News
Pensions Watch - Issue 21
Ringing in the changes
The £37bn BT defined benefit (DB) pension scheme, the UK ’s largest with 344,000 members and an estimated £16bn shortfall, could soon be moving future accruals to a career average earnings
basis, changing the accrual rate for post-1986 members from 1/60th to 1/80th, raising the normal retirement age from 60 to 65, and increasing contributions for all but those members who joined the scheme before 1972. Meanwhile, BT and the government continue to wrestle over whether and to what extend the telecom group’s DB liabilities are covered by the Crown Guarantee, purportedly given when the firm was privatised in 1984 via the Telecommunications Act 1984, in the event of BT becoming insolvent. In addition, the company’s two defined contribution (DC) schemes will combine into a single DC scheme for the company’s 20,000 DC members, potentially saving the fixed line telecoms operator a further £100m a year.
Risk and reward
Those DB pension schemes which pursue lower risk investment strategies are to be rewarded by the Pension Protection Fund (PPF), the DB scheme financed safety net put in place in April 2005 to protect scheme members against sponsor insolvency, with lower levies. This change, which seeks to align the levy with the long term risks each scheme poses to the PPF, is unlikely to be implemented much before 2011/12, and will probably coincide with the adoption of a medium term assessment of the sponsor’s risk of insolvency, so as to minimise the volatility of the annual levy charged to individual schemes. The levy, which is currently 80% weighted to Dun & Bradstreet’s assessment of the risk of the sponsor’s insolvency over the next 12 months and 20% weighted towards the size of a scheme’s PPF liabilities, applies to all schemes whose PPF liabilities are less than 140% funded. In the meantime, the levy for 2009/10, which is likely to rise in line with average earnings, is set to generate £700m for the PPF; an increase of £25m on the £675m raised in 2008/09.
Trigger happy
Of all the Pensions Act 1995’s 181 sections, “section 75” is one of the few that since its inception has been referenced by its section number rather than by its title or effect (and continues to be known as “section 75” despite the amending regulations of the Pensions Act 2004). Redefined in April 2005, after Maersk, the solvent Danish shipping group, wound up its UK-based Sea-Land Services DB pension scheme in 2003 with liabilities only funded to the, totally inadequate, Minimum Funding Requirement (MFR) level (but later voluntarily plugged the scheme’s £5m deficit), a section 75 debt (to give it it’s extended title) – the requirement to fund a DB scheme to buyout level - is triggered when a sponsor either winds up a DB scheme or divests itself of a division with a DB scheme. However, responding to repeated calls from the CBI , on behalf of an increasingly beleaguered UK plc, that the provision hampers corporate restructuring, Rosie Winterton, the newly appointed Pensions Minister, has launched a month-long informal review of this cornerstone of pension scheme member protection, to be followed by a wider public consultation in February next year. The end result could well be diluting the funding of a section 75 debt to the PPF protected rights level.
It pays to be a Trustee
Against the backdrop of the demise of the City bonus culture, Mercer report that the median pay rates of Trustee Chairs have risen by 14% to £20,000 over the past year, whilst those of the median Pensioner Trustee have sky-rocketed by 80% to £9,000. According to Mercer, “schemes are recognising that trustees should regard themselves as directors of multi-million pound businesses.”
How refreshing.
The dash for cash
As a consequence of the dramatic fall in global equity markets and the comparative calm in fixed income markets (everything is relative), many DB schemes have experienced a substantially reduced strategic weighting to equities. However, rather than redress the balance, a number of schemes have been forced to exacerbate this strategic underweighting by selling equities to meet ongoing expenses and member benefit payments, owing to equities currently being a more easily realisable asset than bonds. In addition, some schemes, following the example of the mighty Harvard Endowment and a number of family offices (wealthy families who employ their own dedicated wealth manager to manage the family wealth), have also begun to offload their private equity holdings through the heavily discounted, but increasingly liquid, secondary market (increasingly liquid as the 50+% discounts on offer begin to reel in the buyers).
Living life to the full
Research from consultant Hewitt Associates suggests that 98% of DB schemes are now using the “medium cohort” (prepared by the Continuous Mortality Investigation Board (CMIB) of the Institute and Faculty of Actuaries) as the basis for scheme mortality assumptions, with an increasing number of schemes reviewing the rate of mortality improvement, or “underpin”, that should be built into scheme liabilities. However, as the medium cohort only builds in recent yearly rates of longevity improvements until 2020 (by contrast the “long cohort”, initially favoured by The Pensions Regulator, extends these improvements to 2040), a separate report, compiled by Alistair Byrne at the University of Edinburgh Business School, suggests scheme liabilities could still be understated by as much as 5%, making longevity the second largest contributor to scheme risk after investment risk. Meanwhile, consultant Hymans Robertson’s new longevity research venture, Club Vita, has found that, aside from gender, lifestyle is the single largest contributory factor to longevity. In particular, those who retire later tend to live longer.
And finally…
Untimely demise halts longevity plans
Whilst on the subject of longevity, former Wall Street investment bank Lehman Brothers had planned to launch a longevity swap – a means by which schemes could hedge longevity risk – but its sudden demise on September 15th ironically put paid to this initiative (and, in turn, put the management of another risk, counterparty risk – the risk of the other side of a transaction, typically an “over-the-counter” derivatives transaction, not fulfilling its obligations – firmly on trustees’ radar).
