Pensions Bulletin 2016/50

LCP reports on ten years of pensions de-risking

LCP’s leadership in pensions de-risking is illustrated in our latest annual report on the buy-in, buy-out and longevity swap market. Designed to help finance directors, trustees and other senior decision-makers understand opportunities available for transferring the risks associated with DB plans, this year’s report contains a market review and outlook, articles on managing longevity risk and an examination of the options available for smaller pension plans.

Amongst the wealth of information contained within it, the report shows how the de-risking market has evolved since 2007 (with 2016 marking the point where over one million people in the UK have now been insured through a buy-in or buy-out), a prediction of new records being set in 2017 and LCP’s position in the market – winning no less than 8 out of 9 pensions industry de-risking adviser awards since 2011.

Comment

This is a comprehensive read for those interested in passing pension risk to insurers, illustrating the strength and depth of this now well-established market.

Landmark review of auto-enrolment launched

Pensions minister Richard Harrington has announced that the widely anticipated review of the system of auto-enrolment will go ahead next year. More information is in the Government press release. The review will consider the success of auto-enrolment to date and explore ways that the policy can be further developed.

Through this policy almost seven million people have been enrolled into a pension scheme by nearly 300,000 employers. This is expected to lead to around 10 million people newly saving or saving more by 2018, generating around £17 billion a year more in workplace pension saving by 2019/20.

The review will:

• Gather evidence on groups such as people with multiple jobs who do not qualify for auto-enrolment in any single job
• Consider how the growing numbers of self-employed people can be helped to save for their retirement
• Examine the thresholds for triggering saving and the age criteria for when people will start to be auto-enrolled
• Consider whether the technical operation of the policy is working as intended and whether there may be any policies which disproportionately affect different categories of employers or could be further simplified; and
• Include the statutory review of the alternative quality requirements for defined benefits schemes and the certification requirements for money purchase schemes

The review will also examine the level of the charge cap, assessing whether it should be changed and whether some or all transactions costs should be covered by the cap.

The review will led by a DWP team supported by an external group chaired by and made up of experts from within the pensions industry, and people who will also represent member and employer interests. The Government will announce membership and the terms of reference for this group in early 2017 and intends to publish a report with policy recommendations towards the end of 2017.

Comment

This will be a highly significant exercise. The implementation of auto-enrolment to date has been a great success but this review, five years since the first employees were auto-enrolled, will guide how it develops in future.

As all commentators are agreed that the minimum contribution rates currently required for auto-enrolment are woefully inadequate for a decent level of retirement income, all eyes will be on whether they will be increased, from when and by how much.

DWP publishes its latest progress report on auto-enrolment

The DWP has published its annual evaluation of how well the implementation of auto-enrolment is going. It all looks good so far, some highlights being:

• Up to the end of October 2016, more than 6.87m workers have been auto-enrolled into a workplace pension, with 265,000 automatically re-enrolled
• 15.1m employees are participating in workplace pension membership – up from 10.7m in 2012; and
• By the end of March 2016, NEST, the government-sponsored auto-enrolment vehicle, has more than 3.2m members with over 86,000 employers participating – up from 2m and 14,000 respectively last year – with assets under management of around £827m compared to £420m the previous year

The report concludes that auto-enrolment remains on track.

Auto-enrolment parameters for 2017/18 settled

The time of year has come around again when the Government sets the earnings trigger and qualifying earnings band for auto-enrolment purposes in the following tax year.

A review has now been published in which the Government concludes that for 2017/18 the earnings trigger will remain at £10,000pa and the lower and upper limits for qualifying earnings will remain linked to the national insurance lower earnings limit and upper limit and so rise to £5,876pa and £45,000 respectively.

We expect regulations to this effect to be laid early next year.

Comment

For some while now there has been criticism of the way in which these key parameters result in a significant section of the working population not being brought within scope of auto-enrolment. The logic for doing nothing this year is a little more understandable given the launch of the auto-enrolment review.

Company balance sheets threatened by proposed accounting rules

Proposals discussed this week by the International Accounting Standards Board could mean many companies have to show large extra liabilities on their balance sheets in future.

On 13 December the IASB met to approve the proposals, which affect companies accounting under the IAS 19 pensions accounting standard. This follows an exposure draft published in 2015 (see Pensions Bulletin 2015/27) proposing amendments to “IFRIC 14” – a document setting out additional rules on IAS 19.

The IFRIC 14 proposals are intended to clarify and tighten up complex rules, which in some circumstances require companies to reflect the funding contributions agreed with pension scheme trustees as a liability on the company balance sheet. These liabilities can be much bigger than the normal IAS 19 deficit figure, causing problems for those companies caught up.

The latest proposals differ from last year’s exposure draft in a crucial respect:

• Under the 2015 proposals, companies had to consider whether trustees had a unilateral power to “wind-up” the plan – a relatively rare power. If the trustees had such a power, the company might well have to show extra liabilities
• Under the current proposals, companies have to consider whether trustees have a unilateral power to settle all the plan benefits (eg via buy-out) – a much more common power. This means many more companies could be faced with having to record extra liabilities in future

It is planned that these new rules will come into force for accounting periods beginning on or after 1 January 2019.

Comment

IFRIC 14 has long been a “legal lottery” for companies sponsoring pension schemes. Depending on obscure details of the pension scheme trust deed and rules, companies may or may not have to show large extra liabilities on the balance sheet. The latest proposals could mean many more companies are losers in this legal lottery. These losers will have to show far higher pension liabilities than other companies, purely because of legal and accounting details rather than because of substantive differences in their pension liabilities. This cannot be a good thing.

The proposals are not expected to come into force until 2019, and therefore will not directly affect companies preparing their accounts at the end of this year. Nonetheless, given the size of the potential problems, companies should consider getting specialist advice to assess whether their balance sheet is under threat, and if so, what they can do about it.

This year’s Purple Book reveals stable trends

Every year the Pension Protection Fund publishes a “state of the nation” review of where the nearly 6,000 DB pension schemes eligible to enter the PPF in the UK are at in terms of their demographics, funding and investments.

This time last year (see Pensions Bulletin 2015/52) the PPF, together with the Pensions Regulator, produced a “state of the decade” Purple Book. The PPF has now published this year’s Purple Book, the headlines of which are:

• Schemes closed to future accrual rose again (from 34% to 35%), the percentage of schemes that are open remained at 13% and the proportion of members who are active fell from 16% to 13%
• Scheme funding improved a little between end-March 2015 and end-March 2016 resulting in the aggregate deficit, measured on the PPF valuation basis, falling from £244.2bn to £221.7bn while the aggregate funding ratio rose from 84.2% to 85.8% – however, this ratio deteriorated markedly to 78.3% by end-August 2016 largely because of the sharp fall in gilt yields following the EU referendum
• The proportion of assets invested in equities fell from 33.0% to 30.3% while the proportion in bonds rose from 47.7% to 51.3%. The share of other investments fell again – from 19.3% to 18.4%. Within this, the hedge fund share rose for the seventh successive year, to 6.6%, but this was more than offset by falls in the shares of cash and “other”
• The proportion of UK-quoted equities in total equity holdings fell again from 25.6% to 22.4%, while the overseas-quoted share increased from 65.4% to 68.6%
• Within bonds, the corporate fixed interest securities’ proportion decreased from 37.7% to 33.7%. Meanwhile, the proportion of government fixed interest securities rose from 20.3% to 21.9%. The balance of holdings in index-linked securities also rose to 44.4% from 42.0%

Comment

The Purple Book is one of the most authoritative datasets about DB schemes available and reading it one can see the rocky ride that many schemes have had this year, although the August cut-off date does hide the slight bounce-back that might have happened to gilt yields since.

PLSA annual survey shows significant increase in DB operational costs

The Pensions and Lifetime Savings Association has published its 42nd annual survey of its members, providing an insight into the pension provision of some of the UK’s largest employers and pension schemes. The survey highlights that costs for operating DB schemes have increased by 37% since 2015.

This increase is largely driven by increases in fund management and custody costs, up 32%. Smaller schemes, those with 5,000 or fewer members, have seen the greatest rise in running costs with an average increase of 63%.

In 2016, only 10% of DB schemes were open to new members compared to 21% in 2015. That figure is only 4% in the private sector. The PLSA says that rising costs, as well as economic volatility and low interest rates, are proving key factors in the decision to close to new members.

DC schemes continue to grow, thanks to auto-enrolment, with master trusts playing a significant role – between June 2015 and June 2016 they enrolled an estimated 1.8 million new members.

Within DC schemes the average employee contribution rates remain at 4.2% (same as 2015) and employer contribution rates sit at 7.9% (8.0% in 2015). Savers continue to benefit from low charges, with the average annual management charge of 0.4% as it has been for a number of years.

A copy of the survey (in pdf format) can be purchased via the PLSA’s website “Shop”.

New technical standards will apply to all actuarial work

The Financial Reporting Council has issued a new suite of Technical Actuarial Standards that will apply to all “technical actuarial work” from 1 July 2017. These TASs will replace the existing ones on Reporting (TAS R), Data (TAS D), Modelling (TAS M), Pensions, Transformations, Insurance and Funeral Plans. The change is the culmination of a project launched in November 2014.

The big change is the increase in scope – TAS 100 (which replaces TASs R, D and M) will apply to all “technical actuarial work”; broadly work which requires use of actuarial principles/techniques. To balance the increase in scope, the principles within TAS 100 are generally higher level than the corresponding principles in TASs R, D and M.

The Pensions TAS and the pension elements of the Transformations TAS have been combined within the new TAS 300. This applies additional principles to those areas of work thought to be most in the “public interest”. The areas covered by TAS 300 include scheme funding (from both a trustee and employer perspective), individual calculation factors, incentive exercises, scheme modifications, bulk transfers and debt calculations.

The full suite of documents includes a feedback statement on the consultation, a framework document, a glossary and track-changed versions of the TASs.

Although the new TASs come into force from 1 July 2017 early adoption from 1 April 2017 is permitted.

Comment

The expansion in scope of the TASs is generally welcome, but there are some areas (for example, much of the work performed by in-house actuaries) that do not sit comfortably within the TAS framework.

The new TASs are much improved, being both more user-friendly and much shorter than their predecessors. We do, however, note that scheme funding valuation work for scheme sponsors has been added into the scope of TAS 300 with little in the way of formal consultation. Such a big change should perhaps have been discussed more widely before incorporation.

Industry-led proposals published to improve pension and investment transfer process

Eight investment and pension trade associations, under the collective banner of the newly formed Transfers and Re-registration Industry Group, have published a consultation paper that examines ways in which the process of transferring and re-registering pension and investment assets can be improved.

Transfers are defined as the movement of assets in the form of cash between providers. Re-registrations are defined as when the assets themselves are moved between providers.

The review was set up following discussions with the Financial Conduct Authority in March 2016. Targeted at the FCA-regulated sector, it is suggested that if this initiative is unsuccessful, then there is a likelihood of regulatory intervention from the FCA in the future in relation to the firms they authorise.

The Group makes five suggestions:

• Create clear service expectations, including a 48 hour standard for completing each step in the process
• Collect high level management information and establish a common reporting methodology
• Create a forum to identify, prioritise and implement solutions that resolve unnecessary barriers
• Develop common industry standards and good practice guidelines for the retail investment and pensions industry; and
• Establish an independent governance and oversight body to oversee the implementation of the final proposals

The consultation paper argues that there is room for improvement when it comes to DC pension transfers, illustrating this by a table showing turnaround times that are significantly higher than when the same asset types are being transferred between non-pensions wrappers. It is particularly concerned when it comes to small single employer trust-based pension schemes.

The Pensions Regulator, HM Treasury and the DWP have also been consulted (amongst others). The consultation paper notes that the Government is committed to the development of Pension Wise guidance (a pensions transfers “roadmap”) and making trust-based pension schemes more transparent and accountable for their performance in processing transfers through a new reporting regime (see Pensions Bulletin 2016/06). On this, the authors understand that the issues are currently being progressed by Pension Wise, the Pensions Regulator and the DWP.

Consultation closes on 31 January 2017 with a final set of recommendations due to be published in spring 2017.

Comment

Other than as reported above, there is little that is pension-specific in this consultation paper. However, it is clear that improvements are necessary across the whole gamut of transfers and re-registrations. On this, it would seem that an industry-led approach, with Government backing, is likely to be more effective than regulatory intervention.

Pensions Regulator guides Monarch Airlines scheme to the Pension Protection Fund

A regulatory intervention report published by the Pensions Regulator provides yet another illustration of the use of a regulatory apportionment arrangement to manage an otherwise likely uncontrolled insolvency, but in this case with the clear objective of bringing the stressed DB scheme safely into the Pension Protection Fund.

After a false start when the trustees offered to buy the failing business, a turnaround specialist was identified that was willing to step in, but only if the DB scheme could be separated from the business. A regulatory apportionment arrangement was proposed and subsequently improved from a pension perspective when the Regulator had concerns that the scheme was not being treated fairly compared to other unsecured creditors. The normal tests were applied by the Regulator, which amongst other things concluded that insolvency was otherwise inevitable and there was no evidence of avoidance activity. The deal was completed in October 2014.

Separately, the PPF reports that the Monarch Airlines Limited Retirement Benefits Plan completed its transfer into the PPF in November 2016.

Comment

As is often the case with these regulatory reports, it is not as complete a rendition of the story that readers might like to see. Whilst it is clear that the revised offer was an improvement on the first, the extent to which the deal constituted “a better outcome for the scheme” than had insolvency been allowed to occur is not made clear. And of course, it is not the scheme that is benefitting in this case, but PPF levy payers.

HMRC addresses a pot pourri of topics in its latest pension schemes newsletter

The pensions measures announced in the Autumn Statement and draft Finance Bill form the opening topic in HMRC’s Pension schemes newsletter 83, which goes on to address a whole range of other issues, mainly of relevance to pension scheme administrators.

However, under “Lifetime allowance” it usefully mentions an addition to the functionality of the Lifetime Allowance Online Service. Individuals who have protected their pension savings online are now able to amend their protections themselves – such as if they have made mistakes with the values when they applied, or if they have pension debits which affect the amount they have protected. But if anyone loses a Lifetime allowance protection, they need to inform HMRC in writing.

Pension providers making good progress on reducing fees and charges

The DWP says that pension providers have made significant progress towards meeting the recommendations of the Independent Project Board to reduce costs and charges in certain legacy DC schemes. However, progress remains unsatisfactory or unclear in a minority of cases. Richard Harrington has said that he will be seeking assurances from the providers of those schemes that they will be taking steps to resolve this issue.

The details are contained within a report published by the DWP and the Financial Conduct Authority.

The report follows a recommendation for such a joint review in the Independent Project Board final report in December 2014. The IPB was established by the Association of British Insurers in response to the Office of Fair Trading’s 2013 market study which found that £30bn of savers’ funds in DC workplace pensions was at risk of delivering poor value for money.

ACA reports likelihood of big shift in typical retirement ages over the next decade

The Association of Consulting Actuaries, in its third interim report taken from its 2016 smaller firms’ pension survey, reports a big shift in such firms’ expectations of the typical retirement age of its employees over the next decade or so as State Pension Age is raised.

35% of respondents report that the typical retirement age of their employees is currently 66 or above, as opposed to just 8% two years ago, with the change most marked amongst firms employing fewer than 50 employees. And looking ahead, many employers expect that typical retirement ages in the smaller firms’ sector will outpace the increases in State Pension Age already legislated for.

In relation to the current review of State Pension Age (see Pensions Bulletin 2016/47), if there is to be any further change, by far the most popular option would be to allow a flexible State Pension Age from age 66.

Comment

This snippet is an interesting insight into changes in retirement age, almost certainly driven by stretched personal finances since the economic downturn and aggravated by quantitative easing. It is also a further pointer to the possibility that we may get more than a simple further raising of the State Pension Age next May.

Covenant advisers examine transactions in a non-distressed environment

The Employer Covenant Working Group, a forum established for employer covenant advisers to discuss best practice, raise standards and promote awareness, has followed up on an earlier publication (see Pensions Bulletin 2016/15) by looking at a range of corporate transactions in a non-distressed environment.

In its latest guidance, the Group seeks to assist practitioners in evaluating the impact of such transactions on the covenant of sponsoring employers, the risks to the security of member benefits and in considering what mitigation might be appropriate where material detriment to covenant arises or is likely to arise.

Four types of transaction are considered, with the guidance utilising a number of case studies to illustrate the judgments that need to be made. The guidance also comments on a number of practice matters including arrangements with confidential information and interacting with trustees.

Comment

Once more this is a very accessible publication, not only for covenant advisers, but also for those who wish to find out more about the way in which such advisers go about their work.

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.