Top 5 DB Pension Topics Employers Should Be Looking At
Employers continue to struggle to meet their Defined Benefit (DB) pension obligations. Based on our knowledge and experience, we have pulled together a list of the top five topics employers should be looking at with regard to DB pensions, namely transfer values, accounting matters, risk management, investment strategy and the PPF levy.
High transfer values could mean more company deficit contributions
The pensions freedoms introduced by Steve Webb and to be championed further by Dr Ros Altmann mean members of DB schemes may find transferring to a DC arrangement more attractive and suitable for their own circumstances. Members may get access to more tax-free cash and/or a higher pension. The trustees are responsible for calculating and paying the transfer value but from the scheme sponsor’s perspective the amount paid out of the scheme is critical. In the current economic climate, transfer values may appear relatively high and this could leave the scheme sponsor with a call from the trustees to make up a bigger residual deficit. There are many issues to consider and now is the time for companies to engage with trustees on the amount of transfer values they will be paying.
Bulk annuities – yields rising and prices falling
Legacy DB pension scheme arrangements absorb a lot of management time and are inherently full of risks. Sudden increases in deficit seem to emerge at regular intervals. Companies are keen to remove this problem and one way of achieving this is to transfer the scheme to an insurer. This is a relatively costly option and so only those that are well-prepared and well-financed can take this option. However, rising gilt yields and greater market competition means prices are starting to come down. Prices can change suddenly and so those employers looking to transfer their DB schemes should now be asking their trustees if the scheme is ready, asking insurers for a price and then taking the action they need to so as to properly deal with the scheme once and for all.
Corporate bond yields are still low – accounting deficits are still high
Low yields on corporate bonds at 31 December 2014 meant that many companies were disclosing significant pension scheme deficits in their year-end balance sheets. While as at date of writing (early June) corporate bond yields have increased slightly since then, and investment returns have generally been positive, the current expectation is that 2015 year-end positions will still require significant accounting deficits to be disclosed.
Now is an appropriate time for companies to be considering the impact of the pension scheme on this year’s disclosures by considering the choice of assumptions in light of the nature of their liabilities, emerging market practice and through benchmarking against similar companies. This enables both a better understanding of the projected year end position and consideration of the impact of potential market movements.
Investment strategy – the employer has a say too
The investment strategy for a DB pension scheme is normally set by the Trustees. If the Trustees choose a strategy that is too prudent or cautious then this could lead to increased employer contributions. Even if the investment strategy is not too cautious, a scheme could be exposed to risks which both the employer and trustees do not fully appreciate – leading to a potentially volatile funding position. The Trustees are obliged to consult with the employer and so the employer has an opportunity to influence the chosen strategy. The employer should be checking whether the Trustees can target a higher level of return for the same level of risk or whether they can target the same level of return but at a lower level of risk. There are knock-on effects on the wider funding arrangements for the scheme so the employer should be engaging with the Trustees on the scheme’s investment strategy as early as possible.
PPF levy – act now to manage your 2016 levy
One of the drivers of the PPF levy is the employer’s month-end Experian scores which measure the likelihood of insolvency of the sponsoring employer. The 2016/17 levy will be based on the Experian scores at each measurement date in the twelve months to 31 March 2016 and so the current Experian scores are already influencing the levy that will be payable next year. Therefore pension scheme sponsors need to check that their current scores are correct by ensuring the data held by Experian is accurate and up-to-date. Employers should also be thinking about how they can reduce the levy by using other assets where possible such as parent-company guarantees or other free assets (property, goods and produce). In addition, an understanding of the financial variables that make up the Experian score and any potential effect on the levy payable will help inform corporate decision making, for example, in relation to any borrowing activity undertaken by sponsor or other company within the group which could materially increase any PPF levy payable.
These are just some of the areas employers should be looking at closely. We will be publishing a series of articles covering these topics in the coming weeks. In the meantime, if you want more information on the topics above or if you have queries relating to other DB pensions topics, please contact Head of Corporate Consulting, Mark Evans.