pension freedoms: a new spectre looming for employers? 6 · 06 pension freedoms: a new spectre...

London | Birmingham | Glasgow | Edinburgh T 020 7082 6000 | www.hymans.co.uk | www.clubvita.co.uk

Corporate consulting in pensions and benefits Spring 2016

Inflation transformation 3

Setting your sights on sustainability 4

Pension freedoms: a new spectre looming for employers?

Feature

GO ScottishPower - A DC savings revolution 8

6

More risk than reward 11

Welcome

Inside this issue

2016 has already proved to be fascinating for the world of pensions and savings. The highly anticipated pensions relief taxation changes expected in the Budget were scrapped at the last minute. Yet whilst the industry

breathed a collective sigh of relief, the Chancellor instead threw us a curveball in the form of LISA – the lifetime ISA.

LISAs will run in parallel with traditional pensions saving from April 2017, and represent a real opportunity to become a core part of leading benefits packages. To find out more about LISAs have a read of our inFORM special edition which you can find in our Knowledge Centre at www.hymans.co.uk

So, yet more choice for savers. But as we know, with more choice comes added complexity and confusion for employees. Our recent research among employees told us that 71% believe their employers are responsible to support them in making decisions regarding retirement savings. Lee Hollingworth explores the role of employers in helping educate and support employees on pages 6 and 7.

Scottish Power are a great example of a company who are providing a high level of support to staff. Recognising that their DC members needed to save more they introduced our Guided Outcomes (GO) solution

in November 2015. Through GO analysis they’ve understood the wide ranging circumstances of their membership, to make sure GO will work for everyone. Our case study on pages 8 and 9 shows how their employees are benefiting from the simplicity of GO.

In the DB world, legislation is also creating opportunities to reduce liabilities; on page 3 Luke Burton explores how recent Court rulings will allow some schemes to switch from the RPI to the CPI index for inflation-linked pension increases which can lead to substantial cost savings for employers. Capital markets are the key driver of DB costs in the long run. On page 11 Graeme Johnston looks at the current challenges markets are posing.

There’s an abundance of both challenge and opportunity for those sponsoring DB and DC schemes. I hope you find this edition helpful in thinking about how you seize these challenges and turn them into benefits for you and your employees.

Jon Hatchett, Partner

@hymansrobertson

@JHPensions

08 GO ScottishPower - A DC savings revolution

10 Time for change?

11 More risk than reward

03 Inflation transformation

04 Setting your sights on sustainability

06 Pension freedoms: a new spectre looming for employers

http://www.hymans.co.uk/media/592499/160324-inform-special-edition_march-2016_final.pdf

The informed view

Inflation transformation

Following recent Court rulings, trustees have more freedom to switch from the RPI to the CPI inflation measure for members’ benefit increases. Switching typically reduces scheme liabilities by 5% to 10%, so revisiting past decisions could well be worthwhile.

Inform Spring 2016 03

The credibility of the RPI as an inflation measure has been in question for some time, not least because it has an in-built bias to overstate inflation. From 1 January 2011, the CPI replaced the RPI as the measure of inflation used by the Government to calculate the statutory minimum increases to pensions.

Many schemes specifically reference statutory increases within their rules. For these schemes, the Government changes automatically flowed through to members’ benefit increases.

For many others the change will not have been automatic. This could be because their scheme rules either specifically refer to the RPI or permit the trustees to select the reference index, i.e. the RPI or the CPI, or indeed one of the many other published measures. Until now it has been a case of ‘wait and see’ for these schemes until the case law had been developed.

Court rulings have now provided some desired clarification. For schemes where the trustees have the power to select the reference index, there can be situations in which the trustees may properly decide to use their power to switch the reference index from the RPI to the CPI.

The decision of whether to switch is likely to depend heavily on the rationale for change. For example, consider the case where it can be shown that there is a material risk that the sponsoring employer may struggle to fund the scheme in the future based on RPI increases. In this situation, there may be a case for making the switch to CPI increases, to help protect the security of members’ benefits. This would increase the likelihood that all members receive their benefits in full and reduce the chance that the scheme falls into the Pension Protection Fund.

Taking appropriate legal advice throughout assessing and implementing any change will be critical. For any schemes where the change to CPI did not flow through automatically, sponsoring employers should review their scheme rules and past decisions. In many cases there will now be a compelling case for asking the trustees to switch their benefit increase index to a more fit-for-purpose index, which more accurately reflects inflation, and significantly lowers the cost of meeting liabilities.

In many cases there will now be a compelling case for asking the trustees to switch their benefit increase index to a more fit-for-purpose index, which more accurately reflects inflation, and significantly lowers the cost of meeting liabilities.

Luke BurtonLuke is a qualified actuary with over six years of consulting experience. He provides both actuarial and investment advice

to the sponsors and trustees of defined benefit pension schemes of various sizes, and is particularly interested in helping clients to manage the inherent funding and investment risks associated with running their schemes. Contact Luke for more information on T 020 7082 6237 or E [email protected]

CPI RPI

Setting your sights on sustainability

04 Inform Spring 2016

Undoubtedly a successful strategy starts with an in-depth understanding of long-term objectives. If you don’t know where you’re going, you’ll probably end up somewhere else. But are you aiming too high, too quickly and repeatedly falling short?

Chasing a high funding target over a short time frame will typically drive high cash contributions and/or high levels of investment risk. This puts an unnecessary strain on your finances; in a recent survey we carried out, one in seven CFOs said that DB pensions were one of the biggest risks their business faced. In contrast, setting your sights on sustainability rather than buy-out, means you can adopt a strategy to get there at a lower level of cost and risk.

So, with this in mind, is it time to review, rethink and reset your goals?

ReviewIn recent years, trustees have increasingly moved towards

very low risk strategies aligned with a traditional aspiration to buy-out liabilities with an insurance company. As a result, most schemes have adopted a strategy of taking more risk today in the hope of taking less risk later.

However, as we’ve seen in recent months this comes at a price. Despite significant amounts having been paid in deficit repair contributions, many schemes with 2016 valuations will be facing larger funding deficits. This will feel like groundhog day for many finance directors. Clearly, the approach of paying more and more and pinning hopes on equity market growth and yield reversion just isn’t working.

And yet when we asked trustees in our 2015 Trustee Barometer research, an

overwhelming majority (81%) recognised that full buy-out might not be a near term goal for their scheme.

So if buy-out is not the immediate priority for companies or trustees, does a target and strategy aligned with this make sense? The answer would seem to be a resounding ‘no’ if it brings with it unnecessary volatility today.

RethinkMoving away from the end-game buy-out target enables the focus to shift towards a more commercially sustainable target and timeframe that’s

better aligned with the needs for your business.

Rather than trying to eliminate all risk, the goal is to reduce it and maintain appropriate levels of volatility over an extended period. By using the strength of the company and/or security to support the residual risk, you avoid paying for insurer profit and risk margins today. You also alleviate the risk of a trapped surplus in future.

The picture below illustrates how a typical insurance company invests its annuity funds – typically little in growth assets, lots in high quality bonds and gilts and well hedged against movements in interest rates and inflation – to deliver a relatively low risk strategy yielding around 1% p.a. above gilts. Of course insurers have to hold capital against the risks, and perhaps it makes sense for DB schemes to seek to be better funded, but nonetheless self-sufficiency targets of around gilts +0.3-0.5% p.a. look to strike an attractive balance of cost (for you) and security (to help obtain trustee agreement).

Growth Income Protection

50%50%0%

Growth Investment grade credit/debit

Gilts / Swaps / Cash

100%

50%

10%

Source: Hymans Robertson


ResetFaced with the current funding challenges, it’s essential that companies look for opportunities to make their schemes more resilient. Deciding not to try and get to the end point as quickly as possible is one of the simplest ways to reduce

risks and stabilise scheme funding. As the picture below suggests, aim for a commercially sustainable target, pay a stable, lower level of annual deficit contributions for a longer period of time, and combine this with a simple, lower risk investment strategy.

Ultimately a slow, steady, sustainable approach to funding may provide more certainty on cost and could achieve better results. After all, as they say, “slow and steady wins the race”.

Laura McLarenLaura is a qualified actuary in our Glasgow office with 11 years’ consulting experience. She advises a variety of trustees and sponsors

providing strategic advice across areas including objective setting, risk management and governance.

Contact Laura for more information on T 0141 566 7914 or E [email protected]

Case study Over the past five years we have supported our client (sponsor to a multi-billion pension scheme) in de-risking, stabilising and shrinking their DB pension costs. As a retailer, stability and predictability of cash flow is critical, so their primary objective was to agree stable cash contributions and bring risk within the scheme down to a level that was acceptable to the business.

They recognised that managing a DB pension scheme is a long-term game and accepted there was no particular urgency to get to buy-out and, importantly, that taking their time would have a positive impact on risk reduction. This risk reduction was achieved by reducing their funding target by around 10% (from gilts + 0% p.a. to gilts + 0.5% p.a.) and dialling down their allocation to growth assets, such as equities, while placing more reliance on income generating and protection assets. Importantly, they increased the level of interest rate and inflation protection significantly.

Overall this slow and steady strategy has resulted in a portfolio that has delivered the returns needed to stay on track while immunising them against the market falls which have hurt most other schemes. Five years on they are now sitting on a healthy surplus.

Scheme Assets Reduced risk and no trapped surplus

Buy-out

Sustainability

Technicalprovisions

Time

Long-term

Contributions &

Investment Returns

Lower risk - more certainty

Higher investment risk

Plan for buy-out over long term, if and when it becomes a nearer term goal

Build in some flexibility to help stabilise cash contributions (rather than aiming at one specific point)

Accept it will take longer to get there but with less volatility and less chance of having to pay in more cash in the future

Aim for a commercially sustainable target

Take less investment risk today

Illustrative scheme. Source, Hymans Robertson


Educate staff now or pay later Now faced with a raft of options, will your employees make good decisions around use of their pension pots? And if not, could they hold you responsible?

Pension freedoms: a new spectre looming for employers?

Not so long ago, an employer or trustee’s main concern when it came to staff pensions was around encouraging employees to save enough into their pot and provide appropriate investment options. It was a fairly simple arrangement, where a healthy sized pension pot would allow an employee to purchase an annuity, securing them a regular income for their retirement. From an employer and trustee perspective, their job was done.

However, this familiar path ended in April 2015 when the Chancellor’s pension freedoms came into force. Workers now have the freedom to invest, or spend, their retirement savings as they wish. While in many ways this freedom can be seen as a positive development, it does introduce new problems for employers and trustees, problems which could

undermine the good work they have already done around their workplace pension arrangements.

Unfortunately, greater levels of choice also bring an increased potential for employees to make poor decisions. If poor decisions are made, this increases the chances that some may not be able to afford to retire. For example there is already emerging evidence that some workers are spending a large proportion of their pots to supplement their lifestyle while they are still working, rather than saving it for their retirement. This could lead to serious issues around workforce management, where younger generations of workers struggle to find room to grow due to an ageing and costly older workforce who cannot afford to retire. There is also the possibility that retirees who have made poor decisions

could even blame their employers for not providing sufficient guidance around the new set of choices.

Research we conducted recently suggests that many employees reaching retirement are not using the Government’s Pension Wise service. In fact 71%* of employees believe it’s an employer’s responsibility to support employees’ decisions regarding retirement savings. Whether employers or trustees like it or not, their responsibilities increasingly look to be extended to support employees ‘at retirement’ choices, as well as just saving for retirement in a workplace pension.

of HR heads are confident Pension Wise will offer

adequate guidance

of employees believe it’s the employer’s responsibility to

support employees’ decisions re retirement savings

of employers think employees will hold their company responsible if

they make poor decisions

51% 71% 48%

*Hymans Robertson Employer and Employee Research 2015


Pension Wise has been designed as a one-off conversation about an individual’s retirement options. The reality is that when a worker has reached retirement age, it is often a case of ‘too little, too late’ to have any real impact on the worker’s retirement outcomes. Instead, regular dialogue is needed to safeguard against both bad decisions and bad outcomes. This dialogue should ideally begin at least 10 years before the individual’s selected retirement age. Ongoing engagement and intervention is needed on the options, and the impact of employee’s decisions, on their eventual retirement income.

Many of our clients have now re-designed their default investment option using projected pot size as a suitable proxy for the decision members are likely to make at retirement age. This involves segmenting individual members into an appropriate glide path to take them to an asset allocation suitable for either drawdown or encashment at retirement. Having implemented these solutions, there is now a need to engage with members to inform them of the path they have been defaulted to and the alternative options that may be more suitable given their individual circumstances.

They also must be able to understand that withdrawing too much money, too soon, from their pension pots can have severe consequences later down the line. For example, there is a real risk that many of your employees will seek to access their pots while still working for you, effectively deferring the age at when they can afford to retire.

Responsible employers need to start considering how they can deliver support to staff to ensure that they understand their options and make good decisions, both in planning for and at retirement. For a large proportion of workers, a comfortable retirement hinges on the quality of the guidance, information and support they are given. This support should be delivered earlier than the point of retirement to ensure people are better prepared when they reach retirement. Informed employees are empowered to make decisions which improve the chances that they will be able to afford to retire rather than continuing to work, and reduces the likelihood that they will feel they have not been given adequate guidance and look for someone to blame in future.

In summary x Pension freedoms have added a lot more complex options for workers to consider

at retirement.

x Increasingly employers and trustees are expected to support workers in making retirement decisions.

x Employers and trustees can best act now by implementing an engagement strategy in the period leading up to retirement.

Many of our clients have now re-designed their default investment option using projected pot size as a suitable proxy for the decision members are likely to make at retirement age.

Lee HollingworthLee is a Partner and Head of DC Consulting, responsible for the business development, planning and marketing of the Firm’s DC

consulting services to clients. Notably, he led the development of our multi award-winning auto-enrolment proposition and has recently focused on creating our Guided Outcomes® approach to DC. He also retains some ongoing client engagements and has experience of working with blue chip clients including Asda, Axa Group, M&S and Virgin Money.

Contact Lee for more information on T 020 7082 6324 or E [email protected]

GO ScottishPower - A DC savings revolution

ScottishPower have around 4,500 contributing members in their DB scheme and around 2,500 members in a contract based DC plan with Fidelity. The DC plan has been open since 2006 and all new hires join. It is growing rapidly and we were keen to ensure the DC arrangement was working well, both for members and in terms of supporting our HR strategy. In particular we recognised that DC members needed to be saving more and wanted to find an effective way of making this happen.

We appointed Hymans Robertson, who had looked after our DB arrangements for some time, to introduce Guided Outcomes® and help achieve our DC goals. The project involved four phases:


2. GO scheme design

We had people in a wide range of different circumstances and needed to make sure that GO worked for everyone. The design process enabled us to do this.

We set a long term objective to get members to “green” and used GO to look at the changes needed to savings behaviour to get them there. We then created rules to make sure any changes to retirement age and contributions suggested to members were sensible. For example we built in an option to cap automatic annual contribution increases to 2% a year if the member preferred, where they were facing a larger initial increase to get back on track. Over the long-term the GO modelling showed this didn’t materially reduce member outcomes, but it did make it more likely members would sign up to saving more straight away.

3. Operational requirements

To make GO work we needed to get data from our payroll system and from Fidelity, the pension provider.

We had a workshop to agree the administration routines and data requirements and then worked together to create data interfaces and test everything worked properly.

1. Assessment of current position and setting success factors

Our DC scheme operates under a relatively generous matching structure, but not all members choose to pay a level of contributions that attracts the highest employer match amount. While we intuitively knew this meant, overall, members weren’t saving enough. The GO™ analysis enabled us to get a really good handle on by how much and why. We have a skilled workforce and typically long service, so members can get material salary growth through their careers here. What was striking was how pension saving behaviour hadn’t changed even as people’s salaries increased.

The GO analysis also really helped us educate internal stakeholders around the position of the scheme, and we agreed a common set of objectives from the introduction of GO.

0200400600800

100012001400

Highly unlikely Unlikely Moderate Likely Highly likely

Member Status

Source: Hymans Robertson GO analysis sample


4. CommunicationsIt was critical to the success of the initiative that the communications were simple and engaging. We spent some time working together (along with communications agency like minds) to develop our strategy and create the underlying material.

The campaign included on-line and off-line material, ranging from a personalised member statement to a wobbler!

Paul is a Partner in the Actuarial and Benefits Consulting practice. Paul specialises in the development and delivery of DC, workplace savings and financial education strategies and has worked with a wide range of large organisations. More recently, he has helped lead the development of our Guided Outcomes (GO) DC proposition.

Please contact Paul on T 020 7082 6281 or E [email protected]

™

Paul Waters

Partner & DC Consultant, Hymans Robertson:

For too long DC members have been the poor relations to their DB cousins. While they may never enjoy such generous arrangements, they can now get the clear support they need to save enough for retirement, while their employer can benefit from insightful M.I. to help run the scheme even better than before. GO makes DC simple.

Anne Harris, UK Pensions Manager, ScottishPower - Our members have been delighted with GO – they find it simple to understand and easy to use. We get comments like

I’m happy to save more towards my retirement, I just needed someone to tell me what I should be paying into my fund each month.

We launched the scheme in November and it has been really well received by members. Over a third of members logged on to the site straight away, with lots of positive feedback from people across the business about how simple it all was.

As we expected, the option to get back on track over time while capping contribution increases at 2% has proved very popular – although one member did immediately increase their contributions by 13%!

We are now able to access regular management information about the performance of our scheme through GO.

Members are now much better informed about how much money they will need to live on in retirement and how much they are likely to receive from our scheme. Most importantly they are saving more than before.

This is just the beginning with a number of further initiatives planned for 2016, including member drop in sessions and launching “single sign on” later in the year.

Time for change?

A recent survey* suggest 20% of sponsors of open DB schemes are reviewing benefit levels. Whilst some have to address this issue because their DB scheme is simply no longer affordable, others are making changes for different reasons. Even profitable companies should review DB pension levels. Reasons for this include:

1 Responding to legislative changes – increases to the level at which employees can access their State Pension are coming through from April 2016 onwards. Companies should align DB pensions with these changes, for example by reducing the accrual rate and increasing the normal retirement age.

2 Market alignment – many companies closed their DB schemes to new hires over 10 years ago, and if affordability is not an issue, have then not reviewed DB or DC benefit levels since. These benefits could now be seriously off-market. Typically reducing DB levels (or even closing DB) and increasing DC levels will ensure your reward package is competitive.

3 HR and reward issues – any company that has closed DB to new hires has a two tier workforce issue that gets starker over time, leading to inequity and unfairness. One of my clients worked out they spend £15,000 per head on employees in their DB scheme and £2,000 per head on employees in their DC scheme each year. This in itself justifies DB change, as it enables the pension spend to be spread more fairly amongst staff and frees up budget for other reward initiatives.

4 Risk management – DB closure is often appropriate to manage risk and get cost certainty rather than necessarily reducing cost. Falling yields also mean that companies with a triennial valuation this year can expect a 15-25% increase in future service contributions, meaning DB change is necessary to prevent further cost increases rather than to save money.

5 Multi-employer issues – DB closure prevents the triggering of “Section 75 debts” for companies with more than one employer in their scheme. This in itself can be a corporate driver to close DB because it ensures that buy-out levels of debt payments are not triggered when the last active member leaves each participating employer.

In summary, while affordability is often a key driver for reviewing pension benefits, there are other compelling reasons why a host of employers are looking at this closely in 2016.


Alistair is a partner and a Fellow of the Institute and Faculty of Actuaries. He joined Hymans Robertson as a graduate in 2000 and has been a practicising Scheme Actuary since 2006. Many of his clients are in the not-for-profit sector, where he advises both pension scheme trustees and sponsoring employers on pension funding, design and risk management. Alistair also leads our advice to social housing clients.

Please contact Alistair on T 020 7082 6222 or E [email protected]

Alistair Russell-Smith

Even profitable companies should review DB pension levels.

*ACA Survey 2016

and finally...

More risk than reward

x Did a 75% fall in oil prices spell more disruption to producers than gains for consumers? The modest recovery of recent weeks is probably preferable to bandwagon-jumping forecasts of $10 per barrel. Supply – it might be stabilising after strong growth in recent years – should remain a more important factor than demand.

x Deflation fears have resurfaced and the level at which short-dated inflation protection is priced has fallen … or perhaps it was the other way round. Headline inflation is minimal, but keep an eye on ‘core’ versions. They have been drifting higher – now over 1% in the UK and over 2% in the US.

x US and UK central banks are hardly enthusiastic about raising interest rates, but investors still think they are over-optimistic. Futures markets now imply perhaps one rise in US rates this year and no rise in the UK for the next three. This makes for potentially expensive interest rate hedging, unless your economic view is very gloomy or you need to manage volatility.

x Consensus global growth forecasts are not that gloomy, albeit under downward pressure. This year and next look about the same as last year. A soft end to 2015 in the US led to some speculation about an imminent recession, but activity seems to have picked up a little. China remains the big uncertainty – can the continuing slowdown be managed or is a credit crunch imminent?

x All this and a referendum, too. The long-term consequences of Brexit would not become clear for many years. For the moment, financial markets will have to make do with speculation and uncertainty around a binary outcome.

Markets are treading a narrow path between rising interest rates and poor economic growth. The risks of veering far in one direction or another may not have crystallised, but they are real. Companies have an asymmetric exposure to these risks which drive scheme funding positions. Any deficits they need to meet, but any surplus will be trapped in the scheme. Given this, they should be circumspect about how much, and which, risks they take within their pension scheme and proactively engage with trustees to drive this agenda.

A sharp fall in equity markets at the start of the year suggested investors were worried. Cue the explanations that economic conditions had changed. A subsequent recovery cast some doubt on this, but the issues that caused alarm are still the ones that matter.


Graeme is a Partner in our investment practice and is responsible for our Capital Markets Service.

Contact Graeme for more information on T 0141 566 7998 or E [email protected]

Graeme Johnston

Markets are treading a narrow path between rising interest rates and poor economic growth. The risks of veering far in one direction or another may not have crystallised, but they are real.

London | Birmingham | Glasgow | Edinburgh T 020 7082 6000 | www.hymans.co.uk | www.clubvita.co.uk

This communication has been compiled by Hymans Robertson LLP based upon our understanding of the state of affairs at the time of publication. It is not a definitive analysis of the subjects covered, nor is it specific to the circumstances of any person, scheme or organisation. It is not advice, and should not be considered a substitute for advice specific to individual circumstances. Where the subject matter involves legal issues you may wish to take legal advice. Hymans Robertson LLP accepts no liability for errors or omissions or reliance upon any statement or opinion.

Hymans Robertson LLP (registered in England and Wales - One London Wall, London EC2Y 5EA - OC310282) is authorised and regulated by the Financial Conduct Authority and licensed by the Institute and Faculty of Actuaries for a range of investment business activities. A member of Abelica Global. © Hymans Robertson LLP. Hymans Robertson uses FSC approved paper. 4691/MKT/Inf0416

Guided Outcomes is a registered trademark of Hymans Robertson LLP.

Please note the value of investments, and income from them, may fall as well as rise. This includes but is not limited equities, government or corporate bonds, derivatives and property, whether held directly or in a pooled or collective investment vehicle. Further, investments in developing or emerging markets may be more volatile and less marketable than in mature markets.

Exchange rates may also affect the value of investments. As a result, an investor may not get back the full amount of the original investment. Past performance is not necessarily a guide to future performance.

pension freedoms: a new spectre looming for employers? 6 · 06 pension freedoms: a new spectre...

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