Backdrop
Life expectancy assumptions are coming down further in actuarial tables. Liabilities will fall by around 3% to 5% for most DB schemes. Current annual payments to pensioners represent typically around 3% to 5% of assets after recent falls in value (and greater falls in liabilities for the better financially managed).
Trustees and sponsoring employers can decide to distribute additionally benefits to past and present employees in response to changed information. This is a straight improvement to the scheme’s finances. The assets are not affected by the assumption changes – as happened when interest rates increased.
Standard industry thinking is to accelerate Risk Transfer Transactions. The industry’s tables are prepared by practitioners with vested interests in risk transfers – but even they are reducing assumptions. Analysis of the real risks and values is needed.
Proposal
The benefit of discretionary payments can be split. Increased payments can be made directly to past and present employees. These comply with tax and legislative requirements. C-Suite has worked through the detailed requirements. Sponsoring companies can also benefit from reduced contributions.
The principle of discretionary payments is established. The time over which they are made and the delivery mechanisms are then scheme specific.
Campaign Objectives
The objective is to help past and present employees in the tough current economic circumstances. The over funding of pension liabilities makes this practical. Sponsors and trustees may then see their pension schemes as Flagship ESG policies not a legacy problem. That results in having a long term investment strategy for the scheme and having a modernised tier within it.
Pension scheme members and current employees can put the case to sponsors and trustees for “one less one more”
HR as well as finance teams of corporates should take up the opportunity. Member nominated trustees are particularly relevant. Here is a break point where intergenerational unfairness is on the agenda and there is an action plan.
Scope to Exercise Discretion is there. Use it.
On the author – William McGrath
William McGrath, the writer of this piece has this to say about himself and his organisation C-Suite.
Former Aga Rangemaster CEO, now addressing alternative pension funding strategies for corporates. We advocate sponsors make their DB pension schemes a flagship for their ESG policies. We’re working closely with companies who are ready to make a mindset change to see pensions as a positive business feature, benefitting all stakeholders.
During my 25 years’ boardroom experience, as FD and CEO, I dealt with and addressed substantial pension funding issues. Now my consultancy, C-Suite Pension Strategies, provides corporates facing the same challenges with the answers.
C-Suite Pension Strategies’ purpose is to enable you to protect cash resources, the real value of members’ pensions and improve modernised current pension provision. C-Suite provides you with the analytics and ideas to enable you to do just that.
He offers us further reading on good and bad behaviour
If you would like to dig deeper, he recommends.
The fundamental problem is pension funds are considered purely in terms of risks, opportunities appear to be entirely ignored.
Surely a pension scheme with a reduced risk measure of its liabilities, whether from changes to the mortality assumption or the assumed investment return, is failing in its fiduciary duties to both employer and members by selling its assets to an insurer. Instead it should productively invest all its assets to enhance the future benefits of the members through on going discretionary increases reflecting the improved investment return experience while at the same time improving the reported profitability of the employer.
Under IAS19 the assumed interest on the assets is taken to the sponsors P&L A/c reduced by the interest on the present value of the liabilities discounted at the same rate. Therefore a reduction in the mortality assumption provision improves the reported profitability of the employer. If however the pension scheme assets are sold to an insurer that annual credit to the Profit and Loss account is lost and the net effect on the balance sheet assets is regarded as a remeasurement (taken below the line to Statement of Other Comprehensive Income).
Incidentally it also appears not to be widely known that under IAS19 paragraph 108 discretionary increases granted in the year using powers contained in the Deed at time of service should not be reported as a change to past service benefits reflected in the Employer’s P&L A/c but regarded as a remeasurement of liabilities in the same way as changes to mortality, inflation, or discount rate assumptions (even when the relevant assumption made to calculate the current service cost in the service year was set to zero).
Many of the long established pension schemes currently being considered as buy-in or buy-out targets for insurers had pension increases provided on a discretionary basis but in order to meet Inland Revenue requirements the Deed specified increases to pensions should not exceed those required to bring the initial pension up to a current RPI linked value. As pension scheme trustees are required to secure the assets for benefits provided under the Deed the buy-out must secure current pensions inflated according to the powers in the Deed. This is a remeasurement below the line as explained above. However in completing a buy-out with defined future inflation, members are losing the possibility of future discretionary increases. It is therefore common to further enhance the current pension above the level provided by the Deed, as appears to be envisaged by the Pension Schemes Bill. Such an augmentation of benefits is then clearly a change to past service benefits and the cost of the augmentation does then hit the employer’s Profit and Loss Account in the year the decision to buy-out on these terms is taken.
I trust actuaries assessing possible buy-in or buy-out transactions under TAS300 v2 are ensuring employers are fully advised on the effects on their Accounts and are giving sufficient weight to opportunities and not just talking in terms of risks.
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