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Lane Clark & Peacock LLP Trustee Consulting Investment ConsultingCorporate Consulting Insurance Consulting Business Analytics www.lcp.uk.com
LCP Annual Pensions ConferenceTuesday 28 September 2010
Delivering pensions in a new era of austerity
2
Bob ScottChairman’s welcome
3
Bill GalvinActing Chief Executive of The Pensions RegulatorOpening address
Richard MurphyMeeting the challenges
5
Agenda
Managing the liabilities
Devising viable recovery plans in difficult times
Setting long-term strategies for delivering benefits
6
Managing liabilities now
Controlling the future
Capping off the past
Closing out the risk
All options available
Tax and auto-enrolmenttriggers for review
Planning and communicationare keys to success
7
Managing liabilities now
Controlling the future
Capping off the past
Closing out the risk
Address as part of future changes
Cap the growth of the liabilities
Simplify the benefit structures
8
Pension increase exchange
Member optionBenefit certaintyCost savingsIncreased PPF levy
Uplift now
Member option to convert to a level pension
Fixed for lifetime
9
Managing liabilities now
Controlling the future
Capping off the past
Closing out the riskBuyouts and buy-ins
(Enhanced) transfer values
10
Meeting the funding challenge Using the whole toolkit
Longer recovery plans
Back-end loaded
Contingency on profitability
Trigger-based payments
Contingent assets
Parent company guarantees
Anything else!
Assets
Deficit
11
LCP Prudence Index update Benchmark your funding strategy
Average scheme size £300mAllows for:
– Funding assumptions– Asset allocation– Employer covenant
Covenant scores have deteriorated since 2006No obvious link between covenant strength and funding strategyIdentify your position before deciding on your recovery plan
Scheme Risk Index against Covenant Risk Index
12
“Fix it so it stays fixed”Setting the objectives
Deliver promised benefits
Affordable and practical set up going forward
Off the company balance sheet when possible
Minimise costs and risks in the meantime
Employer’s and members’ interests no longer aligned
13
Case study: de-risk to wind-up
Closed to new entrants
Closed to future accrual
2001 2002 2003 2004 2005 2006 2007 2008 2009
Company decision in principle to de-risk over 10 years; deficit £100m
Indicative buyout quotations showing opportunity
Competitive buyout auction - locked in to deficit of £40m
2010
Completed scheme wind-up
Late 2006:started to switch assets
14
Setting your strategic plan
Asset strategy– Manage risks– Set triggers to lock in good
performance as it happens
Certainty on benefits
Funding strategy
Monitor and, when opportunities arise, take action
15
Conclusion
Steps are there for you to manage your DB liabilities– Be ready for tax and auto-enrolment changes– Manage the existing liabilities
Set your strategic plan
Monitor, and grab opportunities
16
Q&A session
17
Jonathan RufferChief Executive, Ruffer LLPA fund manager’s view of the future
18
Q&A session
Lane Clark & Peacock LLP Trustee Consulting Investment ConsultingCorporate Consulting Insurance Consulting Business Analytics www.lcp.uk.com
LCP Annual Pensions ConferenceTuesday 28 September 2010
Delivering pensions in a new era of austerity
Gavin OrpinInvestment for DB schemes Making your assets work harder for you
21
Agenda
Protecting against high inflation/deflation
Locking in good performance/managing the downside
22
£10,000
£26,000
Equivalent to a cap of
8% pa
Why is high inflation/deflation a worry for pension schemes?
Inflation 10% pa for next 10 years
£10,000£8,000
Pension cannot decrease
Deflation 2% pa for next 10 years
£21,500
23
How can you protect against rising inflation?
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
1981 1985 1989 1993 1997 2001 2005 2009
Index-linked gilts
Rea
l yie
ld
24
How can you protect against rising inflation?
-5%
0%
5%
10%
15%
20%
25%
30%
1949 1959 1969 1979 1989 1999 2009
Inflation swaps currently 3.5%
Inflation swaps only
Infla
tion
25
0%
3%
6%
9%
12%
15%
18%
1980 1989 1998 2007
Fixed interest gilts
Fixed interest gilts are likely to give poor returns
in an inflationary environment
How can you protect against deflation?Yi
eld
26
Risks of buying inflation swaps only
INFLATION
FALLS -
LOSE MONEY
ON HEDGE
TECHNICAL PROVISIONSRISE DUE TO FALLING INTEREST RATES
27
What have we been advising clients to do?
Use triggers to gradually increase inflation hedge if levels become more attractive
Don’t do too much inflation hedging by itself
Inflation rate swap triggrs
3.00%
3.25%
3.50%
3.75%
4.00%
Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10
Trigger 1
Trigger 2
Source: Bloomberg
Trigger 3
Trigger 4
Infla
tion
leve
l
28
Locking in good performance
Out of equities
50%
60%
70%
80%
90%
100%
110%
Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10
Trigger 1
Trigger 2
Trigger 3
Trigger 4
Trigger 5
Trigger 6
Trigger 7
Trigger 8
Fund
ing
leve
l
29
Locking in good performance
Out of corporate bonds
However, until triggers are hit no downside protection
0.00%
0.40%
0.80%
1.20%
1.60%
2.00%
2.40%
2.80%
Jan 07 May 07 Sep 07 Jan 08 May 08 Sep 08 Jan 09 May 09 Sep 09 Jan 10 May 10
Yiel
d ov
er g
ilts
30
Managing the downside
Diversify beyond equities and bondsConsider giving significant flexibility to fund managersUse in conjunction with triggers
Source: WM
Perc
enta
ge a
lloca
tion
31
Advantages of manager discretion
Static diversification failed in 2008
Faster reaction times to changing market conditions
Focus on capital preservation– If fall 20%, then need 25% return to get back to starting point!
Delegate to professional fund managers– But remember that they can get it wrong as well!
Many of you already invest in this type of approach:
Diversified growth funds
32
Diversification of manager risk very important
Over long term equities may still do better– Keep core allocation in equities, say 50% of growth assets– Consider triggers from equities to Diversified Growth Funds if
equities perform well
Risks
Manager A
Manager B
Manager CManager A
33
A new investment idea
Source: University of Groningen
34
But emerging market equities are volatile
1994-1995 Mexican Peso crisis. Peak to trough = -34%
1990-1991 Gulf War. Peak to trough = -34%
1997-1998 Asian financial crisis and Russian default. Peak to trough = -59%
2007-2008 Fallout from global credit crunch. Peak to trough = -55%
0%
200%
400%
600%
800%
1000%
1200%
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
Cum
ulat
ive
retu
rn
MSCI World Index (GBP returns) MSCI Emerging Markets Index (GBP returns)
2009
2000-2001 Argentinian and Turkish financial crises. Peak to trough = -50%
Source: Bloomberg
35
Diversified Emerging Markets Funds
Switch between equities, bonds and currencies depending on economic outlook
Be able to move out of emerging markets into cash if outlook is poor
LCP is working with fund managers to develop appropriate pooled funds
Watch this space!
How can we get access to emerging markets but with reduced short-term volatility?
36
Conclusion
Inflation and deflation are large risks
Currently finely balanced between the two– Will the Bank of England lose control of inflation in next 10 years?
Manage inflation risks explicitly– But try to balance inflation AND deflation risk
Use trigger points to capture outperformance
Manage downside risk by diversifying and giving flexibility to fund managers
James TraskInvestment for DC schemesDesigning an appropriate default fund
38
The importance of the default
DC now covers the majority of private sector employees
Over 80% “choose” the default when one is offered
Schemes must provide default option by 2012 to qualify as auto-enrolment schemes
Trustees and sponsors of DC schemes need to act
39
The Regulator’s DC focus
Objective to improve “work-based” pension schemes– Lack of member understanding– Poor administrative practices– Poor investment practices– Unduly high charges– Poor decisions on retirement choices
40
The DC lottery
Annual pension relative to 1990 retiree
50%
60%
70%
80%
90%
100%
110%19
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
41
Typical Lifestyle option
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0
Years to retirement
Allo
catio
n of
mem
ber's
ass
ets
Global equities Index-linked gilts Cash
42
Trustees’ and sponsors’ objectives for a default fund?
43
Ways of reducing DC investment risk
Low guaranteed returnBalanced fundWith-profitsDecumulation phase
– “Lifestyle”– Target date funds
Diversify growth assets
Hedge “unrewarded” risks– Interest rates, inflation
44
A better default strategy
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0Years to retirement
Allo
catio
n of
mem
ber's
ass
ets
Global equities Diversified Growth Corporate bondsIndex-linked gilts Fixed interest gilts Cash
45
A more reliable outcome
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
£0 £5,000 £10,000 £15,000 £20,000 £25,000 £30,000
Pension pa
Prop
ortio
n of
out
com
esCurrentProposed
46
Fewer shocks along the way
31 March 2009 benefit statement
100% global
equities
50/50 equities/
diversified fund
-37%
-18%
47
Case study: Volkswagen UK
48
Conclusion
As DB declines, spotlight falls on DC
Majority choose the default investment option
Applying DB investment techniques can reduce the risks
Review your default design now
James TraskInvestment for DC schemesDesigning an appropriate default fund
To Do list
Get staff to take pensions seriously
Improve default fund
Make statements useful
Figure out auto-enrolment
Sort tax changes
Stacy BoldCommunicating with members
52
Agenda
Employee perceptions
Overcoming inertia
Common member behaviour
The future for communications
53
What do members expect?
43% believe that where employers provide a
pension scheme they should also provide
financial education
Source: Scottish Widows
Over 76% would like financial guidance from their
employer on retirement Source: Scottish Widows
54
2012
Auto-enrolment
55
Age old questionHow to make pensions more interesting!!
Member joiner pack
Simples!
56
Addressing all members
The early years
Mid career
At retirement
57
Addressing all members
The early years
Mid career
At retirement
58
Addressing all members
The early years
Mid career
At retirement
59
Common behaviourInfluencing decision making
Anchoring
Negativity bias
Procrastination
60
Behavioural traitsAnchoring
AnchoringRely too heavily or “anchor” on one trait or piece of information when making a decision
“The default fund is suitable for most members”
61
Behavioural traitsAnchoring
Anchoring
62
Behavioural traitsNegativity bias
Negativity biasThe tendency to pay more attention and give more weight to negative than positive experiences
1 year later
63
Behavioural traitsNegativity bias
Negativity bias
64
Behavioural traitsProcrastination
ProcrastinationThe counterproductive deferment of actions or tasks to a later time
Sex and the City generation
Females age 25 - 45Limited pension provisionWaiting for Mr Big
Almost as many women surveyed own 30 pairs of shoes, 26%, as have a personal pension, 31%.
Source: Friends Provident
65
Behavioural traitsProcrastination
66
Behavioural traitsProcrastination
ProcrastinationTargeted / segmented communications
– Create a brand
67
The future for communicationsAppealing to Generation Y
68
Conclusion
Employees’ expectations are high
Pension costs are set to rise
Ensure benefits are valued and recognised
Engage through communications
Stacy BoldCommunicating with members
To Do list
Get staff to take pensions seriously
Improve default fund
Make statements useful
Figure out auto-enrolment
Sort tax changes
Karen Goldschmidt & Mark JacksonPensions strategy from April 2011
72
April 2009 Budget
“It is difficult to justify how a quarter of all the money the
country spends on pensions tax relief goes to the top 1.5% of
pension savers.”
“So from April 2011, I will restrict pension tax relief for those with incomes over £150,000 so it is gradually tapered to the same 20% rate the majority receive.”
73
The Emergency budget June 2010
Any alternative must still yield £3.5bn in 2011/12An annual allowance £30K - £45K might deliver yield
Labour’s approach has: “unwelcome consequences
for pension saving, bring significant complexity to the tax system, and damage to
UK business and competitiveness”.
74
Agenda
Latest developments in pensions taxKaren Goldschmidt
Impact of the new tax on pension scheme designMark Jackson
Karen Goldschmidt Latest developments in pensions tax
76
The changes from 2011:savings below the annual allowance
Post April 2011:For savings
below the AA
Pension account
Employer contributions_________________Corporation tax relief
National Insurance free
Employee contributions_________________
Full income tax relief
25% tax-free lump sum
Pension, subject to income tax
Investment return mostly tax free
77
The changes from 2011:savings exceeding the annual allowance
Pension account
Employer contributions_________________Corporation tax relief
National Insurance free
Employee contributions_________________
Full income tax reliefNo tax relief
Benefit in kind income tax paid by employee
25% tax-free lump sum
Pension, subject to income tax
Investment return mostly tax free
78
The tax calculation: DC
Basic (pensionable) salary £150,000Employer contribution: 14%, so £21,000 pa
£21,000 is less than £40,000New tax: NIL
Basic (pensionable) salary £160,000Employer contribution: 30%, so £48,000 pa
First £40,000: no new tax£8,000 balance: tax at 50%New tax: £4,000
The above assumes an annual allowance of £40,000
79
The tax calculation: DBA high earner in a 1/60ths scheme
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
£160,000 x 24/60 = £64,000 pa +4%
= £66,560 pa
£168,000 x 25/60
= £70,000 pa
£3,440 paX 20 = £68,800£3,440
First £40,000 = No tax
Excess £28,800 taxed at 50% = NEW TAX £14,400
80
The tax calculation: DB A high earner in a 1/60ths scheme
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
£160,000 x 24/60 = £64,000 pa
= £66,560 pa
£171,000 x 25/60
= £71,250 pa
£4,690 paX 20 = £93,800£4,690
First £40,000 = No tax
Excess £53,800 taxed at 50% = NEW TAX £26,900
+4%
81
The tax calculation: DBLower paid…
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
+4%
£40,000 x 24/60 = £16,000 pa
= £16,640 pa
£42,000 x 25/60
= £17,500 pa
£860 paX 20 = £17,200£860
Below £40,000 NO NEW TAX
82
The tax calculation: DBLower paid with a promotion…
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
+4%
£40,000 x 24/60 = £16,000 pa
= £16,640 pa
£45,000 x 25/60
= £18,750 pa
£2,110 paX 20 = £42,200£2,110
Excess £2,200 taxed at 40% NEW TAX £880
83
The tax calculation Ordinary early retirement – maybe?
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
£40,000 x 10/60 = £6,667 pa
+4% = £6,933 pa
£40,000 x 11/60 at age 55
= £7,333 pa
X 26 - x 20 = £51,998£7,333
Excess £11,998 taxed at 40% NEW TAX £4,800
£6,933
84
The tax calculationIll-health retirement – maybe?
The above assumes an annual allowance of £40,000 and a multiplier of 20 and an inflation offset
£40,000 x 10/60 = £6,667 pa
+4% = £6,933 pa
£40,000 x 40/60
= £26,667 pa
£19,734 paX 20 = £394,680£19,734
Excess £354,680 taxed at 50% = NEW TAX £177,340
85
“Spikes”: exemptions and other assistance
ExemptionsDeathSerious (terminal) ill health
Other help“where schemes are not able to smooth away spikes … there may be a role for the tax system to help …”
86
Possible trade-offs for higher annual allowance
Relief restriction to 40%
Basic (pensionable) salary £150,000Employer contribution: 14% (£21,000)
£21,000 less than £40,000
New AA tax: NILNew relief restriction £2,100 (10% x £21,000)
The above assumes an annual allowance of £40,000
LTA tightened – Down from £1.8m to? – DB factor increased– 2006 protections changed
87
Delivery and compliance
Mark JacksonImpact of the new tax on pension scheme design
89
April 2011 and beyond A new landscape for pension design
90
Case study: DC plan
Ill-health insurance = 5 x salary lump sum
Bonus sacrifice facility
No limit on AVCs
Employer and employee contributions exceed annual allowance
Issues
DC themes:
- Relatively simple design changes- Communication exercise is main challenge- Smaller pensions: not just for “high earners”
Employer match
Employee match
Employer core
6%
6%
3%
Annual Allowance
Spread lump sum over more than 1 year
Communicate headroom
Communicate headroom
Option to take cash
Solutions
91
Case study: DB planBackground and issues
£0
£2,000
£4,000
£6,000
£8,000
£10,000
£12,000
£14,000
£16,000
£18,000
£20,000
- 25,000
50,000
75,000
100,000
125,000 150,000
175,000 200,000 225,000
Pensionable Salary (before increase)
Tax
char
geTax charge - £40k annual allowance
92
Objective: No employee can have an increase in pension value above the Annual Allowance
Solution:Limit to pensionable salary of £120,000Cap increases in pensionable salary at CPI
Case study: DB planSolutions
Deficit reduces from £100m to £70m
DB themes:
- Tax charge is a catalyst for wider liability management exercises- Employees who retain DB pensions are unlikely to be compensated for lower pensions
“Why are we giving more than £40k in pension value to anyone?”
93
Short-term impact…
Oct Nov Dec Jan Feb Mar
Apr
il 20
11
Confirmation of Annual Allowance
Draft Finance Bill
Scheme design changes
Communication with employees/presentations/one-to-ones
Consultation period for scheme amendments
Mark JacksonImpact of the new tax on pension scheme design
To Do list
Get staff to take pensions seriously
Improve default fund
Make statements useful
Figure out auto-enrolment
Sort tax changes
David JonesLooking to the future
97
Agenda
Short term action plan
Planning for auto-enrolment
Where is this leading us all?
98
On your marks…
99
What’s coming up?
Imminently – clarity on tax regime from 2011/12
Autumn – CPI / RPI implications
Autumn – avoid losing powers to make payments to employers
Autumn/Spring – action to mitigate PPF levy
5 April 2011 – transitional tax regulations cease to apply
100
In the meantime…
DB schemesReviewing future benefitsCapping of the pastDe-risking exercisesFunding negotiationsMaking assets work harder for you
DC schemesDefault investment strategyGovernance structureCommunications
101
2012
Compliance with auto-enrolment
Employer debt regulations?
Solvency II?
State pension changes?
50% MNTs?
DC contracting-out abolished
Planning for updated IAS19
GMP equalisation?
tPR record keeping deadline
102
Auto-enrolment
Is this really going to happen?
When do I need to start thinking about this?
103
Do you know when you will need to comply?
120,000 employees
400 employees
Phasing
Staging
October 2012
October 2013
October 2014
October 2015
October 2016
Staging date dependent on no. of employees
October 2012
October 2013
October 2014
October 2015
October 2016
October 2017
ER 1%Total 2%
ER 2%Total 5%
ER 3%Total 8%
Required DC contribution rate (%QE)
10 employees
104
Auto-enrolment: action plan
Understand startingpoint
Agree strategy
Implementation
105
Auto-enrolment: action plan
Understand startingpoint
Do existing schemes meet quality requirements?
How many employees need to be auto-enrolled?
Cost of using existing schemes?
106
Auto-enrolment: action plan
Agree strategy
Harmonise benefits across all employees?
Cost of using new arrangements or NEST?
Options to mitigate costs?
107
ImplementationAdministration and systems issues
Consultation and communication
Auto-enrolment: action plan
108
“There is almost universal acceptance that the combination of the present state pension system and the present voluntary system of private pension saving is not fit for purpose and will result in pension provision which is increasingly inadequate and unequal.”
Pensions Commission final report
And beyond?
109
The “haves” and the “have nots”
Private sectorCopper-bottomed DB pensions for the baby boomer generationLess generous DC schemes for most of the rest
Public sectorAround 5 million in DB schemes currentlyBut at what cost and for how long?
State benefitsProtection from poverty onlyIncreasing state pension age
110
Vision of 2046
Occupational and private savings too low to retire onState pension at poverty level from age 68 (or later)Compulsory retirement age abolished?
Need higher retirement savings
111
How?
Fairer risk sharing
Flexibility
Simplicity
Political support and stability
Tax incentives
112
The likely default?
The Australian model
Anticipate higher minimum contributions
113
Bob ScottChairman’s conclusion and questions
1
Scope
LCP is part of the Alexander Forbes Group, a leading independent provider of financial and risk services. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC301436. LCP is a registered trademark in the UK (Regd. TM No 2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members’ names is available for inspection at 30 Old Burlington Street, London, W1S 3NN, the firm’s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. Locations in London, Winchester, Jersey, Belgium, Switzerland, the Netherlands and Ireland.
This generic presentation should not be relied upon for detailed advice or taken as an authoritative statement of the law.
If you would like any assistance or further information, please contact the partner who normally advises you.
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