Posts Tagged ‘Pension Deficits’

Richard Smith

With 31 December being the most common date for corporates to have their year-end, Finance Directors will soon be turning their minds to their annual accounts. After a number of years of falling yields and growing deficits, they might be hoping for a Christmas present of an easing of the pensions problem, particularly if they have read recent headlines around improving pension scheme funding levels

Whilst there is still some time before the year-end, and (as the US election has recently reminded us) anything can happen, we will aim to give sponsoring employers advance warning (unfortunately this wording is chosen deliberately) of what they can expect come the year-end. Read more »

David Davison

Finance Directors of charities not disclosing their multi-employer pension liabilities on their balance sheet may be sleeping just a little uncomfortably at the moment following a consultation document issued by the Financial Reporting Council.

If the proposals are accepted charities will need to recognise any agreement to fund a deficit in a multi-employer scheme on their balance sheet. Read more »

David Davison

A wave of optimism broke out as I read a recent interview with Sarah Smart, the Chair of the Pensions Trust (“the Trust”) in which she quite sensibly highlighted the risks faced by charities from their final salary pension schemes.

However the optimism was short lived, as whilst finding it difficult to disagree with the sentiments expressed they struck me as being at odds with another recent article where Mrs Smart appeared to continue to promote the use of Defined Benefit schemes with the statement “Despite numerous and well-publicised assassination attempts on DB Schemes over the past few years, I remain hopeful that they may yet prove to be Rasputin-like in their resilience and stubbornly refuse to lay down and die.” In the same article she had confirmed that she had effectively turned a DC Governance seminar into a sales pitch for DB. Am I the only one who sees some inconsistency here? Read more »

Greig McGuinness

How many times have I dug out my drive-way this week? Each time I broke my back to dig down to the paving more snow appeared and the colourful language commenced.

Feel free to draw any analogies with funding a DB pension schemes still open to future accrual.

It couldn’t be worse, or could it? Well only if you’d:

  • no option on shovel size
  • no option to use grit or salt
  • your neighbour kept pilling all his snow on your drive

Ah, that will be a multi-employer scheme.

Alan Collins

‘Ello, I wish to register a complaint.  Much like Monty Python’s famous Norwegian Blue parrot, private sector defined benefit pension schemes are dead.  They are not resting, stunned or even pining for the fjords – they’re stone dead.

I therefore believe the calls by the UK pensions industry to shield defined benefit pension schemes from the effects of Solvency II are somewhat misplaced.  If the only reason for not adopting Solvency II is to prevent the further closures of such schemes, then these calls do not stand up to scrutiny.  Schemes have been closing rapidly under the existing regime and will continue to do so irrespective of European legislation.

Many employers overburdened by regulation and the dawning realisation of the real cost of pension guarantees have called time on defined benefit provision. The adoption of Solvency II may well further hasten this inevitable demise. For a large number of schemes, accepting this now will be a good thing in the long run.

The closure of schemes leaves two main issues: (1) should defined benefits constitute a cast-iron promise to beneficiaries and (2) how do we best close the funding gaps to ensure all liabilities are met?

The magnitude of UK defined benefit obligations have grown over time, often beyond the sponsors’ control. Layer upon layer of legislation, primarily relating to guaranteed indexation, has left employers to fund obligations which were not present or intended when schemes were first set up.  In effect, this has hindered the private sector from delivering pensions which can be guaranteed.

Beneficiaries certainly believe a promise is a promise and fully expect employers to stand behind their obligations irrespective of the above problems.  This feeling is heightened by the fact that fewer and fewer beneficiaries have an ongoing mutual interest in the prospects of the sponsor. However, by allowing measures which rely so heavily on employers, it is also clear that the UK funding regime has never been set up in a way to match the understanding of the beneficiaries.  It is a structure based on hope rather than expectation.

As integration across member states continues and the workforce in the EU becomes increasingly mobile, I would expect that benefit promises made by companies in all EU states will face harmonised regulation and enforcement. UK residents who end up working in other EU states would fully expect benefit promises to be honoured just as our European counterparts would surely expect the same protection working in the UK.

The expectation of benefit promises being honoured seems to make it inevitable that there will be levelling up of pension legislation across the EU, whether by Solvency II or other means.

The National Association of Pension Funds claims that the UK system already provides a strong level of protection for its members through the employer covenant, The Pensions Regulator (tPR) and the Pension Protection Fund. While the current regime is undoubtedly more robust, any inference that the existence of the PPF is a justification for a lower funding target should be discounted.

In support of this view, the Association of Consulting Actuaries believes that the current directive with its requirement for the prudent funding of technical provisions is providing ‘an appropriate balance between protecting members’ benefits and keeping the cost to employers at an affordable level’.  While balance is appropriate, I believe it would be a mistake to retain a lower funding target because it is all that can be afforded in the short-medium term.  It is much better to aim for the right target, even if it is going to take longer to get there.

As well as possible directives on Solvency II, there are a number of additional factors which support stronger funding targets such as the views of the Accounting Standards Board; the ultimate legal obligation on employers is already set at buyout; and the dominance of solvency levels in pension related discussions during mergers & acquisitions, where FRS and technical provisions are cast aside.

For all but the very largest of schemes, the only realistic end game is to buy out all of the remaining benefits with an insurance company as soon as it is affordable and efficient to do so.  In the meantime, the need for employer flexibility and the reluctance of tPR to accept very long-term recovery plans have lead to the adoption of weaker funding targets which rely on the ethereal employer covenant.  However this is the system we must work within at the moment.

Whichever way we end up reserving for and funding schemes, the UK pensions industry needs to face up to the fact that its biggest task is dealing with legacy deficits and not propagating the virtues of future benefit accrual.  The private sector defined benefit experiment has failed and the best that can be done is to ensure that current obligations to members are met. It is time to admit that the parrot is truly dead.

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.

David Davison

Pension liabilities have been cited as one of the main barriers to pursuing a merger, and it is understandable given the complexities of the legislation, HR issues and potential threat of triggering a significant financial burden.

It is no wonder then that the last two years has seen few mergers completed and a significant number being abandoned before conclusion.

Mergers are inevitable in the current market environment as a way of improving competitiveness, scale and efficiencies, but to navigate the pension minefield professional advice sought at an early stage of the negotiations is vital.

This advice would allow a full investigation of the implications of any change to ensure short term objectives are not being met at the expense of the long term security of the organisation.

Read the full article by David Davison at Civil Society.

David Davison

I read my colleague Val Hartley’s blog on post code mortality with great interest and it raises a number of important questions such as:

If you run a DB scheme in one of the areas in the first table (or indeed anywhere above the average mortality rating of 10%) and are using standard mortality tables you could well be placing a higher value on the pension liabilities disclosed in your accounts than might be necessary.

Another colleague, Ian Campbell, highlighted in his blog on FRS17, how companies were likely to see a rise in liabilities and deficits when preparing figures in 2010 and experience is proving him to be correct with numerous organisations concerned about the results they are seeing. Often, in the past, companies FRS17 figures have been provided by what is, in effect, the trustees’ adviser, and presented to companies as a fait accompli. However companies are increasingly seeking an independent view on their disclosures and the assumptions used.

Mortality is one of the key assumptions in any actuarial assessment of pension scheme liabilities and it can be worthwhile, and surprisingly cost effective, even for smaller schemes, to obtain a specific post code mortality assessment. Whilst not perfect, a scheme specific mortality rating will provide support for a specific level of mortality assumptions to be used in calculations. This, in turn will give you a better estimate of your liabilities. There is scope within FRS17 to adopt mortality assumptions more specifically aligned to a particular company’s circumstances which can have a material impact on the deficit ultimately disclosed.

The key point is don’t just accept what you’ve been provided with – a bit of digging and a second opinion may prove valuable.

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