The new regulations which enable CDC schemes require an annual viability statement to be prepared. Of necessity, it must be a forward-looking document, and that means that it will in part be reliant on the actuary’s/trustees’ estimates of the future returns of the fund. By contrast the value we ascribe to a member’s beneficial interest in the scheme is based upon the contractual accrual rate, which is a verifiable fact.
While the contractual accrual rate is related to the expected returns on assets in the terms of awards made, it is to be expected that this will vary from that expected at the point of viability valuation. The scheme’s contractual accrual rate may be expected to be below the scheme’s expected return on assets. This would apply also to new awards as provision is necessary for the administrative operational costs. If the contractual accrual rate were above the expected return on assets, it would indicate clearly and unequivocally that the scheme is not sustainable.
Note that if the viability valuation indicates a shortfall, cuts to the immediately payable benefits are required. These may be spread over three years to reduce the prospect of large cuts coming as unpleasant surprises to members, but any cuts made in this way may not be ‘back-ended’ – a uniform rate of application is the maximum acceptable.
The risk-sharing rules we have proposed are based upon the actuality of today’s position – the accrued pensions ‘promised’ to members, their beneficial interest in the scheme and today’s asset values. By contrast, the viability statement will be taking the present value of projected benefits using the expected return on assets while comparing this with today’s assets.
To reiterate this point, the risk sharing rules we advocate in the first part of this blog apply to the situation as is, that which has been achieved to date, while the viability report applies to that which is expected to be.
The difference between these is such that the beneficial interest estimate is likely to show a shortfall while the viability statement does not. These beneficial interest relative shortfalls are the trigger for and basis of operation of the risk-sharing rules proposed.
It is, of course, possible that a statutory viability-based intervention could occur during the operation of the forbearance phase of operation of the risk-sharing rules, in which case they will over-ride those rules and require an immediate cut in benefits.
The method of estimating the expected return on assets will be important, and doubtless a matter of discussion between actuary and trustees. Questions such as the amount of any change to it after large changes in the achieved returns will need to be addressed.
The regulations envisage cuts applied to the immediate year and also multi-year cuts. The risk sharing rules proposed operate on the immediate year, and when the forbearance periods or amounts are exceeded, absolute cuts. These latter cuts can be seen simply as cuts applied equitably over the entire term of the scheme. Multi-period cuts of intermediate term are problematic in that they will usually carry consequences of intergenerational unfairness among members.
This approach makes available a number of new metrics of scheme performance – for example, the value for money (or efficiency) of a new award would be the ratio of that award’s CAR to the scheme’s expected return on assets. The ratio of the scheme CAR to the expected return on assets is a measure of the sustainability of the scheme – if greater than one, the scheme is not sustainable.