Delivering pensions in a new era of austerity Lane Clark & - - PowerPoint PPT Presentation

Lane Clark & Peacock LLP Trustee Consulting Investment Consulting Corporate Consulting Insurance Consulting Business Analytics www.lcp.uk.com

LCP Annual Pensions Conference Tuesday 28 September 2010

Delivering pensions in a new era of austerity

2

Bob Scott Chairman’s welcome

3

Bill Galvin

Acting Chief Executive of The Pensions Regulator

Opening address

Richard Murphy Meeting 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-enrolment triggers for review Planning and communication are 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 option Benefit certainty Cost savings Increased 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 risk

Buyouts and buy-ins (Enhanced) transfer values

10

Meeting the funding challenge

Using the w hole 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

Benchm ark your funding strategy

Average scheme size £300m Allows for: – Funding assumptions – Asset allocation – Employer covenant Covenant scores have deteriorated since 2006 No obvious link between covenant strength and funding strategy Identify 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

• pportunity

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 Ruffer

Chief Executive, Ruffer LLP

A fund manager’s view of the future

18

Q&A session

Lane Clark & Peacock LLP Trustee Consulting Investment Consulting Corporate Consulting Insurance Consulting Business Analytics www.lcp.uk.com

LCP Annual Pensions Conference Tuesday 28 September 2010

Delivering pensions in a new era of austerity

Gavin Orpin Investment 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

Real yield

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

Inflation

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?

Yield

26

Risks of buying inflation swaps only

INFLATION FALLS - LOSE MONEY ON HEDGE TECHNICAL PROVISIONS RISE 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

Inflation level

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

Funding level

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

Yield over gilts

30

Managing the downside

Diversify beyond equities and bonds Consider giving significant flexibility to fund managers Use in conjunction with triggers

Source: WM

Percentage allocation

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 C

Manager 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

Cumulative return

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 Trask Investment for DC schemes Designing 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% 1990 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

Years to retirement Allocation of member's assets

Global equities Index-linked gilts Cash

42

Trustees’ and sponsors’ objectives for a default fund?

43

Ways of reducing DC investment risk

Low guaranteed return Balanced fund With-profits Decumulation 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

Years to retirement Allocation of member's assets

Global equities Diversified Growth Corporate bonds Index-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 Proportion of outcomes Current Proposed

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 Trask Investment for DC schemes Designing an appropriate default fund

T

• D
• l

i s t

Get staff to take pensions seriously Im prove default fund Make statem ents useful Figure out auto-enrolm ent Sort tax changes

Stacy Bold Communicating with members

52

Agenda

Employee perceptions Overcoming inertia Common member behaviour The future for communications

53

What do members expect?

4 3 % b e l i e v e t h a t w h e r e e m p l

• y

e r s p r

• v

i d e a p e n s i

• n

s c h e m e t h e y s h

• u

l d a l s

• p

r

• v

i d e f i n a n c i a l e d u c a t i

• n

S

• u

r c e : S c

• t

t i s h W i d

• w

s

Over 76% would like financial guidance from their employer on retirement

S

• u

r c e : S c

• t

t i s h W i d

• w

s

54

2012

Auto-enrolment

55

Age old question

How to m ake pensions m ore 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 behaviour

Influencing decision m aking

Anchoring Negativity bias Procrastination

60

Behavioural traits

Anchoring

Anchoring

Rely 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 traits

Anchoring

Anchoring

62

Behavioural traits

Negativity bias

Negativity bias

The tendency to pay more attention and give more weight to negative than positive experiences

1 year later

63

Behavioural traits

Negativity bias

Negativity bias

64

Behavioural traits

Procrastination

Procrastination

The counterproductive deferment of actions or tasks to a later time Sex and the City generation Females age 25 - 45 Limited pension provision Waiting 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 traits

Procrastination

66

Behavioural traits

Procrastination

Procrastination

Targeted / segmented communications

– Create a brand

67

The future for communications

Appealing 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 Bold Communicating with members

T

• D
• l

i s t

Get staff to take pensions seriously Im prove default fund Make statem ents useful Figure out auto-enrolm ent Sort tax changes

Karen Goldschmidt & Mark Jackson Pensions 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 2011/12 An 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 tax Karen Goldschmidt Impact of the new tax on pension scheme design Mark 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 relief No 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 £150,000 Employer contribution: 14%, so £21,000 pa £21,000 is less than £40,000 New tax: NIL Basic (pensionable) salary £160,000 Employer 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: DB

A high earner in a 1/ 60ths schem e

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 pa X 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 schem e

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 pa X 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: DB

Low er 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 pa X 20 = £17,200 £860 Below £40,000

NO NEW TAX

82

The tax calculation: DB

Low er paid w ith a prom otion…

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 pa X 20 = £42,200 £2,110 Excess £2,200 taxed at 40%

NEW TAX £880

83

The tax calculation

Ordinary early retirem ent – m aybe?

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 calculation

Ill-health retirem ent – m aybe?

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 pa X 20 = £394,680 £19,734 Excess £354,680 taxed at 50% =

NEW TAX £177,340

85

“Spikes”: exemptions and other assistance

Exemptions Death Serious (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 £150,000 Employer contribution: 14% (£21,000) £21,000 less than £40,000 New AA tax: NIL New 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 Jackson Impact 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 plan

Background and issues

£0 £2,000 £4,000 £6,000 £8,000 £10,000 £12,000 £14,000 £16,000 £18,000 £20,000

• 2

5 , 5 , 7 5 , 1 , 1 2 5 , 1 5 , 1 7 5 , 2 , 2 2 5 ,

Pensionable Salary (before increase) Tax charge

Tax 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 £120,000 Cap increases in pensionable salary at CPI

Case study: DB plan

Solutions

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 April 2011 Confirmation

• f Annual

Allowance Draft Finance Bill

Scheme design changes Communication with employees/presentations/one-to-ones Consultation period for scheme amendments

Mark Jackson Impact of the new tax on pension scheme design

T

• D
• l

i s t

Get staff to take pensions seriously Im prove default fund Make statem ents useful Figure out auto-enrolm ent Sort tax changes

David Jones Looking 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 schemes Reviewing future benefits Capping of the past De-risking exercises Funding negotiations Making assets work harder for you DC schemes Default investment strategy Governance structure Communications

101

2012

Compliance with auto-enrolment Employer debt regulations? Solvency II? State pension changes? 50% MNTs? DC contracting-

• ut 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.

• f 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 starting point Agree strategy Implementation

105

Auto-enrolment: action plan

Understand starting point

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

Implementation

Administration 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 sector Copper-bottomed DB pensions for the baby boomer generation Less generous DC schemes for most of the rest Public sector Around 5 million in DB schemes currently But at what cost and for how long? State benefits Protection from poverty only Increasing state pension age

110

Vision of 2046

Occupational and private savings too low to retire on State 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 Scott Chairman’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.