LCP Annual Pensions Conference Delivering pensions in a ... annual... · 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Cumulative return MSCI World Index (GBP returns) MSCI

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




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




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


The early years

Mid career

At retirement

58


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


66


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





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


£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


+4%

81

The tax calculation: DBLower paid…


+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…


+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?


£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?


£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


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





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


Understand startingpoint

Do existing schemes meet quality requirements?

How many employees need to be auto-enrolled?

Cost of using existing schemes?

106


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


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.

Documents

LCP Annual Pensions Conference Delivering pensions in a ... annual... · 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Cumulative return MSCI World Index (GBP returns) MSCI