Making Sense of Pensions

Angela Burns

There have been huge increases in the numbers of individuals taking transfer values from their defined benefit pension schemes over recent years. This has been driven by numerous factors, one of which being all time low interest rates, giving us record high transfer values. Individuals have been seeing multiples upwards of 30 times pension in many cases, which when added to the increased flexibility now available, is proving a mixture all too difficult to resist.

With the Bank of England raising interest rates for only the second time in a decade (up 0.25% p.a. from 0.50% p.a. to 0.75% p.a.), having been stuck at 0.5% for over nine years, this change is likely to have an negative impact.

Gilt yields rising results in liabilities falling, all other things being equal, so we are likely to see a reduction in transfer values. At this stage the impact is likely to be relatively modest with a 0.25% p.a. increase in gilt yields reducing a £150,000 transfer for a 45 year old by about £10,000 and for a 60 year old by about £5,000.

Such a change means that the amount transferred needs to return a lot more to be able to match, or improve on the benefits offered by the scheme. This change is likely to see the investment return needed to match or improve on the benefits increase by around 0.5% p.a. for the 45 year old and by 1.0% p.a. for the 60 year old.

The investment return required in the period until retirement (also knows as the critical yield or in recent parlance ‘personalised discount rate’) is often seen as a benchmark which needs to be reached before an adviser can even consider if a wider discussion on transferring benefits is even possible. So lower transfer values, which result in higher critical yields, is likely to mean that fewer people reach the threshold and so many more stay with their existing scheme.

For employers incentivising staff to transfer through the use of enhanced transfer values, lower transfer values will mean that higher top-ups are required to reach an attractive level, placing a greater cash requirement on the employer and therefore making exercises less attractive. Alternatively, retaining the same top-up value may result in a lower take-up.

As the transfer value basis in some schemes may not react immediately to changes in gilt yields this may provide individuals with a short window of time before any changes are made. In addition, individuals who are currently within their transfer guarantee period may be keener to have their transfer value processed within the guarantee window, to ensure they take advantage of a higher value than would be likely to be available post the guarantee, given the gilt yields rise.

Further rate rises may be on the horizon. We don’t have a crystal ball to see what will happen in the future, however, current perceived wisdom seems to be that rates will slowly rise over time on the basis that they can’t possibly stay this low. However, this has been the general belief since around 2009! Some think we have entered a ‘new norm’ where rates are unlikely to rise materially.

Individuals and sponsors should take care when considering transfer values or transfer exercises as gilt yield increases can materially affect the ‘real’ monetary value of any transfer, with timing now increasingly important.

David Davison

In an earlier Bulletin ‘A Landmark Judgement’ I provided some information on the welcome news that the Government had thankfully lost a case in the High Court which would have forced LGPS Funds in England and Wales to invest their assets (£263Bn in 2017) in accordance with UK foreign and defence policy.

Unfortunately my relief that common sense had prevailed on this issue was misplaced as on 6 June the Court of Appeal overturned the High Court ruling forcing schemes to comply with government policy, all this despite numerous warnings from pension experts about the negative impact and increase in pension scheme costs such a decision could have.

This whole saga started back in 2016 with the Government introducing legal guidance as it was concerned pension schemes could be taking actions which might “give mixed messages abroad, undermine community cohesion in the UK, and could negatively impact on the UK defence industry.”

The policy was successfully challenged by the Palestine Solidarity Campaign and an individual scheme member in 2017 when the High Court ruled it unlawful.

The whole approach smacks of state intervention and interferes with the ability of pension schemes to take decisions wholly in the interests of the members of the scheme. The Appeal ruling also seems to contradict proposed policy to require trustees of pension funds with 100 or more members to show how they have considered environmental, social and governance factors in their investment decisions.

The Government has refuted that its objective is to make pension schemes invest in line with government policy and has commented that it is not seeking to direct schemes investment decisions but despite the assurances the legal position seems to contradict this view.

It’s hard to see how the ruling won’t lead to schemes having to review policy resulting in increased complexity and additional costs which will be wholly unwelcome and not adding any value to scheme members.

Watch this space!

Andrew Kerrin

“Time flies like an arrow – but fruit flies like a banana.” Just a personal favourite line (often attributed to Groucho Marx) that popped into my mind when sitting down to introduce Spence & Partners latest Quarterly Update. It seems like only last week that I was searching for words to introduce our first report of 2018!

Having taken aim at the topics that hit the headlines over the last quarter, marking with an arrow those of most interest, we have fired them into a neat summary for your consideration. We hope you enjoy reading this compilation, that it helps you pass the time, and who knows, might help you avoid a banana skin or two.

This quarter we have a wide variety of tasty morsels for you to digest, including a summary of the potentially far-reaching opinion from the Advocate General in Hampshire v PPF, a discussion of the main cyber security issues for trustees coming from the Regulator’s recent practice note, to a bite-sized rundown of the key legislative changes that hit the pensions industry back in April.

Enjoy your latest Quarterly Update – I hope you agree that our selection has hit the bullseye and our efforts have been fruitful!

To download this report click here or on the image above.

As always we love to get feedback from you. If you like what we do please tell us – it’s nice to get great feedback. If you would like things included, excluded or done differently please drop us a line too. The report is to help you, so help us tailor it to your needs.

And … if you find that you do have time to keep up with things, why not follow us on Twitter @SpencePartners and keep up to date as you go along.

Angela Burns

We all face decisions every day – what to have for dinner, whether or not to go to the gym – but how many of these decisions materially affect the quality of our future?  Imagine having to make decisions that do materially affect your future without having sufficient information and understanding?

Studies have shown that around 40% of adults cannot understand basic mathematics.  Yet pension professionals expect to be able to talk about annuities, cash commutation and income drawdown with an understanding audience.

Are we doing enough to support individuals at retirement?

In the defined benefit landscape (yet more jargon) individuals have a number of complex decisions to make at retirement.

  • Do I exchange pension for cash? The rate at which this can be done will determine how valuable (or not) this benefit is (as well as how long you will live) – are individuals mathematically minded enough to understand this?  I expect not.
  • When should I draw retirement benefits and from which arrangement– how do individuals assess value?
  • Would a transfer to a defined contribution arrangement make sense to access new flexibilities in this area? There are lots of points to consider (see my recent article on ‘What Drives People to Transfer?’) and the decision is not a simple one – although the requirement for individuals to take financial advice for transfers above £30,000 provides a helpful structure.
  • Finally, many schemes are now trying to provide more flexibility at retirement (pension increase exchanges, partial transfers etc) but with this comes added complexity, jargon and choice.

Many of these decisions are one-off choices which can’t be re-visited, and decision taken at one point in time may not be the most suitable at another.  How do we help people make the best decisions about their retirement options?

Ultimately individuals will need help to make informed decisions. At the simplest end, this could be via communication provided in an accessible way.  For more straight-forward choices, decision trees or financial guidance may be enough to achieve the right result.

For others the complexity of their pension arrangements or indeed their personal circumstances may require experienced financial advice.  So how do individuals access this advice and avoid falling into the hands of the unscrupulous?  Individuals need to be much more questioning of any offers they receive.  Often a pension is the largest asset an individual may have, individuals therefore have to  be sure who to trust – a professional glossy website does not always mean the appropriate due diligence is being carried out.

At the most basic level individuals can use the www.unbiased.co.uk  website to find financial advisers in their area. Recommendations from friends and colleagues can help as can support from employers and pension scheme trustees.

There is a material risk that bamboozled with options, individuals may just chose the simplest option which may not be the most valuable. There is undoubtedly a place for support through employers and pension schemes providing security and validation. This can give access to quality advisors and a straight through process that makes it easy for individuals to make informed decisions. There is also great potential to better use technology to get key information out there in an accessible way.

Thankfully, the market does seem to be reacting to this need with member engagement packages coming onto the scene.  Depending on providers, individuals can have online access to information when and where they need it and access educational tools such as videos to explain key options.  This can then be linked to access to reputable, experienced financial advisors, overall resulting in a more supported straight through process.

I expect this will be the norm in the years to come and I am hopeful that the result is better informed individuals, and better decisions at retirement.

Mike Crowe

Whilst we have seen a number of cases coming through the Courts that have had a pensions element to them I wanted to concentrate on one that I had looked at before. This is the Court of Appeal decision in British Airways plc v Airways Pension Scheme Trustee Ltd [2018] EWCA Civ 1533 (5 July 2018). Back in 2017, I wrote a blog for our sister company Dalriada Trustees’ website, and I looked at the original decision which the Court decided in favour of the Trustee (https://dalriadatrustees.co.uk/archives/british-airways-v-aps-trustees-ltd-a-flight-of-fancy-for-trustees/). The facts of the case and the learning points for trustees are set out in this blog.

The issues (and the costs) involved always meant that this case was going to be appealed and earlier this month we had the outcome. As is sometimes the case when two heavyweights step into the legal ring there was a split decision with the majority of Judges eventually finding in favour of British Airways and the original decision was reversed. What this meant was that the Court of Appeal found that the decision of the Trustee of the Airways Pension Scheme to exercise its unilateral power of amendment to introduce a new trustee power to provide discretionary pension increases was invalid. In reading the judgement (at 39 pages a lot easier read than the original 164 page decision) a couple of points stood out. In paragraph 102 Lewison LJ noted

“… the function of the trustees is to manage and administer the scheme; not to design it. The general power that is given to them is limited to a power to do all acts which are either incidental or conducive to that management and administration.”

In paragraph 121 Peter Jackson LJ said

“… there is nothing to suggest that the power of amendment was intended to give the trustees the right to remodel the balance of powers between themselves and the employer”

Now it is always difficult to highlight only two points of interest in a complex case (which relies on the facts) but it struck me that these two points in particular indicated the attitude of the Court to the exercise of a unilateral power by trustees and what their parameters should be. Indeed, the balance of power between trustees and employers is very much a fine balance.

Trustees have to be cognisant of their powers and duties and take care in exercising them properly ensuring the “… journey itself is permitted… “ [paragraph 122], especially in the area of discretionary increases. If trustees are unsure then they may need to take legal advice and I am sure their legal advisers will be taking this case into account. If they don’t then I am sure the lawyers for employers will.

It should be noted that the Court of Appeal granted the Trustee permission to appeal to the Supreme Court and I would be very surprised if this did not happen.

Angela Burns

This guide is intended to be a useful reference for companies preparing their 30 June 2018 pensions accounting disclosures, whether under FRS 102 or IAS 19.

In this guide we will review the changes in the investment markets over the last 12 months and consider the impact these will have had on a typical pension scheme. We will also review recent developments in the area of pensions accounting, highlighting issues that you should be aware of.

Download your report

To discuss these topics further, please contact Spence through your usual contact or connect with our Corporate Advisory practice associate, Angela Burns, or by telephone on 0141 331 9984.

David Davison

On Friday 25th May 2018 new LGPS (Scotland) Regulations 2018 were published and came into effect from 1 June 2018. The Regulations are a result of a long and in depth consultation process focused on trying to assist with the difficulties faced by community admitted bodies (‘CAB’s), mostly charities, participating in these schemes. Charities are often trapped in LGPS unable to afford the contributions to stay in or the cessation debt which would be imposed to exit. The current approach offers CAB’s with only a threatening cliff edge and is inflexible, inconsistent and does not reflect the approach adopted across stand-alone or segmented schemes.

The new Regulations do indeed add some flexibility in a couple of key areas:-

  • The addition of the option for the administering authority (‘AA’) and the employer to agree a ‘suspension notice’ which would defer an employers requirement to pay a cessation debt. The employer would still be required to pay on-going contributions to the Fund as set by the AA. There is not really any specific guidance provided how such an agreement can be reached, which is a bit of a double edged sword. It does not therefore restrict the authority in terms of the approach it can take but as a result leaves the way open for a lot of interpretation. It is to be hoped that AA’s apply this flexibility pragmatically to arrive at reasonable outcomes for both parties.
  • The recognition that if an employer is over-funded then on exit they should have the right to the repayment of that surplus in full. The Regulations have therefore added a definition for an ‘exit credit’ which for the small minority of employers in this position will be welcome news and prevent Funds from just pocketing their surplus on exit.

Unfortunately however even with these changes the revised Regulations are a bit of an opportunity lost. In January 2018 the Pension Committee at ICAS provided a response to the Scottish Public Pension Agency (‘SPPA’) suggesting some additional items which would make these changes more workable and balanced. These recommendations included:-

  • a recognition that CAB’s should be able to make deficit contributions to Funds on a ‘closed on-going’ basis until the last member’s beneficiaries have ceased to receive payments.
  • A consistent basis for the calculation of these payments.
  • That CAB’s funding position be fully and consistently adjusted to recognise and reflect inherited liabilities from prior public sector employments. It is wholly unreasonable that CAB’s are expected to pay for benefits built up for staff who previously worked for public bodies.
  • It should be compulsory for all LGPS funds to provide CAB’s with a note of their estimated cessation value annually to allow both to better manage their funding position.

Scottish Government is to be commended for at least leading the way in trying to find a resolution to the difficult issues faced. A review of 3rd Tier employers in England & Wales is currently underway and it is to be hoped that the findings of this exercise will lead to similar changes to those implemented in Scotland but hopefully even taking a step further. It will be hugely interesting to see how these new Regulations are enacted in practice.

David Davison

Nearly three years ago I wrote an article praising Lothian Pension Fund in Edinburgh for an enlightened move they announced which protected organisations burdened with legacy LGPS debt. This is a huge problem, as outlined in a previous Bulletin, which unreasonable saddles admitted bodies with past Council liabilities without full compensation and usually without them even being aware. The process adopted is akin to someone buying a car but having to pay for the previous owners lease as well as your own!!

The logical and reasonable approach that Lothian Pension Fund took was to confirm that where participation in their Fund had effectively come about via an outsource from a local government entity that on exit from the Fund the exit debt would be calculated on an on-going basis rather than the much more penal cessation basis and I have been fortunate to witness a number of my 3rd sector clients benefit greatly from this wholly sensible change. Some of these issues are dealt with via transferee admission agreements but not all with many legacy arrangements still in place.

What however has surprised me is that other Funds have steadfastly refused to follow suit, a position highlight by four recent exercises I have been undertaking where all the organisations hold very significant amounts of legacy Council benefits under their membership.

How can it be reasonable for an individual to work for 35 years for the Council and then move to a small 3rd sector organisation with LGPS membership for a couple of years prior to retirement and for that small organisation to inherit the past liability in full. Patently it can’t be!

The Lothian approach recognised this and provided a clear policy statement so that everyone knew exactly where they stood.

Unfortunately, while hugely welcome, even Lothian’s approach doesn’t go quite far enough. I struggle to see the difference between members who transferred across at outset (which the policy covers) and those who transfer across at a later date (who aren’t covered). The historic liability is the same. Indeed the policy also doesn’t reflect transitions from other public sector employers and schemes which results in a similar inequity.

Scottish Government missed a huge opportunity to resolve this issue when they introduced their new 2018 LGPS Regulations but unfortunately it was absent from the revisions. This is an area which could have benefited from some prescription and a clear policy statement that it is unreasonable for public bodies to expect other organisations to pick up their liabilities and that any such liabilities should be excluded in the calculation of contributions and in the settlement of any cessation liability.

With the findings of the Tier 3 review due shortly to the England & Wales Scheme Advisory Board it is to be hoped that they will deal with the issue. In the meantime Funds have the opportunity to behave fairly and responsibly and deal with their own liabilities in full.

Angela Burns

You would have to have been living on the moon over the past few months not to have seen the huge amount of press about pension transfers. Reading it you would be lead to believe that all individuals are gullible idiots and that all financial advisers are scurrilous rogues. Whilst undoubtedly there may be some who fit in to these categories it is far from all. So what is actually driving individuals to consider transferring their defined benefit pot to something with a much less certain outcome?

There is no doubt from my experience that individuals have a more unhealthy pessimism about their life expectancy than statistics would justify and a greater sense of expectation about how they can manage money than experience would suggest.

A starting premise for financial advisers when providing transfer advice is to begin with the assumption that it is not in the individuals best interests to transfer out of a defined benefit arrangement. However with more than 100,000 people having transferred out of DB schemes over the last year (according to Royal London), £10.6bn transferred in the first quarter of 2018 and no sign of a slow down – why has transfer activity increased so significantly in recent years?

Pension Freedoms

Undoubtedly the pension freedoms and choice introduced in April 2015 are the single greatest reason for the increase in transfer activity.  On transferring liabilities to a defined contribution scheme, individuals can access a range of flexibilities including:

  • Purchasing an income (always available but no longer a requirement)
  • Taking their fund as cash subject to tax charges
  • Entering into a drawdown arrangement whereby an income can be taken each year and the fund remains invested

There are also changes to death benefits whereby residual funds pass to dependants tax free on death before age 75 (previously taxed at 55%).

With this in mind, many individuals have looked to access these flexibilities.  Individuals may also feel that they get better value from transferring if:

  • They are single and would not benefit from a spouse pension on death from a defined benefit arrangement. Transferring to a defined contribution scheme means they can access the full value of their accrued benefits with nothing lost on death;
  • They are in ill health and have a lower life expectancy where greater value can be derived over a shorter term.

If an individual already has sufficient pension savings elsewhere or their spouse has material savings, then transferring part of a defined benefit to a defined contribution arrangement could provide a fund that can be taken more flexibly facilitating early retirement, a new career or even a release of early value to children or grand children.

Releasing funds to deal with debt may be more attractive than securing long term income and for those in financial hardship and accessing pension savings via a defined contribution arrangement may be their only option.

Shape of benefits

The provision of a set income increasing by a fixed rate with a spouse benefit may not provide an individual with the shape of benefits they may need or want. The ability to take more income early to facilitate early retirement for example,  and lead a lifestyle in the earlier years of retirement may be a strong driver.

Value for money

With interest rates still at very low levels and inflation relatively high, transfer values are much higher than they might have been historically and as a result, are being seen as good value.  Multiples of 30-40 times the individual’s pension are not unheard of.

Discharging pension scheme liabilities via transfer values is a lower cost option for employers and as such incentivised employer sponsored transfer exercises are still prevalent in the industry.  Individuals may view a transfer value already set at an attractive level but with a further enhancement, as too attractive to turn down.

Overall the perception that transfer values are now providing good value for money is resulting in more individuals now considering this as an option.

Risk

Finally, individuals in a defined benefit scheme with a high risk sponsor may feel that remaining in the scheme presents a risk.

Some individuals may also feel that they can manage their money better and invest their defined contribution fund in such a way that they get more at retirement.

Ultimately the decision is a highly complex one hence the requirement for anyone with a transfer value about £30,000 to receive independent financial advice is a sensible one. There are a huge amount of issues that should be considered and individuals should do what is right for them based on their own circumstances. Without this expert guidance people may make decisions which are unsuitable based upon inappropriate, misleading or indeed no information which may ultimately lead to bad outcomes.

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