the case on either a funding or accounting measure. Often this is the first point that an admitted body may be aware of this liability, as unfortunately numerous funds still do not provide organisations with an annual estimate of the potential cessation debt.

The conservative approach taken reflects that once an organisation exits an LGPS, the fund cannot pursue them for any extra money if the cost of providing members’ benefits is higher than expected. The fund therefore wants to make sure that there is a minimal risk that other employers in the fund would be responsible for paying for any of these exiting liabilities. As such the approach is a protection for all. However, what has been called in to question more recently is whether the basis adopted is reasonable, and indeed suitable in all circumstances. What is clear however, is that there is a great reluctance on the part of the funds to change, not surprisingly.

Whilst the approach to calculating a cessation debt across Funds, and across the various fund actuaries, tends to be consistent, the circumstances in which it applies can vary significantly. For example, some funds offer public sector out-sourcers ‘pass through’ protection, which means that any cessation debt is calculated on the much lower on-going funding basis. Other funds recognise where the last employer has inherited significant liabilities from a public sector body, and will account for these by ensuring that the public sector body picks up their fair share. Unfortunately, though the vast majority of funds do not.

Some funds are prepared to negotiate around the cessation amount payable, subject to affordability and the term of any repayment. However, in most circumstances these negotiations need to be conducted in advance of any formal debt trigger / calculation.

Admitted bodies therefore need to be aware of their situation and look to plan for it, as far in advance as possible, as allowing a cessation event to just happen could have catastrophic implications for the charity.

In my next bulletin I’ll consider why change should be considered.

David Davison

They always say that sequels are never as good – well here’s a publication that well and truly proves that adage wrong.  This fourth edition has taken over nine months to compile and provides over 50 pages of invaluable information, compiled by industry experts, which will hopefully allow finance directors, HR managers and CEO’s to find information on the issues which affect their charity and therefore help them get the most from their pension provision.    

I am delighted to have been able to contribute to, and indeed sponsor, the publication of “Navigating the Charity Pensions Maze” produced by Charity Finance Group (CFG) having provided input in the area of Section 75 debts in non-associated multi-employer defined benefit schemes, and providing our experience on how the problems can be addressed.  We believe that this document will provide charities with an invaluable reference guide to the complex pension issues they face.

Read more »

Richard Smith

At the risk of showing both my age and my teenage self’s film preferences, I have to confess I enjoyed a bit of Bill & Ted and their musical adventures through time. One of the scenes I recall from the second film was an evil Easter Bunny, pursuing our terrified heroes through the underworld. It was incongruous how a loveable character could be portrayed in such a scary manner. But what’s that got to do with pensions accounting?

Back in November I wrote a blog about my expectations for accounting disclosures for companies reporting at the calendar year-end. Many recent events have proved the foolishness of attempting to predict the future, but (unfortunately perhaps in this case) taking an educated guess at the broad size of upcoming accounting deficits was fairly straightforward back then. Sadly, it made uncomfortable reading, and I predicted that pensions deficits would be an unpleasant surprise in the FD’s Christmas stocking.

Read more »

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