Connected Research

Union policy research in the 21st century

Posts Tagged ‘Defined benefit

PPF index shows a slight slip

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The Pensions Protection Fund published the PPF7800 Index today for the end of April, showing the state of health of the 7,400 pension schemes under its supervision.

The Index is currently showing a small net deficit, of £2.2bn, reversing March’s small surplus (£0.3bn). Given the growing turmoil in currency markets during April associated with the financial and economic situation in Greece and other small EU countries, something which was only capped this week with the agreement between EU finance ministers, a drop of the Index back into negative territory is not surprising but the small-scale nature of the drop was a surprise, and a particularly welcome one.

Some 69% of schemes were in deficit this month, more or less the same as the 68.5% in March, which seems to support the view that the picture is, essentially, little changed. Evidently, this remains an uncomfortable proportion of schemes in deficit, even if the overall net balance of assets and liabilities lends the view that the average scheme is not all that much in deficit. The total assets of these schemes reached £913bn, a drop of 0.2% over the month and an increase of 18.2% since April 2009; total liabilities stood at £915bn, a small increase on the month but a drop on the £961bn recorded in April 2009.

During April, the value of both assets and liabilities deteriorated, the latter by more than the former (hence the drop of the net figure into negative territory). Over the year as a whole, rising stock markets have added 16.4% to pension scheme assets, while rising bond yields have added only marginally to liabilities.

So, overall the picture continues to be encouraging, although the change in the actuarial assumptions underpinning the calculation of the Index in October last year continues to affect the figures. Caution remains necessary – pension schemes are far from out of the woods just yet.


Written by Calvin

11/05/2010 at 9:09 pm

IASB puts up new Exposure Draft on pensions accounting

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The International Accounting Standards Board has put up a new Exposure Draft proposing amendments to the accounting regime for defined benefit pension schemes.

The Exposure Draft is, essentially, the accounting profession’s way of publicly consulting on changes to the accounting standards which govern financial reporting regimes. Like everything else, accountancy is governed by global standards which seek to harmonise how accountants report company accounts; unfortunately, IAS19, which governs how defined benefit pension schemes are accounted for, is subject to the same short-termist approach as the rest of the corporate world, implying that it is inimical to the long-term nature of defined benefit pension schemes. Both it and its predecessor in the UK (FRS17) have been blamed, at least partly fairly, for contributing to the rush to close DB schemes.

The IASB has already been through a lengthy consultation process on its preliminary views on refining how defined benefit schemes are financially accounted for; this new consultation runs until early September this year. The Draft is available for public comment and the IASB aims to finalise its plans by mid-2011, with a view to the new standard becoming effective in 2012 or 2013.

The new Exposure Draft seeks to ‘improve’ (in the context, a word full of dread!) pension scheme accounting by requiring companies:

– to account immediately for all estimated changes in the cost of providing pension benefits and all changes in the value of plan assets

– to use a new presentation approach that would clearly distinguish between different components of the cost of these benefits

– to disclose clearer information about the risks arising from defined benefit plans.

Some of this inevitably needs decoding. According to KPMG, what this means in practice is that companies will henceforth have to stop booking a ‘profit’ in their accounts equivalent to the gap between expected investment returns and the interest cost paid on pensions liabilities. This ‘pensions credit’ is, essentially, a way of recording a paper profit from the pension scheme where schemes’ investment returns are higher – as they usually are, where schemes are investing in equities – than the AA corporate bond yield used to discount liabilities. The introduction of the amendments to IAS19, which will require the assessment of investment returns to be based on the same yield on AA corporate bonds, thus effectively ending the credit, will, clearly, lead to greater transparency in accounts – and, at the same time, to a further reduction in the attractiveness of running DB pension schemes.

KPMG’s press release quotes that this will ‘cost’ UK businesses £10bn in lost earnings, with the largest schemes facing a ‘loss’ of £50m per annum, while the ubiquitous John Ralfe believes that this will ‘cost’ BT £750m (turning a £500m ‘profit’ from the scheme on the existing basis into a £250m ‘loss’ under the new one). Ralfe has a long-standing antipathy to schemes investing in equities – as this blog has previously observed. In terms of the actual cost in individual cases, much would seem to depend on how much schemes have invested in equities – though (perhaps to disappoint Ralfe) this is unlikely to result in schemes adopting more cautious investment profiles in the interim.

Will it make much difference? Yes, clearly, to those schemes which remain open to future accrual (the BTPS among them): changes in accounting rules which take money away from the profit and loss account – however much such money was paper only, and regardless of whether pension schemes should have been used in this way to boost earnings – will have an impact on ordinary workers since that ‘profit’ will have to be found from elsewhere so as to retain the level of earnings. Whether it will lead to more schemes being closed, given the numbers of schemes which have already come crashing down and the weight of other arguments against running DB provision which already exist, is a moot point.

Certainly, however, it – together with the requirement for further ‘clarity’ on the risks associated with defined benefit provision – can’t help; I’m almost of the view that it’s the latter that is the most damaging feature of all this: regardless of the ‘losses’ which need to be made up, having to write (or read) even more stuff in company accounts about just how much risk is posed by running a defined benefit scheme may well end up wearing down even the most resilient of corporate defenders of DB provision.

Clearly, these remain tough, and worrying, times for DB schemes, and most of all for the members of them.

Written by Calvin

30/04/2010 at 6:19 pm

Posted in Pensions

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Pension Trends: ONS speaks on contributions

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The Office for National Statistics produced the most recent instalment of its ongoing Pension Trends publication, which it appears to update on a rolling basis, last Friday. This most recent update is for Chapter 8, on pensions contributions.

The headline stuff from the report, and the policy implications that flow from it, has been pretty well rehearsed – and is also there in one-page summary at the start of the document. Total contributions into pension schemes went down in 2008, for the first time since the series began in 1995; while the level of total saving in DC schemes, at around 9.1% of salary, not only compares poorly relative to the level of contributions going into DB schemes (21.5%); but also in absolute terms, in the context of the levels of contributions generally thought necessary to produce a decent income replacement rate in retirement. Employers pay around 70% of the contributions, which closely aligns with the policy of the Connect Sector of Prospect for a split of two-thirds: one-third between employer and employee contributions.

These things we know (not least because the ONS has already reported them in its annual survey (press release; report). What I did find particularly interesting about the updated chapter 8, however, was Table 8.14, which reports the changing levels of employer and employee contributions since 2001 by type of scheme; specifically, funded and unfunded ones.

This reports that employer contributions into funded schemes has more than doubled since 2001, to 32.7% (although now apparently off its peak), while the employee contribution has also risen, to 7.1%. In unfunded schemes, the employer contribution has also risen, to 14.8%, but it is the employee contribution that has more than doubled, to 7.5%. Thus, the ordinary members of unfunded schemes are actually paying a higher level of contribution into their pension schemes than are members of funded schemes, in absolute terms, as well as a higher proportion of the employment-based costs of such schemes.

Well worth bearing in mind when considering the position of unfunded schemes and the debates over pensions provision in the UK.

Meanwhile, Philip Inman has an ill-considered and over-the-top piece in The Guardian today which purports to name ‘the California teacher, the BT engineer and the German car worker‘ as ‘the real villains of the piece’ in the global economic crisis, as a result of their membership of occupational pension schemes (the California teachers pension is the second largest in the US; the BT Pension Scheme is the largest private scheme in the UK; and the German car worker – well, it fits the thrust of Inman’s story). According to Inman, it is chasing the level of returns required to finance an ‘otherwise unaffordable’ retirement, forcing investors to ‘stop at almost nothing to win big’, which is to blame for creating the global asset bubbles which led to the crisis. Hold the history books! I thought it was greed that got us in this mess, when after all it was ordinary folks just trying to do an honest job to give us the retirement pensions that we so unreasonably demand…

Bearing in mind that very recent ONS data records that pension funds only account for around one-eighth of the UK stock market, and consistently so since 2006, it’s a little difficult to believe that yours and my pensions are really at fault for investment managers’ speculative activity: still less to pin it down to the ‘greed’ of workers for an ‘affluent retirement’ via their membership of occupational pension schemes. More prosaically, schemes will invest in a variety of investment vehicles commensurate with the age profile of their members. Some of that will be in high risk assets; some in low risk ones. According to its most recent Annual Report, the BTPS invests some 41% of its assets in low risk vehicles such as fixed interest accounts and inflation-linked savings; a further 11% in property, 35% in shares and 12% in alternative investments. That doesn’t look so irresponsible to me, still less the sort of investment profile which gives a green light to investment managers to ‘rape and pillage’ on their account.

A rather shameful piece in this respect, Mr. Inman.

During April and May, the Connect Sector of Prospect is asking branches to help members understand the importance of pension provision and the advice they can get from the union in this area: if anything in this post confuses, concerns or alarms you, why not have a word with your branch principal officers and try and arrange something which seeks to respond to your concerns?

Written by Calvin

12/04/2010 at 4:18 pm

CBI on public sector pensions

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The CBI has put out a report today on public sector pensions (press release; report).

The CBI claims to speak for businesses which ’employ around a third of the private sector workforce’ and to ‘communicate the British business voice around the world’. So, I’m almost tempted to ask ‘what has public sector pensions got to do with you?’ – except, of course, that decent quality public sector schemes highlight the decline into sheer inadequacy of pensions provision across much of the private sector and may also – in somewhat better times – act as a source of pressure on the private sector to improve its own levels of provision. So, the ‘voice of business’ has indeed a very clear reason to intervene in the debate on public sector pensions.

Aside of the usual prejudice in the report – for example, the continued misuse of the total size of the deficit in public sector schemes, as if bill had to be paid now rather than amortised over a period extending well into the future – what is the CBI actually saying should happen to public sector pensions?

No changes to existing accrued rights – that’s clear. But, for the future, what it wants to see is higher retirement ages for all staff, not just new joiners, and for all public sector workers to be moved off defined benefit provision (including career average schemes). Funded schemes (within this context) would be able to choose their own route, while those in unfunded schemes would be shifted into a new type of provision called ‘notional DC schemes’. Here, contributions are built into a series of personal accounts but, instead of being invested in the stock market, are revalued in line with rises in earnings or prices before being used at retirement to buy an annuity.

The CBI doesn’t state what sort of pensions it expects these personal accounts to buy. Over time, and taking a long-term view of pensions investments, simple revaluation is, however, likely to lead to much smaller individual pots than even a ‘conventional’ DC scheme invested in a range of types of investment commensurate with an individual’s age and risk profile. Consequently, notional DC schemes are likely to lead to much smaller pensions.

This leads me to a couple of points:

1. Why does the CBI expect public sector workers in unfunded schemes to have retirement pensions which are substantially poorer than existing DC provision?

2. As a society, do we really want the burden of paying additional state benefits to people unfortunate enough to be in such schemes? The switch to DC schemes in the private sector is already loading the state with additional, and unpredictable, burdens in the future as a result of the pensioner poverty that will be the result; do we really want further burdens from forcing public sector workers into even poorer schemes?

Having a majority of public sector workers in these sorts of schemes would certainly alleviate the potential comparative pressures on private sector employers. Establishing poorer pensions provision into the public sector increases the relative attractiveness of private sector employment – and at no extra cost. It also underpins the removal of the ‘burdens’ on business of decent pensions provision, since it helps to establish existing ‘conventional’ DC provision as the standard. (The burdens on the taxpayer of having a greater number of pensioners reliant on the state for income, and the concomitant reduction in available money to spend on CBI members’ goods and services, is perhaps a concept too far removed from the CBI’s preoccupations and thinking.)

Whether this would lead to private sector employers following suit is uncertain – and perhaps unlikely, since private sector employers are largely interested in containing costs, and switching to ‘conventional’ DC provision tends to do that within existing arrangements establishing pension contributions at fixed levels. So, this move is unlikely to form part of a further general spiral of decline on top of that already in motion. If employers did follow suit, however, it is interesting that the prospect of such poor pensions in comparison with even existing DC schemes is likely to increase pressures on those employers who had gone down such a road to raise contribution rates, since this is one of the few variables that could be changed to improve the eventual outcome.

[Same day edit: The FT‘s report of the story carries a reference to there being a cash balance element to the CBI’s proposals (in which the lump sum that members receive on retirement prior to conversion into annuity reflects a percentage of pay for each year worked, revalued in accordance with prices or earnings). If true, this would alter some of the emphasis of the last half of this post – since the pensions thus generated would be better than it envisages (while remaining poor). However, while the CBI report refers to cash balance schemes at an earlier point in the text, I can’t see there being a cash balance element to the way it writes up its proposals for a notional DC scheme (and, anyway, if it’s intended to be a cash balance scheme, why call it ‘notional DC’?]

Written by Calvin

06/04/2010 at 12:42 pm

Future pensions: the view from the NAPF mountain

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A state pension worth around 1/3rd of average earnings to provide a robust floor of benefits, supplemented by a workplace pension built around auto-enrolment and mandatory contributions, the whole supervised by a new regulatory settlement based on a standing Retirement Savings Commission analogous to the existing Low Pay Commission.

That’s the vision of the National Association of Pension Funds, the industry body representing scheme sponsors, in Fit For the Future, a new report on pensions published yesterday (press release; full report). Praised by the TUC as offering ‘serious and constructive proposals for the future of pensions‘ there’s a lot in the report to commend, as well as some items for debate.

It’s hard to disagree with the NAPF’s view of the pensions landscape: workplace saving has fallen dramatically both in terms of numbers and in terms of the value to ordinary workers of the pensions generated there. Rightly, the NAPF doesn’t spend too long analysing how this situation has come to pass, but is oriented more towards what can be done to stop the decline and get the principle of workplace saving back on track.

There are many factors which help to account for why this situation has come to pass, as these pages have already argued; though it would be perhaps rather churlish in this context to remind that decisions to close schemes appear to stem largely from the unsympathetic and ruthless cost-cutting actions of scheme sponsors themselves. The Connect Sector of Prospect has some experience of negotiating alternatives where employers are looking to move away from defined benefit provision; outside this experience, that employers have tended not to stop anywhere in the middle of the pensions continuum but have leapt straight from defined benefit to defined contribution is less of a reflection of the lack of risk-sharing alternatives, as the NAPF directly suggests, than of the realities of employment relations in the 1990s: employers have done so because they can; and because the will to do something more creative (but evidently more costly) has not, except in a few, admirable cases, been found.

Despite the acknowledgement that ‘workplace pensions remain central to providing people with an adequate
retirement income’ and that workplace provision is ‘at the heart of good pension provision’, the central role in the NAPF’s vision is occupied not by workplace saving, but by a beefed-up state pension scheme – perhaps rather surprisingly, for an organisation representing (workplace-based) scheme sponsors, but perhaps a reflection that what has been lost will be hard to replace other than by slow incremental steps, starting from the 2012 reforms. Even within the context of workplace savings, the primary place in the NAPF programme is taken by a suggestion for a maximum of twenty ‘super trusts’ whose role would be to offer members of small schemes the low charges facilitated by the benefits of scale – a worthwhile, and supportable, idea alongside the NEST but whose contribution to revitalising workplace provision might well turn out to be less than dynamic.

Other suggestions from within the workplace savings context include offering ‘core’, unindexed pensions to scheme members only (it seems to me that indexation is an under-appreciated pensions benefit; while a focus on the scheme member only might be supported when retirement is far away, but deeply regretted once into retirement since ensuring loved ones are provided after your own death becomes much more important the closer you get to that point); improved mandatory contributions to the NEST (definitely supportable); better advice to accounting standards bodies on accounting for pensions (likewise); and a new statutory objective for the Pensions Regulator to promote good pensions provision (clearly a good idea).

So, there are some worthwhile things to explore in this document and the NAPF is to be congratulated for putting it out. It would be a shame if its publication at this point in the electoral cycle led to its many good ideas being lost to public debate. Nevertheless, in the meantime, I’m reminded once again that quality pensions expanded and became more beneficial at a time of labour strength; their contraction at a time of labour weakness simply proves that advances in benefits have to be won by collective action and are not given away by employers for free.

NAPF calls for budget for pensions

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The National Association of Pension Funds has today called for a budget for pensions (press release; full submission) which addresses a couple of its long-running campaigns: firstly on the need for the government to increase the supply of long-dated and indexed gilts (which these pages have supported); as well as a call for the re-structuring of the last Budget’s intention to taper higher-rate tax relief for those earning above £130,000 (which they haven’t).

Issuing more gilts will help pension schemes and would be a welcome development in the light of the continuing decline in the numbers of people saving in defined benefit schemes, since it is one which would help support those schemes which remain by matching the demand of occupational schemes as well as by reducing the strain on company balance sheets caused by volatility. The NAPF also argues that it is likely to assist the government with a cheap and secure source of finance given the suspension of the quantitative easing programme.

Concerning the higher rate taper, the NAPF has upped the ante a little by drawing up three case studies of people earning as little as £40,000 who may – by an unhappy conjunction of circumstances – be caught by the new rules. I don’t want to get too caught up in these simply because the circumstances for ‘Dave’ themselves – 25% rise in pay following promotion, rise in bonus, car allowance and relocation resulting in the award of a hefty cash allowance – seem to be a little unlikely, not least to members of the Connect Sector of Prospect, but also because they are likely to be worked around in the tax efficiency planning that is likely to apply to individuals in these situations. That includes with respect to redundancy payments, too (and there are a host of consultants just waiting to advise). And because all the situations are one-offs, occurring in one particular year, compared to the regular earnings which is the main target of the taper, I’m not sure they’re terribly helpful, either (other than in illustrating some potential pitfalls).

It remains correct to address the imbalance in tax reliefs earned by this part of the population, as the Chancellor is seeking to do: 1% of the population earn at this level (perhaps more correct to say regularly earn at this level) but they receive 25% of tax relief.

What I was attracted by, however, and thus in isolation from the issue of the taper itself, was the NAPF’s quid pro quo for abandoning it: a reduction in the annual allowance for tax-free pension contributions from £245,000 to a figure between £45,000 and £60,000 (figures which, of course, remain well beyond the means of most ordinary pension savers). Not being a tax expert, I don’t know how this works out in terms of likely tax yield or its spread across taxpayers more generally, both of which are clearly critical, but it does seem an interesting option in terms of exploring how what money is made available by the Treasury for pensions tax relief is fairly distributed. The NAPF, which points out that the figures to work out the likely yield simply aren’t in the public domain, argues that it is likely to achieve savings which are at least as much as it believes the measure will yield in practice – and perhaps as much as the Treasury thinks it will. (Nice work, there!)

I’m not sure how this squares with one of the NAPF’s criticisms of the taper (that high-paid executives will lose interest in good quality pensions if they become disengaged from them) – surely the same argument applies if annual tax relief is limited to a maximum of £45,000-£60,000 in pension contributions. Nevertheless, when there is a need to encourage both scheme sponsors to offer good quality workplace provision and to encourage people that pension schemes are worth having and saving in, not least among the low paid, looking at how available tax reliefs are used and distributed is an important consideration.

Written by Calvin

25/02/2010 at 5:38 pm

Heat and light and the BTPS deficit

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Today’s announcement of BT’s third quarter results was accompanied by the long-awaited outcome to the discussions between the company and its trustees on the most recent triennial valuation, due at the end of December 2008.

In brief, the upshot is that the scale of the deficit – as at December 2008 – is some £9bn and that the company has agreed with the trustees of the scheme to make annual payments to clear the deficit as currently envisaged over the next 17 years, starting with £525m per year for the next three years, increasing to £583m in the fourth year and indexed by 3% thereafter. The Regulator, however, which has also been involved in aspects of the discussions up to this point, has concerns over parts of the agreement and will be undertaking its own review of the recovery plan.

The news was greeted rather poorly in the barrowlands of the City, with the results of the day’s share trading activity seeing an 8.6% drop in the value of the company, taking it to a market capitalisation of £9.3bn – just a little over the size of the deficit, incidentally (and some 30% of the asset value of the BTPS). This is despite BT making sufficient free cash from its operations to support a recovery plan of that scale:

This is a prudent valuation and a recovery plan which re-affirms BT’s commitment to meeting its pension obligations. The operational improvements we are making in the business are generating sufficient cash flow to support the pension scheme whilst allowing us to pay dividends, invest in the business and reduce debt. (quote from Ian Livingston, BT  Chief Executive; same link as above)

At the same time, the news was accompanied by an announcement that the trustees of the scheme are to seek a court ruling to clarify the precise scope and extent of the Crown Guarantee given to the members of the scheme on privatisation back in 1984. The question of the Crown Guarantee was examined in today’s Peston’s Picks and it is here where the most heat has been generated (not Peston’s fault – I’m thinking of the uninformed and prejudiced comments on his blog post).

The key lack of understanding here surrounds the circumstances of the Crown Guarantee coming into play – i.e. an insolvent BT with insufficient assets to meet the debts of the scheme. It has to be admitted that such a circumstance is an evidential possibility – but it remains an extremely remote one. The question of how much of the total amount of the debt would then fall on the taxpayer as a result of the Crown Guarantee is the subject of the court case since it may not be all of it – we simply don’t know. The £9bn current deficit is thus, from the point of view of the state, very much a worst case scenario. The circumstances around why the case is being taken now are likely to reflect BT’s contributions to the Pensions Protection Fund and the role of the Crown Guarantee in reducing these which resulted last year – one year ago to the day, coincidentally – in the announcement of the outcome of a European Commission investigation on the grounds of state aid.

The accepted debt of £9bn would put the BTPS’s funding situation at about 79.5% (remembering that this is the picture as at the end of December 2008 – i.e. immediately prior to the rise in the stock market over 2009 which would have inflated asset values).

The Pensions Protection Fund has recently produced the 2009 edition of its Purple Book which provides a comprehensive indication of the state of health of defined benefit pension schemes as at the end of March 2009 – so, more or less similar to the end of the period covered by this BTPS valuation. The Purple Book‘s estimate of the overall funding position of schemes at that point was also 79.5%. Thus, the BTPS was no worse off than the average scheme at that point. It looks worse, because of the size of the deficit which, according to Robert Peston, is a record – but that’s because of the sheer size of the scheme. Given its size, the size of the deficit is, actually, in line with what you might have expected given the average state of health of schemes generally.

The scale of the overall deficit in March 2009 – some £200bn – has, in the nine months in the interim, been reduced to £52bn, indicating an overall funding position of 94% based on total scheme assets of £860bn. The BTPS is also likely to have seen a rise in its funding position in this period although this – and the exact scale of the recovery – is clearly open to conjecture.

Will BT have to pay back this total £9bn – possibly, if the actuaries have their sums right. Depending on the outcome of the next valuation, it may be less than this if stock market recovery continues (or if some of the other assumptions underpinning the valuation change). Of course, that’s an uncertain bet. But if it does, the next valuation will indicate a different basis for the amount to be recovered (and, perhpas, the period over which it needs to be done).

Pensions are long-term investments and the difficulty with valuations is that they provide only snapshots of what is a continually changing picture. Once the regulator has conducted its review of the recovery plan, the reasons for its concerns may become clearer. But, what matters for now is that BT believes the recovery plan to be fair and that it is capable of meeting the costs of this – that, and that the trustees of the scheme are content with the strength of support of BT as scheme sponsor.

Written by Calvin

11/02/2010 at 5:37 pm

Posted in Pensions

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