Why TTIPing may be bad for us

Germany has surprised the European Commission (EC) by suddenly insisting that stiffer data protection controls are incorporated into the negotiations for the Transatlantic Trade and Investment Partnership (TTIP), which began earlier this year, and for which the second round has started this week. For those of you who have not heard of it before (understandable, as the negotiations so far have had a deliberately low profile), the purpose of the TTIP is to create a single transatlantic market, in which all regulatory differences between the United States US and the EU are gradually removed. The EC calls it “the biggest trade deal in the world”.

As the EC goes on to say:

On top of cutting tariffs across all sectors, the EU and the US want to tackle barriers behind the customs border – such as differences in technical regulations, standards and approval procedures. The TTIP negotiations will also look at opening both markets for services, investment, and public procurement. They could also shape global rules on trade.

Concerns have started to emerge about the massive transfer of power from governments to corporations that the final deal might allow. However Germany’s intervention on data protection is just the latest of a list of reasons that have been advanced for why the TTIP talks are unlikely to go anywhere. From the legislative schlerosis of the US, to protectionist instincts on both sides recently strengthened by austerity, to French paternalism towards their film industry, to European fears about an influx of GM foods, the TTIPing point will never be reached, they say. So nothing to worry about then.

Or is there? A document published last year by the US Chamber of Commerce and BusinessEurope explains how it would be able to overturn existing legislation which got in its way. And if the long tortuous progress of Solvency 2’s implementation date, the bureaucratic equivalent of the man with the end is nigh sandwich board on his back, endisnighhas taught us anything, it is that unimplemented regulatory frameworks can still have massive impacts. Just this month it was revealed that the best funded pension schemes in the FTSE 100 are insurers, precisely because of the impact of those schemes on insurers’ solvency capital requirements under Pillar 1 of Solvency 2. And the clear rebuff to EIOPA from exporting these requirements to occupational pension schemes has not prevented the work to develop a framework for imposing them from continuing.

So what would TTIP mean for defined benefit (DB) pension schemes? Well, at first sight, not very much. US DB schemes tend to have funding targets equivalent to FRS17 levels, which would be seen as at the weak end of UK funding targets. However, as we have seen with the process of market harmonisation in the EU, horse trading may lead to the US being stuck with stiffer requirements imported from the EU on pensions in order to maintain subsidies for US farmers, say.

And there are two features of the US DB landscape which would be an issue for many UK DB schemes.

The first is the recovery plan length, which typically does not exceed 7 years in the US. Possibly not too onerous in many cases, if coupled with a FRS17-type funding target, but the EIOPA caravan has surely travelled too far for any dilution of funding target to be allowed at this stage. A 7 year recovery plan would however represent a considerable increase in contribution requirements for many schemes within the UK’s current funding environment.

The second is the restrictions placed on US pension schemes which fall below prescribed funding levels. If the funding level falls below 80%, no scheme amendments are allowed which would increase benefits until the funding level has first been restored to 80% or above, and certain types of benefit payments are restricted. These restrictions become much more stringent below 60% funding, when benefit accrual must cease and the range of benefits which cannot be paid out is extended to cover “unpredictable” contingent events.

We may not be out of the woods of Solvency 2 yet as far as DB pension schemes are concerned. But even if we do manage to break out of EIOPA’s grip, it may be only to find ourselves surrounded by a larger forest.

Illustration by Emma J Hardy
Illustration by Emma J Hardy

Papers and Pensions

mobile pics Nov 2013 010Now that the Great and Good of the actuarial profession and pensions industry have launched their joint consultation with the DWP on defined ambition (DA) options, it is interesting to look at the initial response in the print media.

The first thing to note is how little of it there is. The Daily Mail, Daily Express and Daily Telegraph have it on the front page. The Financial Times, Guardian and Times do not. Nor do the red tops. All three headlines sit alongside photographs of the Duchess of Cambridge.

And the response varies. The Express have written what looks like a positive piece (“Bigger Better Pensions For All”) until you discover it has decided to present the launch of the consultation as an “industry shake-up” which will “spell the end of annuities”. I was a little puzzled about this at first, as the consultation is not really about annuities at all, until I realised that Steve Webb had made a speech the previous day and mentioned the FCA review of annuities. This clearly fed into the default Express editorial line better than the actual topic of the consultation. This became clearer on page 4, with the headline “’Poor value’ annuity payouts are axed in pensions shake-up” next to a big picture of a smiling Ros Altmann. There appears to be only one story possible in the Express on pensions, whatever the actual news event.

The Mail does at least focus on things that are in the consultation, concentrating on the proposals to allow final salary pensions to drop some currently guaranteed elements of benefits such as indexation and spouses’ pensions. “The Death Knell for Widows’ Pensions” is their headline, but the article beneath is fairly balanced on flexible defined benefit (DB), quoting both those highlighting the reductions to benefits the proposal would allow on the one hand, and the danger that all the remaining horses would bolt from the DB stable if changes were not made on the other.

Finally, the Telegraph. “Pensions face new blow from ministers” is their headline. The article is similarly balanced, and is the only one to make the important point that benefits already accrued would be unaffected.

The coverage of the alternatives put up for consultation is patchy. Strangely the Express does best here, despite its desperation to make it a story about the death of the annuity, it does mention in passing collective defined contribution (DC) and guaranteed DC. Otherwise the focus is exclusively on flexible DB in both the Mail and Telegraph, and what members currently accruing non-flexible DB might lose as a result. The comparison with public sector pensions is made several times, with the Telegraph pointing out that the recent settlement on public sector pensions, which would not be removing the requirement to provide indexation and spouses’ pensions, was promised by ministers to be the last for 25 years.

So what kind of start does this represent for engaging the UK public in the debate on the future on pension provision? Mixed, I think. There will clearly be much more scrutiny on any legislative easing to current benefit guarantees than there will be to any addition of guarantees on pensions which currently have none. Perhaps this is to be expected. I do worry that cash balance may get squashed out as an option between the two camps of flexible DB and guaranteed DC – it is barely mentioned in the consultation, and can work well when coupled with a strong commitment to employee education like Morrisons have attempted.

But these are early days and the first thing everybody needs to do is respond to the consultation. Most pensions actuaries and many others will have strong views on many elements of it. So don’t leave it to your firm to do it on your behalf. The deadline is 19 December.

Pension schemes: where mathematics and law collide

I recently attended a lecture given by Professor Raymond Hill on Mathematics and the Law. It focused on a number of cases where a misunderstanding of probability and statistics in particular had led jurors to acquit or convict in the teeth of the evidence presented, to prosecutors to construct cases which made no logical sense, to expert witnesses to mislead and for judges to misdirect juries.

One particular case he mentioned concerned the tragic death of two babies born to Sally Clark, a solicitor from Cheshire, within 2 years of each other. Sally was charged with the murder of both babies once the second had died. At her trial in November 1999, Professor Meadow, a paediatrician but clearly not a mathematician, claimed that, in this case, the chance of two babies dying from sudden infant death syndrome or cot death was 1 in 73 million. This figure came from a study of the deaths of all babies in five regions of England between 1993 and 1996, which estimated that the chance of a randomly chosen baby dying a cot death fell, if the child was from an affluent non-smoking family with the mother aged over 26 like Sally Clarke’s, from 1 in 1303 to 1 in 8543. Piling travesty upon travesty, the chance of Sally Clark suffering two cot deaths was then calculated as 1 in 8543 times 1 in 8543, which is where the 73 million figure comes from. Sally Clarke was convicted on the basis of this ludicrous kangaroo statistical “evidence” and spent over 3 years in jail and needed two appeals before she was finally cleared. A full account of the case, and how Professor Hill went about presenting the absurdity of it, can be found here.

As Blaise Pascal wrote: “You always admire what you really don’t understand.”

Mathematics and law can come into conflict for a number of reasons, but one thing that doesn’t help is that they share a lot of the same words. Proof, for instance. But where this means an immutable truth in mathematics, as true today as it was thousands of years ago and as it will be thousands hence, proof in law will depend on the time in which the trial takes place and the burden of proof required. When there was the threat that Syria would be bombed by the UK and US, some opponents used the idea that you shouldn’t pass a death sentence on whoever would be standing under the bombs unless the Syrian regime had used chemical weapons “beyond reasonable doubt”. I saw one estimate of this as an 80% probability, however I have since seen 99% probability presented as a definition. So proof in law is a more elastic concept.

As a pensions actuary, I have had my own, rather different, problems with the interaction of mathematics and law. Defined benefit pension schemes are mathematical constructs as well as legal constructs. If you do A and B and earn C, then the pension scheme to which you belong should deliver benefits to you of D. However a pensions lawyer would see it rather differently, in terms of obligations of certain parties towards other parties under the legal construct of a trust.

When drafting pension scheme rules, lawyers often have to set up quite complex conditional relationships between possible events and outcomes. It is quite possible for some of these to be left out (in which case we hear that “the trust deed and rules are silent”), and also for them to be included but in a way which displays a certain amount of ignorance of mathematical logic, meaning either that the rules are very difficult to implement or have unintended consequences. This generally then creates work for a different set of lawyers down the track.

As a result, actuaries have long accepted that trying to interpret the rules of any pension scheme without legal advice is just asking for trouble. And the list of legal disclaimers actuaries populate their reports with grows year on year as a new threat of future second guessing emerges. There is therefore certainly considerable respect for the importance of the legal elements of the construct of a pension scheme by actuaries, if not always full understanding. Unfortunately, the same does not always hold in reverse. I have seen numerous examples of rules drafted without the mathematical elements of the construct fully taken into account by the drafters:

  • benefits either too ambiguous to value or in contradiction with each other;
  • double revaluation of benefits built into the rules in one instance;
  • elements of scheme design which would obviously need to be reviewed in the future, like commutation factors of 9 to 1 for instance, hard coded into rules so that they can only be changed by a deed of amendment.

Actuarial input into any issue around a pension scheme is frequently dismissed by lawyers as “crunching the numbers”. I think most of them would be mortally offended if an actuary turned to them and asked them to crunch the words.

Pensions lawyers and actuaries need each other if pension schemes are going to work properly. And they need to understand each other rather better too.

There are things going on that we don’t know

It looks very strange from the outside looking in.

INEOS, the 3rd largest independent global chemical company is seeking to recruit highly motivated technicians, the advert read, posted only 3 weeks ago on 30 September.

These posts are based at our sites at Grangemouth, INEOS’ largest asset which includes Scotland’s only crude oil refinery and Finnart on Loch Long. This is an exciting time to join us: we are fully committed to our business in Scotland and are looking to develop our technology business globally.

…Successful candidates will receive an extremely competitive salary including shift allowance and benefits package including a competitive pension scheme.

Cut to yesterday when the chairman of INEOS Grangemouth announced that the workers had to accept the company’s survival plan or the plant would close, as they were losing £150 million a year and had a pensions deficit of £200 million. Today Unite said around 680 of the site’s 1,370-strong workforce had rejected the company’s proposals, which include a pay freeze for 2014-16, removal of a bonus up to 2016, a reduced shift allowance and replacement of the final salary pension scheme with a money purchase scheme. INEOS responded by confirming the closure of the petrochemical operation at Grangemouth.

It was in 2008 that INEOS originally took the decision to close the company’s final salary pension scheme to new employees due to the costs associated with its continued operation. Following a strike organised by Unite, the company relented following various interventions including by the then President of the Faculty of Actuaries, Stewart Ritchie, keeping the scheme open to new employees in exchange for a 2% employee contribution. Unite made, and then withdrew, a claim that INEOS had asset-stripped the Grangemouth refinery business which had been spun off from BP in 2006. It also claimed that workers at Grangemouth were paid £6,000 less than workers at other similar facilities. One estimate was that the average salary at Grangemouth was £40,000 per year at the time.

Assuming the average has increased to, say, £50,000, that would represent a total wage bill now of around £70 million a year, based on a total workforce of around 1,400. The proposals on increases and bonuses would therefore look inadequate to make much impact on losses of £150 million a year. The pension changes may be more significant (the company estimates pension costs are currently 65% of salaries, although a large part of this is likely to be payments on the deficit which would be likely to remain after any restructure).

However, things are not what they seem. The £150 million pa quoted by the company is negative cashflows rather than losses. The company’s is investing £150 million more than the profits it makes each year at Grangemouth. The refinery is expected to make a profit in 2013.

Atleast it was. INEOS had warned that unless the survival plan were accepted, it would close half of the plant in four years’ time. The action to permanently close the petrochemical plant and not to reopen the refinery while they felt there was still a “threat of strike action” therefore represents a pre-emptive strike by the company, after Unite had agreed to call off strike action last week. The three day stoppage in 2008 was said to have cost the UK economy at least £100 million.

And the strangeness does not stop there. There is another dispute going on alongside the economic one. Unite originally threatened industrial action in July over the suspension of Stevie Deans, a Unite official allegedly involved in the selection of a Labour parliamentary candidate in Falkirk, who was subsequently reinstated and cleared by the Labour Party’s internal investigation. Dean is currently being investigated by an undisclosed third party on behalf of INEOS for allegedly using his position to recruit staff to the constituency party, with the investigation due to conclude on Friday. It is not clear where the announcements today leave this investigation.

If the petrochemical plant is to go into insolvency, possibly followed by the closure of the rest of the site, the next question for the workers after the loss of their salaries will be what is to happen to their pensions if INEOS sell up. To paraphrase Lynyrd Skynyrd, there are definitely things going on that we don’t know here.

The mortality of fairness

There are many reasons why it is much harder for a small actuarial consulting firm to do business than a large one. Large firms can obviously afford to put people on the committees which design actuarial regulation, whereas small practitioners tend not to be able to spare the billing time lost. This has resulted in many recent developments, in regulation in particular, disproportionately favouring larger firms.

The Technical Actuarial Standards (TAS), whatever your opinion of them and I am generally in favour, have spawned TAS committees in larger firms and, in all firms, has required a redesign of most advice given by pensions actuaries. This has been bad enough for large firms, but much more difficult for firms with one or two actuaries. Large firms can devote resources to producing the personality-free template documents we see springing up all over the place and have a ready source of peer advice to help apply the TASs to new documents as they become necessary. The “tick list” approach of GN9, GN11, GN16, GN19 and the rest, so heavily criticised by the now defunct Board for Actuarial Standards (BAS) when introducing the TASs, did at least make compliance relatively straightforward for small firms, allowing them to concentrate on the far more important and personal task of tailoring advice to the specific needs of their clients.

The new guidance for actuaries on conflicts of interest is similarly slanted. The suggestions are almost all big company solutions, from separation of teams to information barriers to setting up conflicts committees, designed to protect the income of firms with multiple offices from the loss of the ability to provide advice to connected parties. The one man business is pretty much left with “ceasing to act” as a strategy, leaving the field even clearer for the bigger firms.

I have been vaguely aware of this for some time, but since I left a medium-sized consultancy last year and started providing peer review services to small firms, it has been harder to ignore. I do not expect to continue as a sole trader over the long term, but I fear for those who do.

And the latest example that has struck me is the recent behaviour of the Continuous Mortality Investigation (CMI). This is an organisation with a proud tradition of providing analysis and resources on all aspects of mortality, longevity and morbidity to the Actuarial Profession. Anyone could access their materials for free, unlike Hymans Robertson’s Club Vita or the postcode analyses provided by companies like Longevitas. It was public data, available and accessible to public, academics, journalists and actuaries alike, working in the public interest.

No more. A fee structure has been put in place with effect from 1 April this year. Large consultancies will pay what, for them, is a flea bite of a fee. But I imagine some of the small firms will think twice about the relative costs of being locked out or the fee for continued access. And to demonstrate just how unfair it is, I have graphed the cost per qualified UK actuary below:

CMI fees.png

Apart from the fun to be had seeing how the formula impacts different consultancies (and speculating about some of the lobbying that might have been going on to achieve this) the graph shows us that the average cost starts at £250 for a firm with one actuary, but ends at around £30 per actuary for a firm the size of Towers Watson (mainly based on the number of UK actuaries listed in the latest actuarial directory – my apologies if any of these are out of date).

There are anomalies too. A firm with 20 actuaries pays £210 per actuary, whereas one with 21 pays £352 (the highest per actuary cost of all).

It is not as if these are avoidable costs. Funding and accounting cost mortality assumptions may not need to be updated every year but other routine work will. For instance, thanks to changes to the Statutory Money Purchase Illustrations (SMPI) technical memorandums since December 2011 (overseen by the Financial Reporting Council’s (FRC’s) actuarial council with, you guessed it, no one from a small actuarial firm on board), anyone without access to the CMI 2013 projections (which are the first to be pay-to-view) will be unable to provide SMPIs from 6 April next year.

This does not appear to me to be fair treatment of smaller actuarial firms, nor of their clients, who are also small firms. According to the Association of Consulting Actuaries’ (ACA’s) Second Report of the ACA Smaller Firms’ Pensions Survey, published earlier this year, small firms, which the larger consultancies increasingly are finding not cost-effective to service, represent a more and more important sector of the economy:

The small and medium-sized enterprises (SME) sector, here defined as businesses employing 250 or fewer employees, is the largest part of the UK private sector economy in terms of employment. These smaller firms employ over half of the UK’s private sector employees (59.1%) and generate just short of a half (48.8%) of all private sector turnover, amounting to some £1,500 billion per year. They make up over 99% of all UK private sector enterprises. The number of these SMEs has increased by 39% since 2000, whereas there are only just over 6,500 UK private sector enterprises that now employ 250 or more employees compared to 7,200 a decade or so ago (a reduction of 10% over the period).

If the CMI does have to charge for its services, then I would propose a flat per actuary fee, set at a rate designed to generate the same level of income, as a much fairer approach. Assuming this aimed at raising between £250,000 and £300,000 from consultancies next year, I estimate this should result in a per actuary fee of around £100. In my view that would be replacing the mortality of fairness with fairness of mortality.

Magical Realism and the Pensions of Europe

shutterstock_154809119The Wizard of EIOPA is back. Gabriel Bernardino, the chairman of the European Insurance and Occupational Pensions Authority (EIOPA), outlined in May the powers he thought were necessary for EIOPA to enhance its role as a European Supervisory Authority for the insurance market. Insurers are currently busily opposing such calls.

On 5 September, therefore, he changed tack with a speech about pensions instead, entitled Creation of a sustainable and adequate pension system in the EU and the role of EIOPA.

“The creation of an adequate, safe and sustainable pensions system is one of the key objectives of the European Union and EIOPA is committed to contribute by all means to the development of such a system,” he boomed, despite the EU’s Constitutional Treaty not mentioning pensions anywhere among its objectives. He went on to state that EIOPA approved of assets and liabilities being valued on a market consistent basis. So far, so uncontroversial.

But then he continued. “EIOPA suggested a number of elements to reinforce the governance of IORPs: for example the performance of an own risk and solvency assessment.” What? An ORSA? You mean that thing that has led the insurance industry to spend millions on consultants, conferences and which, 5 years on from when it was first mooted, is only currently fully implementable by 24% of European insurers with all of the resources available to them? (Moody’s Analytics, in their July 2013 survey of 45 European insurers, concluded that 24% of the insurers interviewed had their processes, methodologies and models in place to fulfil Pillar 2 requirements – the key one being the ORSA).

He wasn’t finished. EIOPA proposed to require defined contributions (DC) schemes to produce a Key Information Document (KID). This would contain “information about the objectives and investment policies, performance, costs and charges, contribution arrangements, a risk/reward profile and/or the time horizon adopted for the investment policy”. So, a massive amount of additional bureaucracy around the default funds in a DC scheme by the sound of it, with no appearance of understanding that members of DC schemes can choose their own investment policies, nor a word about the hottest issue in DC provision at the moment, ie the level of charges. Surely he is KIDding?

Next he carried on a bit about the “holistic balance sheet” concept, despite it having recently been kicked into the long grass for implementation by pension schemes he clearly desperately wants to bring it back if he can, before giving his interpretation of the findings of the quantitative impact study (QIS) as part of the process to advise the European Commission on the review of the IORP Directive. This boiled down to:

  • Some pension schemes have surpluses, others have deficits.
  • Schemes can either make up deficits by paying more contributions (“It is not unusual that future sponsor support needs to cover as much as 25% of liabilities.” Said the Wizard, with the air of a man discovering a new physical law) or by reducing benefits.

I think we can all agree that however much the QIS cost it was worth the money.

Then we moved onto the Swedish part of the speech. “I would like to take this opportunity to thank the Swedish pension industry, the Swedish pension protection scheme (PRI Pensionsgaranti) and the Swedish supervisor (Finansinspektionen) for their contributions to the QIS. Sweden was the only member state with sufficient financial assets to cover the pension liabilities as well as the solvency capital requirement. Pension funds showed on average even a substantial surplus over the SCR of 13% of liabilities. Of course, an important reason for these positive outcomes is that Sweden already imposes a prudential regime that is market consistent and risk based, by using the quarterly Traffic Light stress test. In my view, this clearly illustrates that a future European regulatory regime should be market consistent in order to ensure a comparable and realistic assessment of the financial situation of pension funds; and risk based in order to provide IORPs with the right incentives for managing risks.”

What? According to the Swedish Pension Agency’s annual report on the Swedish Pension System for 2012, it consists of a pay-as-you-go scheme (the inkomstpension) and effectively an insured personal pension (the premium pension). So it clearly illustrates precisely nothing for a defined benefit occupational pension system like that of the UK with total buy out liabilities of around £1,700 billion (according to the UK Pensions Regulator’s Purple Book for 2012). However, did I mention where this speech was taking place? Sweden.

It was time for the Wizard to return to building his empire. EIOPA need more resources, more powers and now, apparently, more of a mandate. Obviously the m-word is a bit of a problem for all European institutions but it grates on the Wizard particularly. Despite the Solvency II omnibus grinding along on the hard shoulder and the first attempt at new funding targets for occupational schemes being rebuffed, he believes that now the time is right for a foray into personal pensions. He refers to occupational pensions as “the so called 2nd pillar” which confused me at first as I thought that was the risk management part of Solvency 2. However, then I realised that it was just that Eurocrats are obsessed with pillars because now he is calling personal pensions “the so called 3rd pillar”. And he wants to run them with the same efficient competence we have come to associate with the Wizard.

The Wizard wants a new sort of personal pension known as an “EU retirement savings product”. This would avoid “the traps of the short term horizon” (ie pesky scheme members deciding they need their money earlier than EIOPA decree they can have it) and “managed using robust and modern risk management tools” (does he mean things like the stochastic techniques and Value at Risk methodologies which have shown no discernible ability to manage risk in banks to date?). Finally “it should have access to a European passport allowing for cross border selling”. There has been scope for UK occupational pension schemes to become cross border schemes for some time now. Hardly any have taken up this “opportunity” so far because it came with a requirement to immediately increase the level of funding of a defined benefit scheme to buy out level. For defined contribution schemes, as we saw with the fate of stakeholder pensions, the appropriate vehicle very much depends on the form of social security system in place, the degree of means testing and when it happens and, most importantly, how it interacts with the state pension system. One size will definitely not fit all, and I expect that the Wizard’s EU retirement savings product will remain a largely theoretical entity for this reason.

However, my favourite part of the Wizard’s speech was left until last. “It is our collective responsibility to face reality,” he offered, with no hint of irony. I fear that the Wizard’s sense of reality is more a type of magical realism where people can fly, or turn into unicorns and EU officials can regulate things they don’t understand without unintended consequences.

“Please help us to move in the right direction,” he concluded. I think we should all do precisely that, by opposing what the Wizard of EIOPA proposes for pension schemes of all kinds.

My ETV – part two

At the end of my previous post, I was keenly awaiting the written report on my enhanced transfer value (ETV) consultation, after feeling some concerns about the process up to that point. What arrived earlier this month came in three part harmony:

1. A Transfer Suitability Report, which summarised the conversation I had had with my adviser, and the recommendation which I had rather wrung out of him not to transfer (a red traffic light illustration next to the summary reinforced the point), and included the modeller output that suggested a 9 in 10 chance of receiving a higher income at retirement (weather symbol: sunny).

sunnyThere was nothing more for me to read on the assumptions here while I waited at the red light in the sunny weather but, instead, a new concept to anyone not working in pensions for a living which had not been mentioned in our previous conversation: critical yield. It explained that this was “the estimated investment return you would need to achieve year on year, if you were to transfer to a personal pension, in order to match the benefits provided by the Scheme at retirement”. It was calculated at 6.4%.

This was a little confusing since, when put together with the sunny 9 out of 10 assessment of my chances of receiving a higher income at retirement, it might lead you to think that there was a 90% chance of at least a 6.4% pa average investment growth over the next 10 years based on my new medium risk tolerance (which only reduced my equity allocation from 90% to 85%). But in fact 9 out of 10 was based on needing no spouse pension (they thought this reasonable as I am currently separated, but my Scheme benefits will include a spouse pension provided I have a spouse at retirement) and lower pension increases than are provided by the Scheme (these are indexed to the Retail Prices Index (RPI) rather than the Consumer Prices Index (CPI) assumed after the transfer, CPI tending to be lower). So 9 out of 10 was not replacing like with like, and the probability of achieving the critical yield over the next 10 years was more likely to be in the cloudy-with-a-chance-of-rain category.

2. Additional Information. This must contain the assumptions used, I thought. But no. It was instead an overview of how they had selected Aviva to be the pension provider, what the pension protection fund and financial services compensation scheme did and a glossary of terms. The glossary, interestingly, included lifestyling. “Lifestyling”, it said, “is an investment approach in which funds are gradually switched from more volatile asset classes, such as UK and Overseas Equities, to lower risk investments, such as Fixed Interest and Cash, in the period leading up to retirement. The aim of lifestyling is to reduce the risk of large fluctuations in your fund value as you approach your chosen retirement age. The reason for this is that, if markets were to fall significantly immediately before you retire, this would lead to significant reduction in your retirement income.” Lifestyling had not previously been mentioned as being assumed to be taking place over the next 10 years in any of my illustrations. This eagerly awaited report appeared to be raising more questions than it was answering.

3. Transfer Value Analysis Report. This gave more details about the benefits I was currently entitled to and that the projections of future income were based on CPI increases of 2% pa. And then finally, in the final appendix of the final report, there were notes on the assumptions underlying the calculation of the critical yield. Unhelpfully this included an annuity interest rate and annuity expense assumptions, but no mortality assumption. You would obviously need to know how long you were expected to live to work out how much they expected the annuity to cost. Or they could just have told me. Unfortunately, how much the annuity was expected to cost seemed to be on the list of things the member was not expected to need to know.

So, at the end of the process, I was still no wiser about the annuity rates assumed, or what high, medium and low meant in the years leading up to retirement. I didn’t think that the adviser I had knew either. And on this basis I was being asked to make an irrevocable decision about a third (more if you considered the cost of purchasing an equivalent guaranteed deferred annuity rather than the transfer values offered) of my pensions wealth.

I reflected on the times in the past when I had advised trustees to ensure as a minimum that transferring members in such exercises received independent advice, and on how inadequate that now seemed to be to support a decision in this case. As far as I could see everyone involved was doing their job in the way the regulatory regime intended them to. It was, in many ways, a model process:

  • The sponsor was making an offer to members, and paying for independent advice to those members. If the advice was not to transfer or the member decided not to take any advice, the transfer was not allowed to proceed.
  • The independent adviser had made a modeller available to members, and had carried out an assessment of each member’s attitude to investment risk. However both of these were seen as guides only, and they were prepared to be influenced in their advice by the attitudes presented to them directly by the members.
  • The Trustee Board had made it clear that it was up to the members to decide and that members should consider any information provided carefully before opting for a transfer.

However, if I had accepted the original risk assessment, and let large parts of the information provided go over my head as too technical, I could well have been both advised to transfer and left with the impression that I had a 9 out of 10 chance of being better off as a result. This would not have been a remotely accurate impression. However, even if I had avoided that particular banana skin, I would still not, at the end of this totally professional and, at first sight, thorough process, have had enough information to decide whether I agreed with the advice given. This meant that, despite everyone’s best efforts here, it would still have been possible to have been missold a transfer.

That that should still be the case after all the regulatory activity in this area suggests to me that there is a limit to what regulators can achieve when it is seen as enough for the regulated to merely follow codes of practice and guidance. To aim higher than this requires both trustees and their advisers to do more than play the referee.

And my pension is staying where it is.



My ETV – part one

Diamond graphA couple of weeks ago, I had a session with Beaufort Consulting. They had been selected by the Phoenix Group to provide independent financial advice to members of the Pearl Group Staff Pension Scheme who had been offered an enhanced transfer value (ETV).

The aim of an ETV is simple. The sponsors of the scheme are looking to reduce the uncertainty and cost (the ETV is normally considerably less than the cost of purchasing an annuity with an insurer to an equivalent level to the pension given up). I have been the actuary to schemes in the past where the sponsor has carried out such exercises and, beyond advising the trustees to press the sponsor for certain minimum standards (for example independent financial advice, communication of risks and making sure the security of the non-transferring members is maintained), it has been frustrating to watch members seeming to give up the security of their benefits in many cases with rather little to show for it. I was curious to experience the process from the member’s perspective.

I had been warned by the Trustee Board of the Scheme that an exercise was going to be taking place in February. Then last month I received a transfer value quotation from the Phoenix Group, indicating that not only would the current reduction to transfer values of 10% be removed, but that an enhancement of a further 10% would be added. I had six weeks to register for advice with the Beaufort Group, and a further six weeks to accept the offer before it was withdrawn. I was directed to the modelling tools on Beaufort’s website and my attention was drawn to the Code of Good Practice and the Pension Regulator’s guidance on such offers. An “important additional information” booklet, in the form of questions and answers on the overall process, was also enclosed. From Beaufort consulting I received a client agreement, a key facts document and log in details for their website (referred to as the “Member Advisory Platform” or MAP).

Whew! So I went on the website and answered the 15 questions designed to assess my risk profile. I was interested to note, despite indicating that I tended to disagree with accepting the possibility of greater losses to achieve high investment growth and rating the amount of risk I had taken in the past as medium compared to other people, that I had been categorised as having a risk rating of medium/high. The suggested asset allocation was 90% in equities and 10% in corporate bonds.

On the basis of this, a requirement to provide a 50% spouse pension and annual pension increases in line with CPI increases capped at 2.5%, and with no lump sum taken, the modeller told me that I had a 6 out of 10 chance of getting a higher income from the transfer at retirement (in 10 years’ time at age 60). Taking out the spouse pension increased this to a 9 out of 10 chance. In fact, out of the high outcome, mid outcome and low outcome shown, only the low outcome led to a lower income from the transfer. The thick black line of certainty of the Scheme benefits was placed beside the alluring diamond of possibilities from the transfer (see diagram above). None of the financial assumptions or assumed cost of buying an annuity were spelt out. I decided this would benefit from further discussion and clicked to arrange an appointment. My slot for a telephone meeting with an adviser was quickly arranged and the afternoon arrived.

The adviser was very polite and unpushy. I explained my surprise at the outcome of the risk profiler, on the basis of which he agreed to reduce my profile risk level; from medium/high to medium.

He explained that Beaufort were not incentivised to get people to transfer and that the same offer was being made to everyone more than five years from retirement.

I asked him what assumptions had been made in the modeller. This took a while to get a response to, during which time I got an interesting account of a stochastic process (this is where you let the various outcomes be chosen randomly but according to an underlying probability distribution, then run the model lots of times to show the relative likelihood of different results. Throwing dice lots of times is a very simple stochastic process). I persisted, saying that the darker area in the middle of their diamond must be based on an average level assumed for investment returns and annuity rates. The response, after a moment when I thought he was going to put the phone down on me due to some noise on the line that I couldn’t hear, was that the assumptions were standard and he thought the low one was 5% pa. I felt that he was telling me all he knew about the modeller.

We moved on to what I thought of the strength of the Phoenix Group, what my preference was on death benefits, etc, before he ran a few modeller examples to illustrate how my income following the transfer would be greater until age 81 (all stochasticism had been abandoned at this stage).

I decided to move my adviser back onto risk. I said that, as my Pearl pension was about a third of my (non-state) total pension benefits, and all my other pensions were per force defined contribution (DC – see my previous post for explanation of defined contribution and defined benefit), it seemed a good idea to diversify my risks by keeping some in defined benefit form. If equity returns over the next 10 years were like those of the last 10, I might be very glad I had.

To his credit, he accepted my argument, and said that he would not recommend I transferred. I thanked him for his time and for a helpful discussion and checked that I would be receiving a final written report, which he confirmed.

I put down the phone and reflected on what had happened. I realised I had some concerns about the process:

  • The adviser had been courteous, and had not pushed me in any particular direction, but had been unable to provide any information to assess the plausibility of the modeller at the heart of the advice.
  • I had had to introduce the idea of the risk of having all my pension benefits in DC form.

In particular, after reading a fair volume of paperwork and spending the best part of an hour on the phone, I was, as a pensions actuary, unable to recreate (even approximately) the modeller calculations from the information provided. I awaited the written report with interest.

To be continued…

The Wizard of EIOPA

My post on 24 April suggested that the threat posed by EIOPA’s proposals for occupational pension schemes (or IORPs, as they call them) went well beyond increases to funding targets, specifically setting out tougher regulation on:

  • Governance requirements;
  • Fit and proper requirements of pension scheme trustees;
  • Risk management requirements; and
  • The establishment of own risk solvency assessments.

“Solvency II” type funding targets have now been postponed, but the other threats remain. So what is the true nature of this threat?

It is easy to portray “Europe” as some massive irresistible force which can only be opposed by an increasingly immovable UKIP-type object. However, occasionally the curtain gets whipped away to reveal, Wizard of Oz style, a few technocrats frantically pulling the levers up and down to maintain the illusion of unquestionable authority.

Gabriel Bernardino, the Wizard of EIOPA, certainly appears to be feeling the strain of maintaining this illusion. Last week he suggested that EIOPA needed more power and more money, some of which needed to come from levies on “the industry”, ie individual pension schemes.

Coincidentally, the Pensions Regulator has also issued a report on occupational pension scheme governance in the UK. There are 128 tables in its accompanying technical report but, picking out one or two statistics on each of the four of EIOPA’s focus areas I have highlighted, it suggests that meeting the tougher regulations on governance and risk management is likely to cause UK pension schemes considerable problems.

For instance, the 70% of small and over 50% (I’m assuming this, the Regulator’s summary of DB/Hybrid medium schemes’ responses only total to 90%) of medium schemes which have trustee meetings less frequently than once a quarter are unlikely to be seen by EIOPA as adequately providing “continuous operational governance”. As EIOPA’s advice recognises (the italics are mine): “many IORPs do not have truly continuous operational governance (e.g. IORP governing bodies that meet monthly or less frequently), so their operational characteristics fundamentally differ from insurance entities”. And the 3% or so of medium-sized schemes who admit to never having had a trustee meeting at all would I assume be seen as not providing operational governance at all.


Next up, if the requirements to establish that trustees are fit and proper persons to govern pension schemes were a worry, the revelation that 57% of small schemes and 41% of medium schemes have no training plan in place for its trustees will not help matters.


Meanwhile, it comes as a bit of a shock to those of us who thought that the Pensions Act 2004 did away with actuaries and other advisors acting as judge, jury and executioner of policy decisions for the pension schemes they represented, that 26% of small, 17% of medium and 18% of large schemes generally let their advisors take the lead on making decisions. Again this is not going to help trustees establish that they are fit and proper to govern their schemes.


It might be hoped that trustees could have a reasonable stab at meeting the risk management requirements of their schemes. However, a stubbornly persistent 13-15% of small and medium schemes (both defined benefit and defined contribution) who have at the very least some form of risk register review it less than once a year.


Finally, there are those who believe that the kicking of a new capital requirement for defined benefit pension schemes into the long European grass, if not the Eurasian Steppe, will just lead to the beefing up of the proposal of a pension scheme own risk solvency assessment along the same lines as insurers are currently developing, ie expecting each pension scheme to develop its own solvency target (which may introduce something equivalent to the holistic balance sheet by the back door) and a reasonably plausible account of how they expect to get there. The nearest thing we have to this in the UK at the moment is for those schemes who are developing a ‘flight path’ to buy out or ‘self-sufficiency’ (itself a concept which may not survive the Wizard of EIOPA). Over half of small and medium schemes have no such plan.


So much to be concerned about here, and none of it without cost. The Wizard may feel he needs help to wiggle levers to maintain an illusion of European managerial competence, but few people the other side of the curtain believe in this any longer. And, with the loss of this illusion, EIOPA’s ability to bully schemes into measures not previously thought necessary in the UK despite nearly 20 years of increasing domestic regulatory hyperactivity in this area recedes. If Bernardino can get the Pensions Regulator to implement all of this and get it to pay EIOPA for the privilege of being more intrusively regulated into the bargain, he will be a wizard indeed.