What key findings did the National Association of Pension Fund's Annual Survey 2008 find?

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• 28% of DB schemes are still open to new entrants (31% 2007, and 33% 2006)
• rate of closure over last two years has remained stable
• 21% of those still open are considering switching to DC
• 10% are looking to reduce their costs or risks.
• growing interest in buyin out
• Planned pension reforms will further change the shape of future provision.

Definition of DB

What are the key design features of a DB Scheme?

• Benefit Structure
  • pension defined in advance as a proportion of pensionable salary calculated by length of service
  • Example ...
  • option to take cash lump sum (% of original pension or calculation)
  • some schemes offer lump sum in additon to pension (public sector)
  • tangible link between anticipated benefit and earnings.
• Cost and Balance of Risk
  • Cost met from contributions -
    • Contribution rate is an estimate based on a number of assumptions.
    • future earnings and pensionable service not known with certainty.
    • pooled and invested but not earmarked
  • Security depends on employer's ability to finance.
  • Risk - unknown costs - employer
  • Risk - employer insolvency/underfunding - employee

1. Final Salary
2. CARE
3. Hybrid
4. Cash Balance Scheme

• Traditionally the most common form of DB scheme.
• Pension calculated by pensionable service and their earnings close to retirement.
  • 1/60 x Pensionable Service x FPS
• Pensionable service (or qualifying service) is usually counted from date of joining scheme but may also include transferred in service.
• FPS can have many definitions depending upon the scheme.
  • e.g. average of your Pensionable salary over any 3 consecutive years in the last 13 before you retire.

• Useful for the flexible working environment.
• Benefits are based on earnings over the member's entire pensionable service, matching fluctuations in earnings more closely.
• May provide a greater stability of cost for the employer.
• To combat effects of inflation, pension accrued each year is increased.
• Pension at retirement is total of the pension earned over each of the preceding years, based on the increased (revalued) earnings. 

Can be either:

1. A scheme which primarily provides benefits on one based but will provide them on another basis if that would produce better benefits

E.g. scheme providing salary related pension promise whilst notional DC accounts are recorded for each member, with notional investment returns. 

Inclusion of underpin makes scheme more complex and expensive

1. An occupational pension scheme which offers both final salary plus money purchase

Examples:

• transfers into a DB scheme may secure DC benefits
• additional voluntary contributions to a DB scheme may be paid on a DC basis
• schemes which offer employees a choice between DB and DC sections.

• Look like DC schemes as they provide an accumulation of contributions with a guaranteed rate of return.
• The target benefit is a lump sum at retirement used to purchase pension
• Method and terms of conversion may be defined or depend upon annuity rates available
• Individual member accounts are hypothetical - funds are pooled - unlike true DC schemes.
• Risk lies with employer.

• Employer Objectives
• Employee Expectations
• Cost
• Taxation

Describe Employer Objectives in relation to

What affects the choice of design?

• Costs and complex responsibilities have led to closure of DB schemes.
• Looking at providing sustainable pension provision in future
• Employers attract and retain workforce with salary and benefits package, i.e. pension.
• Examples of typical employers who have chosen DB schemes:
  • those concerned with staff security at retirement
  • those in traditional industries who have and want to retain a stable workforce
  • those who operate in market places where staff expect DB schemes.
• Many companies involved in, e.g. local authority tendering, must have 'broadly comparable' schemes.
• DB schemes tend to suit large, stable or expanding businesses that has a workforce with a spread of ages and reasonable size.
• Where a company operates a flexible benefits programme, a DC scheme is an easier fit.

Describe Employee Expectations in relation to

What affects the choice of design?

• Ensure DB schemes are valued by employees to attract and maintain a membership profile that helps to sustain the scheme.
• Since 1988 - not compulsory to join employers scheme.
  • Schemes have to be attractive
  • Design appeals to employees need and communication is vital.
  • Value of DB schemes becomes clear if employees understand that State pension provision is becoming a smaller part of an individual's retirement income.
• Common employee needs:
  • financial security in retirement
  • protection of family/dependants in the event of death
  • actual security of the pension they expect
• Other influences:
  • experience and mobility of workforce
  • employees who work variable hours (scheme takes account of fluctuating pay patterns).
  • one pension scheme can accommodate the different needs of all types of employees by having membership categories.
  • pension reforms (2012) could open up choices for employees, so employers may need to reconsider how they offer membership to new employees as well as the structure of the benefits.

Describe Costs in relation to

What affects the choice of design?

• Costs are a major factor - contributions and inclusion of deficit of company's balance sheet
• Ageing workforces are more expensive
• Budgetary restraints have to be considered when establishing DB schemes - Employers will not have unlimited funds to spend
• Good designs should take account of tax concessions
• Other points:
  • cost extends beyond retirment benefits - death benefits, admin services, investment and actuarial advice, etc
  • costs can be offset by requiring employee conts
    • 'tiered' approach
  • Benefits can be targeted to meet the needs of groups of employees - also enhances value of scheme
    • e.g. scheme offering lower accrual but greater death benefits to younger employees.

Describe Taxation in relation to

What affects the choice of design?

• Prior to A-Day, contributions and benefits had to comply with certain max. levels set by HMRC for approved schemes
  • schemes designed to restrict benefits to those max. limits
  • e.g. pension permitted to 2/3 FPS and limiting service in 60ths scheme to 40 years.
• From April 2006, it was replaced with an allowance system - however not compulsory
• Many schemes kept original design on basis of cost - removing the limits would increase the liabilities.

By making an allowance for the fact that at state pension age, members will also receive BSP plus their scheme pension.

• Offset an amount representing the BSP from the pensionable salary used
• Offset from the pension itself.

• Employer takes responsibility for additional state pension for some or all employees, by paying a lower rate of NI contributions and using rebate to fund benefits in the scheme.
• A contracted out scheme is more complex.
• Original attraction of contracting out was that the rebate was seen to more than cover the liabilities, however current rate is insufficient in most cases to provide similar benefits to S2P.
• Disadvantages:
  • no guarantee that reduction in NI conts will cover cost of liabilites.
  • lower paid and older employees may not necessarily be better off.
  • if contracted out benefit represents small proportion of whole benefit (i.e. high accrual schemes for execs), benefit to employer of NI saving is negligible.
  • More complicated to explain and administer.
• DB schemes can contract out on DB or DC basis.
• Pensions Act 2007 proposes to abolish contracting out on a DC bases from 6 April 2012
• PA2007 allows schemes contracted out on a DB basis to convert benefits accrued on GMP basis to a new simplified basis.

• Eligibility Conditions
  • removing waiting period can increase membership levels but may lead to small pensions being retained in the scheme
  • restricting membership controls costs
  • auto enrolment needs to be taken into account
• Accural Rate and Pensionable Salary
  • FPS to CARE - reduces costs
  • Higher accrual = higher pension
  • Pensionable salary that includes variable pay ontop of basic salary = higher pension
  • finaly salary - CARE scheme
• Contributions
• Benefits and Options
  • Normal Retirment - increasing NPA can ease funding
  • Early Retirment - redundancy supported by pension being available early and enabling employees to choose to retire early can help succession planning.
  • Death Benefits - now have to recognise civil partnerships
  • Early Leaver Benefits - Transfer value must be offered to those leaving scheme within 3 months and 2 years.
  • Pension Increases - guard against inflation - linked to price inflation with annual cap.
• Contract Out
  • rebates are reducing and scheme is more complex
  • consider review of this in light of reviews on other areas
  • now allows conversion of GMP's to an equivalent scheme pension

• falling investment returns, worldwide
• increased longevity
• emergence of funding and FRS17 deficits
• increasing complexity and costs associated with runnding a DB scheme
• legacy of the removal of Advance Corporation Tax relief on UK equity dividend income from July 1997.
• deficis attract attention in the commercial world due to their impact on the value of a company's assets and can be the deal breaker in the process of a corporate sale.

De-risking

• looking to limit exposure to the open ended costs of DB
• Transfer liability by buying in/out for a fixed cost now
• Buyout - pensioners become policyholders of the insurer and their connection with the scheme ceases
• Buyin - scheme insures the liability for pension payments.  Pensioners remain in the scheme but risk is transferred out.

Restructuring

• Continue running a DB scheme but reduce benefit accrual for future service, and/or increase member contibutions
• Close the scheme to new members
• Close the scheme to new entrants and to existing members.
  • greater impact on controlling funding.
  • Amendment to the rules and subject to section 67 - changes can't worsen accrued rights.
• Close the scheme to new and existing members and wind up the scheme.
  • any underfunding is greater on this basis and must be addressed in the short term

Large employers (50 or more employees) have to consult with members and relevant parties before making changes. 

• PA04 -
  • Pensions Regulator to stregnthen security for members through more effective monitoring of scheme management.
  • PPF - improve security for member of DB schemes if employer became insolvent after 5 April 2005
  • requirement for schemes to provide an additional option for leavers with less than two years pensionable service
• Civil Partnership 04
  • provide statutory minimum benefits to registered CP or provide same benefits as married spouses
• Employment Equality (Age) Regulations 2006
  • Illegal to enforce retirement before age 65 from Oct 2006
• PA07
  • Framework for Personal Accounts, conversion of GMP's and cessation of contracting out.

• Public sector schemes that are established by TDR and subject to changes in the law like private sector schemes
• Public service schemes - defined by statute, Royal perogative or Royal Charter
  • currently reviewing the design
  • LGPS introduced changes to benefits and contribution structures
• Public Sector Transfer Club