News

Pensions Watch – June 2011

Modesty is not the best policy
Consultant Hymans Robertson found that 65 per cent of defined benefit (DB) pension schemes sponsored by Britain’s top 350 companies are using inflation assumptions below that implied by the conventional and index-linked gilts market (known as inflation break-evens).  In addition, and perhaps more importantly, the average differences in the longevity assumptions made by FTSE 350-sponsored DB schemes were found to be seven years for pensioners and eight years for those yet to retire.  This comes at a time when a redraft of accounting standard IAS 19, to be implemented from 2013, will bring greater transparency to the assumptions used by DB scheme sponsors in their annual accounts, which might extend to disclosing the sensitivity of scheme liabilities to changes in interest rates, inflation and longevity.   

Inflation hedging
Despite price inflation in the UK having been above the Monetary Policy Committee’s implicit and explicit targets for the past 17 months, research undertaken by consultant Redington and insurer Pension Corporation, amongst 44 pension scheme actuaries, suggests that only 15 per cent of UK DB schemes have hedged over 50 per cent of the sensitivity of their liabilities to price inflation, with 55 per cent having hedged less than a quarter of their scheme’s inflation risk.  However, three quarters of schemes expect to go to buyout or execute a buy-in within the next three years.  A buy-in is when a scheme buys an insurance policy to insure a cohort of its liabilities, typically some or all of its pensioners, against investment, interest rate, inflation and longevity risks, whereas a buyout is when a scheme is offloaded in its entirety to an insurer.   

Brisk business expected in risk transfer market
Following three consecutive years in which £8bn of risks residing within DB scheme liabilities were transferred to insurers, consultant Hymans Robertson expects £20bn of DB liabilities to be offloaded by the end of 2012.  One in four FTSE 100-sponsored schemes are expected to participate.  Hymans notes that increasingly these deals are being financed by scheme sponsors using their real estate assets to enter into sales and leaseback arrangements with the insurance company.  Separately, consultancy Lane, Clark and Peacock predict £10bn of risk transfer deals to be completed within 2011.  50 per cent of these are expected to be buy-ins, with the remainder allocated between buyouts and longevity swaps, which insure the scheme against its members living longer than expected. 

Prepare for the worst
Consultant Towers Watson has called on trustees to protect their schemes against those extreme scenarios, or “left-tail events”, in which both the sponsor covenant and the value of the scheme’s assets could be severely impaired.  In mitigating these unwanted correlations between the sponsor’s financial position and the scheme’s asset portfolio, the firm’s Thinking Ahead Group has suggested that trustees could finance the requisite protection by selling some of the potential upside to the scheme’s asset portfolio. 
Separately, consultancy PensionsFirst pointed out that over the past eight months, assets held by FTSE 100-sponsored DB schemes have increased by £29bn, while liabilities have fallen by £25bn.  As such, the firm suggests that many schemes are missing out on the opportunity to de-risk their asset portfolios, just as they did immediately prior to the financial crisis of 2008.

Royal Mail slashes deficit 
The collective IAS 19 deficit of the Royal Mail’s two DB pension schemes has been nearly halved to £4.5bn, principally by moving the basis of the schemes’ statutory minimum indexation from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI).  In addition, the company’s regular contributions have recently fallen from £526m to £442m in line with lower pensionable pay and a reduction in the regular rate of employer contributions from 20 per cent of pensionable pay to 17.1 per cent.  Employee contributions remain at six per cent.  Despite this, the company continues to be technically insolvent and its 38 year recovery plan, agreed at its last triennial valuation, remains in place.   The taxpayer is due to assume responsibility for the scheme deficits in advance of the company's privatisation.

RPI annuities
According to Financial Adviser Hargreaves Landsdown, a man aged 65 today would need to live to 96 for the payments from a RPI-linked annuity to match those of a level annuity, assuming that RPI from hereon averages that of the past 20 years.  In fact, assuming average male longevity at age 65 of 17.8 years, inflation would need to average four per cent per annum for our 65 year old man with a RPI-linked annuity to match what he would have received from a level annuity.  

Heads I win, tails you lose

No, this isn’t a typo.  With all the talk of rising long-term interest rates on the horizon (though we have been here before), the gradual move from RPI to CPI and two years of strong investment returns, attention has begun to focus on the prospect of scheme surpluses arising (they already have for the Marks and Spencer and London Stock Exchange schemes) and the thorny issue of their ownership.  Since the legislation that required surpluses to be used to enhance member benefits by up to five per cent with the remainder passing to the sponsor was scrapped in 2006, pension lawyers remain divided.  However, until the surplus reaches a level at which the scheme can go to buyout, it very much remains the property of the scheme despite the fact that a solvent sponsor remains responsible for any deficit. 

Alexander acts to stem public sector scheme exodus fears
As a consequence of the benefit dilution measures resulting from the recent Hutton Report to be implemented to public sector DB schemes from 2012, and the employee contribution hikes currently being determined by the Treasury to also take effect from 2012 (see “Hutton avoids race to the bottom”, Pensions Watch, March 2011), fears of mass scheme opt outs by public sector workers have become a distinct possibility.  However, in an attempt to temper these fears, Danny Alexander, Chief Secretary to the Treasury, confirmed that all public sector employees earning less than £15,000 will not be required to pay increased contributions and those earning below £18,000 will be subject to contribution increases capped at 1.5 per cent.  Other public sector staff will pay additional contributions at a level to meet an average across-the-board 3.2 per cent contribution hike.

That said, these fears remain real and could impact the economics of a number of funded public sector schemes.  For instance, according to an unnamed firm of actuaries, a potential 30 per cent loss of membership from the funded Local Government Pension Schemes (LGPS) could see the schemes operating on a less sustainable footing as benefit payments would exceed income from contributions and investments.  Moreover, given the implementation of an annual ceiling to government funding of public sector schemes, this might demand a dramatic change in investment strategy, which in itself could potentially store up problems for the future.  The LGPS collectively has £140bn of assets and a £71.5bn deficit.

School’s out
Teachers have voted overwhelmingly in favour of strike action over a threat to their pensions – a move which could lead to millions of children at both state and independent schools being sent home from school later this month.  Voting for its first national walkout in its 127-year history, members of the Association of Teachers and Lecturers (ATL) will be joined by those of the National Union of Teachers (NUT) and the University and College Union on 30 June – the date for the first strike action – with the prospect of more strikes to come in the autumn.  A third teachers' union, the National Association of Schoolmasters Union of Women Teachers, could also join the dispute.
Under the proposed changes, teachers' pension contributions will go up from 6.4 per cent to 9.8 per cent.  In addition, the retirement age will eventually be increased to 68, in line with increases in the State Pension Age, and there will be a prospective 15 per cent reduction in the size of the pension given the move from RPI-index linking to CPI.   Moreover, teachers in independent schools may no longer be eligible for the scheme – which at present covers all schools in England and Wales.
Wish you were here

Travel agent TUI has agreed with the trustees of its DB scheme to the shared ownership of its Thomson, Late Rooms and First Choice brands, collectively valued at £275m, saving itself £38m in annual contributions.  The deal will see the scheme receiving £33m annually with a royalty of 1.6 per cent of TUI’s profits for the next 15 years. 

Dodgy data
According to the pensions practice of accountant KPMG, in polling 16 UK DB schemes collectively with over 100,000 members, faulty and missing scheme member data, such as wrong joining and leaving dates and missing national insurance records, is costing schemes around £50bn per annum, equivalent to around five per cent of UK DB scheme liabilities.  It would seem that it will be some time before most schemes meet the Pension Regulator’s data quality targets.  
And finally…   

Whatever happened to Captain Birdseye’s pension?

The Fishermen’s Pension Scheme is to be wound up in 12 months time, despite having holes in its data records which have left more than a half of its members untraced.  The trust-based pension scheme ran for nearly 20 years from the early 1960s, with members contributing six old pence (2.5p) and employers nine old pence (3.75p) per month, accruing average payouts of £580.  However, the scheme was run chaotically, with just the initial and surname of each member being recorded, addresses rarely being updated and no national insurance numbers taken.  To date only 5,350 of the scheme’s near-12,000 members have been traced and the likelihood is that the near-£2m of unclaimed funds will be distributed amongst the identified scheme members.  For the record, Captain Birdseye was played by actor John Hewer, who sadly passed away in 2008 aged 86.

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