Posts Tagged ‘Pensions End Game’

Alan Collins

I came across an interesting panel discussion in the current issue of Engaged Investor Magazine, where a number of industry experts were asked for their views on developments in pension scheme de-risking. My views on the questions addressed are as follows:

Q1 – Many companies are not able to carry out full buyout in one go. What multi-layered approaches can they take to de-risk their schemes?

The most important first step is for the employer and trustees to agree a common goal for the scheme. In almost all cases (especially closed schemes), the ultimate goal should be to secure all benefits with an insurance company and wind-up the scheme.

An agreed, transparent objective will then set the path towards the ultimate goal. There are many alternative partial de-risking measures that can be taken, most of which can work in parallel. These include employer led exercises such as:

  • a transfer exercise, offering members the opportunity to transfer their scheme benefits to an alternative arrangement via an incentive in the form of an increased transfer value, or sometimes a cash payment; or
  • a pension increase swap exercise, where members give up future pension increases in return for a higher initial pension.

These exercises can generate significant savings to the employer relative to the ultimate cost of buyout. They are unlikely to generate significant immediate savings on ongoing funding costs or FRS 17, though they do contribute to reducing the risk profile of the scheme.

These exercises can be run in tandem with providing opportunities to members to retire early from the scheme, which can generate savings on cash commutation and also insurers prefer the “certainty” of pensioners rather than deferred members. In conjunction with the company, the trustees can also move towards a lower risk investment strategy, using bonds or LDI type investments, and also consider partial insurance such as pensioner buy-ins. I would caution that for schemes with young pensioners or where the pensioner group makes up a small proportion of the liabilities, it may not be efficient to use significant resources of the scheme to obtain insurance covering only a small portion of the liabilities. There are also opportunities developing in the market to enter into a staged buyout process with insurers, where the terms are agreed up front but the whole premium is not required at the outset.

Nor should the trustees overlook the potential for non-cash funding, such as parental guarantees, contingent assets or “asset-sharing” with the company, such as the whisky-bond deal completed by Diageo .

Q2 – In what ways did trustees’ de-risking choices change during 2010?

The choices remained broadly unchanged, though it was a year of massive change in defined benefit pensions, particularly on the legislative front. The single largest issue was Steve Webb’s RPI/CPI summer bombshell, which is expected to have a significant effect on pension scheme funding. Most schemes are expected to see a reduction in liabilities of between 5-15% depending on the nature of the scheme rules.

This meant that larger exercises tended to be shelved as trustees waited for the full impact of the change in inflation measure to come through. I would say the introduction of innovative non-cash funding solutions and the focus by trustees on obtaining enforceable security was the other main development in de-risking.

The emergence of longevity swaps was supposed to be the big-ticket item for 2010, but this remains the preserve on the very largest of schemes and I don’t see that changing any time soon.

Q3 – What early steps, such as data cleansing, communications and legal considerations, should be undertaken before entering into a de-risking activity?

The quality of pension scheme data can be highly variable. It can be held in multiple formats, for very long periods of time and is often subject to major change (e.g. after mergers, systems migrations, legislative changes). When entering a liability management exercise and moving ultimately towards winding-up a scheme, every effort must be made to ensure that members have the correct pension entitlement. The key message on data is that full and accurate data will reduce the cost of staff communication and liability management exercises as well as ultimately buying annuities as it helps to reduce underwriters’ pricing for uncertainty.

The communication process is also vital, both between the employer/trustees and the member. Possibly even more important is the communication between a financial advisor and the member during an employer’s de-risking exercise.

The need for proper legal input almost goes without saying, but the emergence of the RPI/CPI issue and continued problems with sex equalisation and other scheme amendments, mean that assistance from your friendly pensions lawyer is a necessity, not a luxury.

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.

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.

David Davison

Only fools & horses

It’s sad to see a national institution like Readers Digest forced in to receivership by its final salary pension scheme liabilities, although encouraging to note that the receiver has had “significant interest” from potential purchasers so there may be some light at the end of the tunnel – although it may just be a rapidly approaching train!! This is however a salutary lesson in how significant pension liabilities can become and that no business, no matter how well known, is immune to having to deal with their promises.

It reminds me a bit of the old Only Fools and Horses episode where they were asked to take down a chandelier. The lesson was that no matter how much planning was involved and how much you try to focus on the details like sales, budgeting, cashflow etc, missing, or paying less attention to, a significant factor like the creeping levels of pension deficit can be catastrophic.

Alan Collins

At Spence and Partners and Dalriada Trustees Limited, we have long been espousing the value of good recording keeping in relation to pension scheme administration, particularly in our call for action in relation to pension scheme data.

We therefore strongly welcome today’s consultation from the Pensions Regulator (TPR) entitled “Record-keeping: measuring member data“.  We endorse the view that “Trustees and those responsible for administering workplace pensions will need to improve standards of record keeping”.

I was certainly less surprised than TPR by the fact that only 19% of schemes surveyed had checked that they had all the fundamental common data and that over half of the surveyed schemes were missing more than one item of fundamental data.  My experience would indicate lower “success” rates than this.

We further support the proposal for TPR to set, monitor and enforce target levels of accuracy for the common data that schemes must hold and will be interested to see how this area develops.

We note further that TPR intends to work closely with the Financial Service Authority to monitor record keeping in contract based schemes.

Finally, we look forward to further developments in this area and would encourage all trustees to look out for and undertake the soon to be published e-learning module on this subject.

Brian Spence

The former Chairman of The Pensions Advisory Service (TPAS) is quoted as saying that TPAS is in danger of being “dumped or carved up” whereas Government Minister Angela Eagle states that TPAS has embarked on a “modernisation and efficiency programme.”

Members of trust based pension schemes have trustees to protect their interests (increasingly schemes have professional trustees)  backed by legions of advisers and with the might of the Pensions Regulator behind them if necessary.   Trust based schemes are also required to have their own Internal Disputes Resolution Procedure. Usually complaints are resolved either informally or through the Scheme’s disputes procedure. If a member is unhappy with the final decision of the trustees, which is often subject to an internal appeals process as well, their complaint can go to the Pensions Ombudsman.

In contract based schemes there is the provider’s complaints procedure, the Financial Services Authority and the Financial Services Ombudsman.

In the last resort pension scheme members also have recourse to the Courts.

The question is does the taxpayer really need TPAS at all?

Pensions issues are complex detailed and the more difficult issues can often only be resolved with the assistance of highly skilled pensions lawyers and actuaries. Many TPAS advisors are well intentioned but are often volunteers with a busy day job.

Can TPAS really actually add much value to the work of all the professionals involved?

TPAS advisers are meant to be neutral arbiters and not in any sense a member’s “champion” and the majority appear to understand this. However, on occasion, particularly where the issues involved are complex and outside the particular area of expertise of the adviser, they can be more of a hindrance than a help (and arguably add significantly to the professional fees involved in resolving an issue).

If there is a problem with the quality of governance then the root cause should be dealt with and the Pensions Regulator has made great strides in this area.

Is TPAS a sensible use of public money at all in these straitened times? We think not.

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.  Dalriada provides professional trustee services and Spence & Partners can provide support to employers in appointing an independent trustee.  Brian has written a series of articles on appointing an independent trustee.

Follow @SpencePartners and @DalriadaTrustee on Twitter.

Brian Spence

Q.   Every time I open the paper I see another company pension scheme is closing. I am worried that our may be next. How easy is it for my employer to close the scheme to new or existing members, and what as a members should we be monitoring?

Firms cannot any longer have an open-ended commitment to final salary pensions, especially in the environment where deficits narrow or widen almost on a daily basis.

But closing a final-salary pension scheme is not an easy or uncomplicated option. Read more »

David Davison

At this time of year it can be difficult to think of the ideal gift for the pensions professional in your life. Here at Spence & Partners we’ve developed a computer game (with the occasional manual work around) specially aimed at the lucrative and exciting Christmas pensions market. Welcome to Supermario Pensions, a game that any trustee, actuary or pensions administrator can play.

Read more »

Brian Spence

In the pensions endgame business, you only get one shot at calculating all the benefits and they have to be right. The fact that much of the necessary information is still held in a variety of electronic and paper records does not help the process.
The industry has had 20 years now since computerisation became the norm and its record in archiving full information in a consistent form does not inspire confidence – not least because it is a long and laborious task.
But the digitising of vital information needs to be completed now as more and more schemes close to accrual. The time for bad record-keeping is past. Like the rest of the industry, it has to be dragged into the 21st century.

For further information please contact David Davison at consulting actuaries Spence & Partners on 0141 331 1004.

Issued on behalf of Spence & Partners by Karen Milne at Blueprint Media tel 0141 353 1515
Date:   January 2010

Brian Spence

Pensions is a long term business. When I entered the pensions industry I worked for a long since forgotten firm of actuaries, administrators and trustees that had started out in business in 1951.

In the late 1980’s and 1990’s it was not unusual for someone to have to dig a file out of a packed filing room containing records dating back to the 1950’s or 1960’s. The time horizon of a pension scheme goes beyond that of most businesses. Life insurance companies recognise that. But by the late 1980’s not much had really changed from the 1950’s. Read more »

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