The Pensions Trust has been communicating the results of the SFHA actuarial valuation with participants over the last couple of months and as I’d suspected the news is not good. The valuation was calculated at 30 September 2009 and the key results were:-

• The funding position has deteriorated to 64.8% from 83.4% in 2006
• The deficit has increased to £160.1m from £53.6m
• The contribution to fund the past service deficit has increased to 10.4% over a 15 year period from 5.3% over a 12 year period in 2006
• The total final salary contribution has risen from 23.1% to 29.6%
• There have also been very significant rises in the CARE contributions

Interestingly the 2006 buyout deficit quoted at £339.8m (33.7% funding level) was not updated in the presentation but I think it’s reasonable to assume it hasn’t improved!!

The reasons for the deterioration in the funding position is quoted as a combination of poor investment returns and the requirement for more prudent assumptions in respect of longevity and inflation, however, does this present the whole story and are there additional questions that the participants need to address to the Pensions Trust?

Participants may want to ask:-

• Investment markets have undoubtedly been poor and returned less than assumed over the period however has the funding position been worsened by a consistent under-performance of the funds underlying assets?
• Have these assets been invested in appropriate asset classes to effectively achieve returns whilst managing risk?
• Yes, there has been a requirement for a strengthening of the assumptions used however there was already a very significant deficit present in the scheme at the 2006 valuation and does the further deterioration in the funding position not also reflect that the assumptions used at that point were not as prudent as they might have been and have required additional strengthening in the most recent valuation?
• Have the assumptions been strengthened to a reasonable degree in the 2009 valuation or is there likely to be more bad news to come in 2012 and beyond?

As part of the valuation briefing the Pensions Trust also outlined the results of their benefit review and this too provided employers with few crumbs of comfort and little recognition of the position in which employers in the scheme find themselves.  A series of 5 statements have been made by the SFHA Committee and employers have been asked to comment on these and I would actively encourage them to do so.

A couple of these in particular are worth highlighting.

• There is an assertion that there should automatically be an employer to member contribution ratio of 2:1. Is it the role of the SFHA Committee to outline contribution practice to employers? Many employers provide contributions to schemes on a basis below 2:1 and indeed many schemes are moving towards shared cost arrangements. Should this not be an option for participants in SFHA?
• The statement is also made that employers wishing to offer defined contribution options can do so outside the scheme. Whilst I am pro choice for employers as more competitive DC options may exist elsewhere in the market, or indeed in due course may be provided by NEST, the assertion that such steps if taken by employers could be deemed to be selection against the scheme seems inconsistent. Many participants have numerous staff who do not participate in the SFHA scheme and no doubt this will continue to be the case, frequently as a result of the contribution level being seen as a barrier to entry. These individuals will need to be automatically enrolled in NEST so why should it not be possible to offer alternative provision without the risk of selection against the scheme?

SFHA participants need to consider their options carefully and ensure that they forcefully communicate their views to the SFHA Committee and the Pensions Trust.

It is no wonder then that the last two years has seen few mergers completed and a significant number being abandoned before conclusion.

Mergers are inevitable in the current market environment as a way of improving competitiveness, scale and efficiencies, but to navigate the pension minefield professional advice sought at an early stage of the negotiations is vital.

This advice would allow a full investigation of the implications of any change to ensure short term objectives are not being met at the expense of the long term security of the organisation.

Read the full article by David Davison at Civil Society.

I have to ask whether the underlying problem is the inability of Regulators to regulate these activities rather than any fundamental problem with the system as it stands. Undoubtedly adequately tight regulation combined with a high profile case where the advisory firm and/or the employer involved were forced to compensate for any processes which fell outside the required standard would raise awareness and set the benchmark for the future. If employers and advisers are guilty of inappropriate practice then this should be weeded out so that those who perform within the required advisory process can continue to provide the quality service required.

The Financial Services Authority seems unwilling to properly update the regulation of transfer advice and we can only assume the near outright ban proposed by the Department for Work and Pensions has been the only option to protect the majority whilst removing the flexibility of the minority.

This whole transfer process only works on the basis of members taking decisions  based upon informed consent. The current regulatory process, built like a phoenix from the ashes of the pension mis-selling scandal of the 80’s and 90’s, provides a framework for this – providing the process is diligently followed.

Having said that, in my opinion there has  been a failure on the part of the FSA to update the advisory process over the past 10+ years to the point where it is now incompatible with the requirement to protect member’s interests. Advisers have been forced to work within a regulatory framework which does not make it easy to properly advise clients. The transfer analysis systems used to advise clients are a throwback to the technology of bygone years and ill suited for the purpose. There is too much focus on the critical yield and not enough on giving individuals useful information upon which they can make a decision – such as stochastically modelling the likelihood of certain outcomes and updating assumptions on a basis more frequently than yearly.

Systems and processes have improved but the regulatory framework has not adapted to meet what is actually needed by both individuals and their advisers. So advisers are forced to do a job with one, if not both hands, tied behind their back.

It is also interesting that the Pension Regulator’s draft Guidance has focussed narrowly on pension issues and yet this does not reflect the advisory process against which advisers must operate. Advisors need to consider all the financial issues and their relative merits. Is the Regulator, or indeed a scheme trustee, in a position to judge if the payment of a credit card or a mortgage is more or less valuable for an individual than retaining value in a pension? I would have thought not, in the same way that a trustee should not be forced to start from the assumption that a transfer is not in the members interests. Only a financial adviser in possession of all the facts and with suitable qualifications is competent to make such a judgement and indeed is required by regulation to do so.

Obviously, the Pension Regulator has tended to be exposed to examples of bad practice in this area rather than good and this appears to have skewed its perspective and heightened its concerns.

The Pension Regulator’s proposals will undoubtedly help in ensuring that financial advisers are not selected on the basis of their propensity to recommend transfer.  With the involvement of professional trustees and/or advisers, communication should be subject to genuinely independent scrutiny which will be helpful.  

However the Pension Regulator, but more particularly the Department for Work and Pensions and the Financial Services Authority are abdicating responsibility in coming up with a solution which needlessly removes choice instead of just meeting the problem head on and as the same auntie used to say to me – just pull their finger out!!.

It is also worth bearing in mind that this is the “on-going funding position”, on this basis it is assumed that the Scheme (and by extension the participating employers) will continue in existence for ever and a day. The results as at 2008 as shown in the SHPS annual review in 2009 showed an eye-watering deficit of £3.384Bn (31.1% funded) on scheme closure. The Pension Trust make the statement that there is no intention for the scheme to close, however how can they be so sure about future events given the economic background we face at the moment? Up until 2009 there was no intention that the Scottish Voluntary Services Pension Scheme (“SVSPS”) was to close but it did in 2010 with serious implications for many of the participants.

To consider the scale of the deficit faced, the ongoing deficit of £620m at 2010 is equivalent on average to £10,000 in respect of each of the 60,000 membership, whilst the 2008 discontinuance deficit is about £56,000 on average. Interestingly it should be noted that the contributions are funded across only the active membership, and that’s only about 27,000 members out of the total of 60,000 meaning that the funding required per head would increase to on average £23,000 and £125,000 respectively.

It is also important to note that the buyout deficit figure is not only relevant when the scheme as a whole closes, but also has significance in other circumstances such as:-

• Should an individual employer wish to leave the scheme then that employer would be liable for the exit debt (i.e. to make up the 68.9% shortfall), and not the on-going funding debt (i.e. the 24.4% shortfall). Based upon the figures above this could be a five times multiple of the on-going position. How many organisations are in a strong enough position to cope with this level of debt? Very few I imagine. Clearly this seriously restricts people’s ability to exit even if they wanted to, trapping them between the Hobson’s choice of rising contributions or an unaffordable exit cost.
• In addition, if an employer exited on the grounds of insolvency then their full liability under this ‘multi-employer scheme’ would be shared amongst the other participants thereby increasing their liabilities and therefore their exit cost.

In my experience most participants in schemes similar to this wouldn’t agree to join if they understood the full implications. The Professional Pensions article suggests that 3,000 new members had joined SHPS in the last year which must raise the question, do their employers actually fully understand the decision and the linked level of risk they are taking and are these issues being clearly communicated by the Pensions Trust prior to them joining?

The LGPS Scheme has taken sensible steps in this regard to ensure that new participants have the financial backing in the form of guarantees to be able to accept the risks.

This news highlights some pretty worrying figures for the charity sector and raises a number of questions about pension scheme funding in the third sector, the use of these multi-employer schemes and the approach the Pensions Trust are taking. Participants in this scheme and indeed schemes of a similar type, need to have a much greater involvement and understanding of the risks these schemes pose to the future success of their organisation.

This is where Arnaud comes in. Arnaud was what we would call in morden parlance, a pragmatist. He was with the crusaders beseiging Beziers, presumably to provide spiritual and moral guidance. Beziers had a mixed Cathar/Catholic population. When asked by his military colleagues for some guidance as to how they could distinguish the religious adherence of Beziers’ inhabitants in the forthcoming massacre and therefore avoid killing their “good” co-religionists, Arnaud came up with a splendidly pragmatic  response – “Kill them all, the Lord will recognise His own.”

Now don’t get me wrong, generally I see pragmatism as a virtue, but I’m not entirely convinced that, in this case, the end justified the means.

Equally, I am unconvinced that the effective banning of Contracted out DB to DC transfers hidden in the regulations regarding the abolition of DC Contracting-out is entirely justified.

The Government’s approach here seems akin to that of Arnaud. The proposed ban is clearly about a failure of regulation. There are many legitimate scenarios where transferring from a Contracted-out DB scheme to a DC arrangement of some sort makes sense for individuals, given their particular circumstances. Given this, and the fact the the Government will not have sat down with any individuals to ascertain what is or isn’t in their interests, killing all Contracted-out DB to DC transfers seems as overzealous now as Arnaud’s response all those years ago.

So rather than a medieval approach to the issue of transfers and regulatory concerns about protecting members from themselves, can we  have some proper regulation?

By this I emphatically don’t mean the recent consultation document issued by the Pensions Regulator on incentive exercises. It has always been my view that transfer advice is regulated by the FSA and trustees should not be forced to provide a figleaf for any regulatory failings in this area – see our other blogs on this point.

Having said that I think that the guidance around the trustees’ role in this area seems to have completely missed the point that trustees do indeed have a legitimate existing role in the process which could help resolve some of the concerns voiced. It is already the trustees responsibility to set scheme transfer values. The Regulator in its guidance in this area suggests that these can be a ‘best estimate’ of the value needed to replicate the benefits being given up by the member. So setting the transfer value basis for a Scheme rests squarely with the trustees.

If trustees and the Regulator have concerns about members losing out as a result of transfers, even where these are topped up to the full transfer value provided by the Scheme, or beyond, then clearly part of the problem must be the trustees’ transfer value basis.

In my opinion the biggest and best contribution trustees can make to the whole transfer value debate is to make sure that their transfer value basis genuinely reflects the value of members’ benefits.

Obviously this is yet another area where there is a potential for conflicts of interest - some trustees might be tempted to set weak transfer value bases with a view to facillitating positive communication in employer sponsored transfer exercises. A 20% “enhancement” to a weak scheme transfer value could well be less than 100% of a “fair” transfer value and mislead members into thinking that they are getting something “extra”. This is properly an area for scrutiny by the Pensions Regulator and another argument for the appointment of a professional trustee to any Scheme where potentially contentious issues are to be addressed.

This may raise the bar for transfer value exercises by increasing the amounts of any top ups required from the employer – but surely this is a good thing? Transfer exercises would then – quite rightly – be difficult to do “on the cheap” as disclosure requirements would mean that the full transfer value has to be disclosed to the member and any attempt to “incentivise” members’ to transfer out at a level below this would be very apparent to them.

I have to ask if this would not be a simpler and more joined-up solution than a blanket ban by stealth, which appears to be where we are heading?

Hidden within the document (it takes some finding) and then cross referencing  the Contracting-out (Transfer and Transfer Payments) Regulations 1996 (what would we do without Pendragon Perspective!) and it becomes clear – no transfers of GMPs or of post 1997 contracted-out rights will be permitted from DB pension schemes to either occupational DC pension schemes or to personal pensions from 6 April 2012.

Who saw that coming?  The vast majority of DB pension rights are now locked into the DB pensions funding regime until the last member dies, a regulated buy-out is transacted or the sponsor goes bust.

Deferred pension scheme members who may have been thinking for some time about transferring to a personal pension will need to make their mind up soon.  There is a minority of people who would be well advised to take transfers, for example some of those in poor health or without dependents.  Schemes will undoubtedly have to deal with an increased incidence of transfer requests for 18 months and virtually none thereafter.

The whole new industry that has developed around transfer incentives will come to an end.  From the point of view maximising individual choice this is not a good development but there are a number of practitioners who have advised employers to conduct enhanced transfer value exercises in a manner that will in all likelihood result in many of those members who have been advised to transfer coming to regret the advice they have received.

The Pension Regulator’s recent consultation on the subject seemed a rather limp response to some very poor practices on the part of some advisers but maybe this latest announcement goes some way to explaining why.  If the Pensions Regulator and the Financial Services Authority cannot regulate Enhanced Transfer Value Exercises (and certainly over the last few years it is clear that they have failed to do so) then banning transfers seems a logical step.  Whilst we understand the move by the new Pensions Minister Steve Webb, it is a pity that the price of this regulatory failure is to deprive the minority of people who could gain by transferring of that option. It is a price worth paying to protect the majority from the detriment caused by the predatory and harmful practices that have developed.

The whole area of calculating transfer value equivalents to DB benefits has been fraught with difficulty – the mis-selling of the late 1980s and early 1990s having been improved on by some firms only a little in more recent years.

There does however seem to be a high chance of a firesale over the next 18 months as individuals take a final look at their affairs and decide once and for all on whether to transfer out to a personal pension or DC scheme and as employers contemplate making a final and best offer to incentivise deferred members to take their liabilities and leave the scheme.  Hopefully employers and trustees will take the proposed new Guidance from the Pensions Regulator to heart and conduct these exercises in an appropriate manner.  The appointment of an independent trustee in such cases to eliminate conflicts of interest would be good start.

We have argued several times that transfer incentives properly conducted are a legitimate and proper technique for employers to manage their liabilities and at the same time would be happy to advise any employers looking to achieve a fair win/win result in the limited time that now appears to be available or indeed any trustees seeking to meet the demanding new expectations of the Regulator.

PENSIONS
Pensions must be taken into account in divorce proceedings as they can represent a significant financial asset. A divorce often means a decision on how the pension benefit one or both parties must be divided must be made.  The calculations can be complex and the sharing method can also have an impact on the value to be shared.

PROPERTY
The family home can represent the largest joint asset and placed in the theatre of divorce is often an emotive subject. This gives a good run down of what might happen to the marital home and easy to follow advice in question and answer form.

BUSINESSES
The divorce of a business’s founder can have a dramatic and dreadful effect – not just through the distress and distraction for those involved, but particularly through the cost of the final settlement – possibly necessitating the sale of some or all of the business to finance it. This explains the impact divorce proceedings can have on the business owner and the business future.

SECURITIES, INVESTMENTS AND INSURANCE
There are many financial products and vehicles used to invest or hold money securely. The rules surrounding these products can be complex and divorce can see these complications increase. This will give an insight into the ways these assets might be dealt with in the course of divorce proceedings.

Ian Conlon Actuary

Government plans mean many pension schemes in both the private and public sector will not be in a position to implement pension sharing orders or even to issue transfer value statements.

“This is a very disappointing state of affairs” said Ian Conlon, Pensions and Divorce expert at Spence & Partners, Consulting Actuaries. “Peoples’ lives move on and they should be able to sort out their affairs and I am afraid this is an unintended consequence of government pension policy.”

The proposals announced by the Chancellor of the Exchequer, George Osborne, in the June 2010 budget state the Government’s intention to link future increases in public sector pensions to changes in the Consumer Prices Index (CPI) instead of increasing in line with the annual change in the Retail Prices Index (RPI).

Over a period of time it is expected that CPI will be lower than RPI and all public sector Cash Equivalent Transfer Values (CETVs) will reduce to take account of this, a reduction that could be around 20% or more in some cases.

As a result, it is understood that most if not all, public sector schemes have already stopped quoting CETVs and it is likely that this delay will continue until further guidance is published. This, in turn, will mean pension sharing orders issued will not be implemented until the position is clearer, and for those in the midst of divorce proceedings, whose calculations are put on hold, it could mean a considerable increase in costs.

Ian Conlon added: “Divorce proceedings are expensive and stressful enough without a log-jam of cases building up while pensions administrators, lawyers and actuaries debate the legal issues and amend software to deal with the changes.”

“Whilst a degree of uncertainty may remain, it may well be attractive for some parties to proceed having been provided with an estimate of the impact of the change.

“Here at Spence & Partners we have developed specific software which can help divorcing parties and their legal advisers with an estimate of the likely impact of the change and the potential change in value of a pension share which was in the process of being agreed which we believe we will be helpful in many cases”.

ENDS

For further information please contact Ian Conlon (07718 365129), Brian Spence (07802 403013), Rebecca McDonald (0141 331 1004) or email us at divorce@spenceandpartners.co.uk

Spence & Partners are a firm of Actuaries, Consultants and Pensions Administrators with offices in Glasgow, London and Belfast and experience of operating pension schemes in England & Wales, Scotland, Northern Ireland and Ireland.

Visit www.spenceandpartners.co.uk

Note:

In the June 2010 budget the Chancellor of the Exchequer announced the Government’s intention for future increases to public sector pensions to be linked to changes in the Consumer Prices Index (CPI). To date, such pensions were increased in line with the annual change in the Retail Prices Index (RPI).

The Pensions Minister subsequently issued a statement on 8 July confirming that the Government also intends to use CPI for determining statutory minimum pension increases which apply to private sector pension schemes.

Over longer periods of time it is expected that CPI will be lower than RPI. All public sector Cash Equivalent Transfer Values (CETVs) will reduce to take account of this; the position with private sector pension schemes is more complicated and the impact will depend upon the specific scheme rules. In the case of a member of a public sector pension scheme, the reduction in their CETV could be as much as 20% or more.

As this is such a material change, we understand that most, if not all public sector schemes have stopped quoting CETVs and it is likely that they will defer the implementation of pension shares on divorce until revised factors are in place. This will delay divorce proceedings and may increase costs for those in the process whose calculations are put on hold.

Spence & Partners Ltd have developed specific software which can provide divorcing parties and their legal advisers with an estimate of the likely impact of the change in the level of increases on the CETV, and the potential impact on the value of the pension share on divorce which was in the process of being agreed. Whilst a degree of uncertainty may remain, it may well be attractive for some parties to proceed having been provided with an estimate of the impact of the change.

The Pensions Minister subsequently issued a statement on 8 July confirming that the Government also intends to use CPI for determining statutory minimum increases which apply to private sector pension schemes.

These changes will undoubtedly have an impact where pensions are a factor in divorce proceedings.

Although both are measures of inflation, RPI and CPI are calculated using different methods and are based on different “baskets” of goods.  Historically this difference has resulted, for most time periods, in CPI being a lower measure of price inflation that RPI.  Overall, commentators expect CPI to be around 0.5% to 0.8% lower than RPI over the longer term.

For all public sector pension schemes* the expectation is that future increases in pensions will be lower than previously expected.  Therefore, the switch from RPI to CPI will affect the assumptions underlying the calculation of Cash Equivalent Transfer Values (CETVs). This change is likely to reduce CETVs and may have an impact on what is deemed an appropriate percentage Pension Share.

By way of illustration, for someone who is currently 40 years old with a pension in a public sector pension scheme, the impact of this change alone could result in a reduction of around 20% to the CETV.

For private sector pension schemes, the impact of the change is likely to vary by scheme and will depend upon the rules of the particular scheme.

It is likely that many pension schemes will defer issuing new transfer values until the changes have been considered.   Further, pension schemes may decide to put on hold the implementation of Pension Sharing Orders.

For ongoing divorce cases where pension information has been provided, the solicitor and parties involved should carefully consider whether it is appropriate to base any decisions on this information and such advice as may have been provided, whether in relation to Pension Sharing or Offsetting without first seeking further advice from an actuary specialising in pensions on divorce.

Spence & Partners can provide an early indication of the likely impact on the value of the CETV and implications for Pension Sharing on taking account of these changes.

For more information on this or any other pension on divorce issue contact our divorce team divorce@spenceandpartners.co.uk

*Public sector pension schemes include the Principal Civil Service Pension Scheme, Health and Personal Social Services Superannuation Scheme, Armed Forces Pension Scheme, Local Government Pension Scheme, Police Pension Scheme, Teachers’ Pension Scheme and Firefighters’ Pension Scheme.

Ian Conlon Actuary