Pension Corporation

John Fitzpatrick among panellists who are discussing the implications of deflation for trustees, the future of the longevity market, their attitude to quoting for smaller schemes, and the affect of annuity Costs of Solvency II.

The panel

Chairman: David Stewart, partner, Lane Clark & Peacock
Stewart is a member of LCP’s specialist buyout advisory team and since joining LCP he has managed the buyout of over £400m of liabilities including full buyouts and partial buyouts of pensioners.

Andy Reed, director, defined benefit solutions, Prudential
Reed is responsible for innovation within Prudential’s Defined Benefit Solutions, developing new routes to market. Reed led the transaction to secure the first insured £1bn pensioner buy-in (with Cable and Wireless) in September 2008.

John Smitherman-Cairns, corporate development director, Lucida
Smitherman-Cairns is a member of the executive team responsible for the development and delivery of Lucida’s pension de-risking offering to the UK market. He is a qualified accountant and joined Lucida from Prudential where he was head of corporate finance.

John Fitzpatrick, partner, Pension Corporation
Fitzpatrick joined Pension Corporation in 2006. Prior to this, he was a member of Swiss Re Group’s executive board and executive board committee. He served Swiss Re as the company’s chief financial officer, head of life & health business group and head of financial services.

Hugo James, sales development director, bulk annuities, Legal & General
James has overall responsibility for Legal & General’s sales in the bulk annuity market. He is focused on helping develop solutions and structures to support larger schemes seeking to de-risk.

Nick Johnson, head of defined benefit risk, Aviva
A qualified actuary, Johnson has headed up Aviva’s bulk annuity proposition since January 2006. He is currently working with a number of trustees bodies to develop innovative solutions to manage the transition to insured benefits.

Myles Pink, business development director, Paternoster
Pink is responsible for new business generation, negotiation of commercial terms, devising product structures and trustee/adviser relationships at Paternoster. Pink advised on the initial fundraising for Paternoster in early 2006.

STEWART: The UK has just moved into the first period of deflation for many years. What are the practical implications of deflation for trustees preparing for a buyout?

REED: While the increases to most occupational DB pension benefits are linked to inflation, this link is broken when inflation turns negative (becomes deflation). Many schemes who covered these benefits by investing in assets whose payments and value were themselves linked to inflation, will find that in 2009, while these assets have decreased with deflation, the benefits they are covering remain level, leading to a decrease in the level of funding. Some buyout providers may not offer a floor of 0% (leaving trustees with an uncovered liability), or may charge a premium for the extra risk they are taking on. Trustees therefore need to be aware of the type of assets they hold, whether or not they contain a hedge against the deflationary risk (usually options/swaps are required to provide the appropriate hedge) and whether these assets may be transferred across to the insurer via in-specie asset transfer. Schemes looking to undertake a buy-in should consider whether or not to insure the deflation risk with the insurer, or purchase appropriate assets within the market (note the inflation swap market is quite illiquid at this current time).

SMITHER MAN-CAIRNS: Most pension scheme benefits do not deflate. Benefits can only increase with inflation. Hence insurers taking on pension scheme liabilities need to hedge inflation with a floor of zero (and often with a cap of 3% or 5%). In today’s low inflation/deflation environment, the cost of hedging this risk increases. There is also limited availability.

Trustees of schemes having inflation linked benefits will need to work with insurers to address this lack of availability of hedges, for example by purchasing LPI swaps over a period of time so that by the time the trustees are ready to buyout, the scheme has a portfolio of swaps which can be passed to the insurer.

FITZPATRICK: Insurers will insure pension scheme benefits as agreed in the contract of insurance and this includes a floor of zero on RPI. Costing this is complex as insurers will consider inflation expectations over the full 20-50 years, not just over the next few years. It is better if trustees have some protection against inflation, even if this is not perfect protection, because over the long term we will see inflation – not deflation.

JAMES: Negative inflation is particularly relevant for LPI increasing pension benefits with a 0% floor, where deflation has resulted in this floor biting. Deflationary fears have resulted in liquidity in the LPI swap market drying up and prices increasing significantly. Insurers are therefore currently not able to pass significant amounts of LPI risk on to the capital markets and as a result their appetite for pension schemes with unhedged LPI exposure has decreased.

Where a scheme has existing LPI swaps in place, we are able to novate these swaps over to Legal & General to ensure the buyout can proceed. Where a scheme does not have the required LPI swaps in place, trustees may see better “value for money” securing benefits on a zero, or fixed increase basis with the ability to add indexation at a future date.

JOHNSON: A key consideration for trustees for all buyout transactions is to ensure that the benefits they think they are securing actually reflect the benefits provided by the policy. Inflation linked pension increases is an obvious area where a previously unthought of/unlikely set of circumstances and unclear policy documentation could lead trustees to be ‘under insured’.

PINK: When pension benefits are linked to inflation, the scheme rules refer to pension “increases” or “escalations”. In practice, trustees of UK pension schemes will not reduce pension payments in times of deflation and there is therefore an implicit floor in the inflation-linkage. When trustees insure the benefits of a pension scheme any ambiguity or subjectivity in the benefit structure needs to be clarified before codifying it in the insurance policy. Trustees preparing for buyout should ensure their scheme rules are clear on the application of a floor to inflation-linkage and ensure that insurers are including the cost of providing this floor in the premiums they charge.

STEWART: Babcock recently announced the first longevity swap by a UK pension scheme. In response, some commentators are predicting that the longevity market will grow rapidly while others are more sceptical. How do you think the longevity market will develop for the rest of the year and what are the main obstacles to its development?

REED: There is clear interest in longevity only insurance and we expect further deals to follow the Babcock announcement. However, longevity swaps are less likely to be a high volume solution compared with buy-ins, due to the costs and complexities involved in these swap deals. We therefore expect to see a few, larger schemes with high proportions of pensioner liabilities to be most interested.

There are two key considerations that may provide obstacles to this new market. The first is that longevity swaps only hedge against longevity risk, whereas buy-in solutions also mitigate investment risk and inflation risk as well. The second is that there is potential to become locked in to a swaps solution, which may prove restrictive when schemes ultimately look to secure a buy-in or full buyout at a later date. Trustees should carefully assess the structure of any longevity swap before transacting.

SMITHER MAN-CAIRNS: Longevity risk is a key risk facing the UK and for selected schemes, longevity swaps may represent a sensible step along the path to ultimate pension fund de-risking.

However, we would caution against over playing the potential role of this product as a solution for all schemes at present given uncertainties over the ultimate market capacity and the complex nature of this product. We would also highlight there is a cost for longevity risk transfer which is significantly subsidised by asset spread in buyout or buy-in structures. This subsidy is not available in a straight longevity swap transaction.

FITZPATRICK: With funding levels having taken a hit, many schemes are looking to protect against increasing longevity while retaining investment exposure in the hope of recouping losses. In this environment, longevity insurance has increased in popularity. Different forms of longevity protection are available. Protection through an insurance contract has advantages. It operates in an FSA regulated environment, is covered by the Financial Services Compensation Scheme, protects the specific members of the scheme and is unlimited in duration. The main obstacle to date has been “portability” – can the trustee switch cover or cancel the cover. This has now been addressed and demand will grow quickly.

JAMES: The longevity market is still in its infancy and while a large liquid market in longevity will benefit both pension schemes and insurers in the long term, it is unlikely that this market will be quick to develop. Individual transactions are bespoke and require significant negotiation between longevity providers, sponsors, trustees and their advisers before they can be completed. This complexity and the currently limited number of market providers mean that the longevity risk market is unlikely to grow rapidly in the short term.

It is likely the longevity market will grow to compliment the buyout market rather than being a competitor, as longevity only products do not protect schemes against investment risks which have proved to be far more volatile within schemes.

JOHNSON: The first longevity swap has been on the horizon for a number of years, and it was only a matter of time before a group of trustees took the ‘leap of faith’ and undertook a transaction. While the intellectual argument for such swaps is relatively easy to be made as part of an ongoing risk management strategy, there are a number of practical considerations which significantly complicate the use of longevity swaps.

As with any synthetic investment, I’d consider there are two main causes for concern, apart from the obvious counterparty risk: the first being sheer complication of how they operate in practice, and ensuring that they do hedge the risk effectively; the second, being what value (if any) the contract would have should the trustees need to realise assets.

PINK: A pension scheme can insure against principally two risks: longevity and investment. Current uncertainty about the extent to which investment strategies might perform in the future has led to increases in the cost of this component. Demand from pension schemes for a product that strips out investment risk insurance and focuses more on longevity is a logical reaction to the impact that widening corporate credit spreads has had on annuity providers’ reserving policies. Longevity swaps that are tailored to a defined group of members of a specific pension scheme are developing in sophistication.

There are two main obstacles: longevity risk is long-dated and the impact of that risk today appears small, so a swap may often appear expensive and longevity-only insurance is only a partial solution in the de-risking of a defined benefit pension scheme.

STEWART: With fewer schemes requesting buyout quotations in 2009 than last year, are you currently more willing to quote on smaller schemes? What is the minimum transaction size you will quote upon?

REED: We do not have a specific minimum transaction value and will assess each case on its own merits. With many large schemes struggling to afford large one-off transactions, there may well be an opportunity for smaller schemes to take action now. It’s important to note that for quotation purposes, a scheme’s ability to transact is more relevant than the size of the deal. Trustees that have made shrewd preparations (such as completing a data cleansing exercise and moving into appropriate assets), will find themselves in a stronger position and better able to secure the insured solutions that help them reduce their risk exposure.

SMITHER MAN-CAIRNS: We evaluate each new potential opportunity on a case by case basis looking at a range of factors including corporate and trustee buy-in to the affordability, process and scale. For all serious enquiries that meet our selection criteria, we will attempt to provide a quote on a timely basis. However, given the on-going interest in this area and our focus on developing customised risk transfer solutions, we need to manage the number of opportunities we take on and tend to focus on the larger end of the market.

FITZPATRICK: Pension Corporation has completed transactions varying in size from £10m to over £1bn. We have seen an increase in serious demand across the board – large schemes and small schemes. The economic situation has delayed completion of some buyouts and buy-ins but sponsors and trustees are more engaged than ever before. Companies want to remove legacy hurdles to developing their businesses, overseas investors want to restructure their UK operations, and trustees want to bring security and stability to member benefits.

JAMES: Legal & General remains committed to quoting on the broadest spectrum of buyout business, ranging from schemes with less than £1m of liabilities up to schemes with in excess of £1bn of liabilities. One of our key strengths is providing buyouts to smaller schemes. In 2008 we wrote close to 200 policies with the average buyout premium being approximately £10m.

JOHNSON: We have seen the number of quotation requests reduce, but I think it’s yet untested as to whether this results from a reduction in speculative requests that were unlikely to transact in the short term. As for transaction size, Aviva has always considered scheme size as only one of a number of factors that effect the decision to quote. Last year for example we transacted around 30 ‘small transactions’ and fully intend to continue this strategy going forward. It’s fair to say that we wouldn’t rule any scheme out on premium size alone.

PINK: No, we are tending to focus on complex solutions that require flexibility and innovation; these solutions are often being sought by large schemes, typically in excess of £25m.

STEWART: There has been speculation that annuity costs might increase by up to 20% due to the impact of stronger reserving requirements for insurers under Solvency II . Do you agree with this view? How else will the introduction of Solvency II affect pension schemes in the UK?

REED: The outcome of Solvency II is still uncertain as we are still in the consultation period for the implementing measures for this directive, but there are approaches being discussed that would have this type of negative impact. Pension schemes are not covered by the legislation but it is feasible that there would be some kind of future harmonisation which could have significant implications.

SMITHER MAN-CAIRNS: Although the Solvency II Directive was officially adopted on May 5, 2009, this is a “framework” Directive, which confines itself to the principles to which the new system would be subject. More detailed implementing measures will then need to be set down by the Commission which will be done following consultation with key stakeholders. A considerable level of uncertainty remains as to how Solvency II will affect bulk annuity writers in the UK.

In a recent speech, the Chairman of the FSA, Adair Turner, said: “The new Solvency II capital regime needs explicitly to recognize that there is an illiquidity premium in bond yields...”

Given the importance of this issue, we remain optimistic that the final regulation will recognise Lord Turner’s comments and we continue to work with the Association of British Insurers to that end.

FITZPATRICK: Solvency II will put in place a comprehensive and consistent risk framework for all insurers across Europe and this has to be welcomed. Pension Insurance Corporation has an existing strong and comprehensive risk-based approach to capital management, an approach we have been following since we started the business. This is reflected especially in conservative investment portfolios and credit default assumptions. While higher capital may be required under Solvency II, it is also likely that new means of risk transference will develop to the benefit of pension insurers, such that capital requirements are controlled and annuity costs do not rise as significantly as some market commentators predict today.

JAMES: If the recent EU directive on Solvency II is implemented in its current form, it is likely to significantly increase the cost of annuities. We believe that the one-size fits all approach of Solvency II is not appropriate to the UK’s annuity market and that a more appropriate solution will be found before Solvency II is implemented. However, the risk of regulatory change cannot be hedged so trustees who are in a position to enter into a buyout now should consider acting sooner rather than later, as should regulatory uncertainty continue then prices may increase as the implementation date for Solvency II approaches.

JOHNSON: It goes without saying that any additional costs for insurers will at some point be reflected in increased annuity prices, and increased capital is a significant factor in the pricing of annuities. That said, it is early days yet, and the extent to which Solvency II actually increases capital costs for a given insurer will undoubtedly be something that emerges over time.

PINK: Current proposals mean that the implementation of Solvency II will result in a marked increase in annuity costs. The level of the increase is difficult to gauge as insurers are yet to obtain approvals for the models they intend to use to evaluate their capital requirements, but increases of 20% are possible. The model approval process is something which could take several years and the likely increase in cost will become clearer over this timeframe.

Although defined benefit pension schemes share many of the same risks as insurers, they are exempt from Solvency II requirements. Therefore the most likely impact on UK pension schemes will be a restriction in their ability to de-risk the scheme through the use of insurance due to the increased cost of doing so.

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, was named “European Breakthrough Firm of the Year” at the European Pensions Awards 2009. The Awards ceremony was held on Thursday, 9 July, in London.

The judges recognised Pension Corporation as having broken into a challenging market and displaying “a sensitivity to the individual pension market needs”, as well as Pension Corporation’s pioneering efforts in the field of longevity risk transfer.

John Coomber, Executive Vice Chairman of Pension Corporation, commented:

“Pension Corporation strives to offer the best risk transfer solutions available to trustees and sponsors of defined benefit pension schemes. Over the past year we have insured the benefits of around 35,000 pension fund members including both the first transfer of pension liabilities out of the public sector with the Food From Britain pension scheme, and the largest ever UK corporate pension insurance transaction, Thorn.

“Pension Corporation’s products and services have one aim: to bring security and stability to the benefits of members of defined benefit pension funds. We will continue to build on this offering.”

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Pension Corporation removes pension risks from the trustees and sponsors of defined benefit pension funds. As a market leader it is the counterparty to risks ranging from full pension insurance buyout to longevity risk insurance, sponsor stewardship and asset-liability management. Established in 2006 by the Truell Charitable Foundation, the Group now provides increased levels of security and stability for fund members through Pension Insurance Corporation Ltd (“PIC”), an FSA authorised and regulated insurance company; and Pension Corporation Investments LP Inc. (“PCI”). For further information please visit www.pensioncorporation.com

Pensions are an increasing issue of concern. Almost every day we see stories on the closure of defined benefit pension schemes, the iniquity of public sector pensions, the outcries against increasing the retirement age and a host of other pensions-related problems.

Yet few commentators get to the heart of the matter: that these individual issues – big as they are – are symptoms of a wider malaise in the provision of pensions in this country.

What we have seen over the past couple of decades is pension risk being reorganised in an ad-hoc, unsystematic fashion, with little regard for the law of unintended consequences. The net effect of this reorganisation is that the long-established system of pooled risk in pensions is being broken down, with pension risk being pushed down on to the unwilling individual.

Today’s occupational pension liabilities, whether unfunded or funded, public sector or private, are bigger than Britain’s GDP. Add in state pensions, projected to be 6% of GDP every year over the next couple of decades, and the scale of the issue is immense.

As society feels the full effects of the ageing of the baby-boomers, increased longevity and the hangover from the recent debt-fuelled economic party, it is possible to see social unrest, such as some European countries have experienced over this issue, and inter-generational dispute. We must therefore act to create a more equitable, efficient and sustainable system, one in which pension risk is distributed across the board and is therefore manageable for all.

A good example of managing risk has been the pension insurance industry. To help maximise returns, pension insurers have been adopting more sophisticated investment techniques than those typically used by many corporate-sponsored pension funds.

The enhanced portfolios they employ seek to match the duration of the pension liabilities, incorporate greater inflation protection and more closely match cashflows with liabilities. These investment techniques include the use of reinsurance, swaps and more sophisticated asset management strategies.

If the move to individual provision continues with increasing numbers of people in defined contribution pensions, how many of them will be able to use these techniques to ensure a comfortable retirement?

Yet it is clearly not right for corporates to bear the pension risk. In many cases the sponsors of final salary schemes have themselves become enmeshed in a web of pension-related problems they are ill-suited to handle.

For example, British companies have been forced to increase by a factor of 30 the money they put into pension funds to plug deficits since the 1970s. In 2000, British companies were putting £9.2bn into their pension schemes; by 2007 that figure was £33.6bn.

There are many companies in the FTSE 100 facing liabilities that far outweigh their current stock market value. The knock-on effects for the balance sheet and cashflow can be significant, potentially lowering profits, increasing leverage and ultimately, impacting their share price. For them, unloading pension risk is the logical solution.

A recent survey showed that three quarters of companies offering defined-benefit schemes were considering ending all future accruals for existing employees. Recent high-profile examples of this include Barclays and Wm Morrison. We could end up in this country with a system where the only benefits that are secured for the long-term are those of public sector workers.

Politicians of all parties must grasp the nettle and start thinking about the pension system today. In my view, it is essential that we have a national debate without pre-set boundaries around the shape of the provision for our old age: where the risks reside and the best solutions for spreading it equitably, efficiently and sustainably.

Without such a debate, taking full account of the role of the state and the interaction between state provision and occupational pensions, future generations will be left with an unmanageable burden – our old age. The answer is a review to create a system of pension provision fit for the modern age. This might well incorporate some of the features which made pension provision in the past so strong. After all, some of the challenges may be new, but the objective is the same. A good place to start is with a national debate.

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, has today announced the appointment of Schroders to manage an initial £100 million segregated Global Corporate Bond Portfolio for Pension Insurance Corporation.

Mark Gull, Partner at Pension Corporation, commented:

“Schroders was chosen against strong competition because they not only demonstrated a sound process for managing corporate bonds and a well resourced team but, most importantly, they also clearly understood Pension Insurance Corporation’s goal of securing member benefits for the very long-term, and showed the flexibility to work with us in achieving this.

“Investing in Global Corporate Bonds in a mandate designed in partnership with Schroders, helps to maintain Pension Insurance Corporation’s strong risk discipline and enhances the diversity of its portfolio.”

Paul Forshaw, Schroders Head of Insurance Asset Management, said:

“By using Schroders' state-of-the-art Portfolio Modelling technology alongside our rigorous Credit analytics process, we were able to work with Pension Insurance Corporation to develop a customised investment solution to meet their very specific requirements. We see this as the start of a lasting partnership with Pension Insurance Corporation as we continue to work together to meet the challenges of constantly evolving client requirements and a changing market environment.”

Notes to Editors

For further information, please contact:

Schroders
Estelle Bibby
+44 (0)20 7658 3431

Pension Corporation
Jeremy Apfel
+44 (0)7966 138481

About Schroders plc

Schroders is a global asset management company with £103.1 billion (EUR 111.3 billion / $147.7 billion) under management as at 31 March 2009. Our clients are major financial institutions including pension funds, banks and insurance companies, local and public authorities, governments, charities, high net worth individuals and retail investors.

We apply our specialist asset management skills in serving the needs of our clients worldwide. With one of the largest networks of offices of any dedicated asset management company and over 250 portfolio managers and analysts covering all the major investment markets, we offer our clients a comprehensive range of products and services.

Further information about Schroders can be found at www.schroders.com or on Schroders Talking Point www.schroders.com/talkingpoint.

Issued by Schroder Investment Management Ltd, which is authorised and regulated by the Financial Services Authority. For regular updates by e-mail please register online at www.schroders.com for our alerting service.

About Pension Corporation

Dealing with the current economic crisis and its aftermath will undoubtedly top government’s priority list over the coming decade. This will be closely followed by healthcare policy and reform of the pension system in its totality: public sector, corporate provision, private provision and the basic state pension.

As a first step in this process it is essential that we have a national debate around provision for our old age, specifically looking at the levels of systemic risk, how this is distributed and ultimately who bears the cost.

The current reallocation of the financial burden of pensions among government, businesses and individuals, which at best is unplanned, is significantly affecting the future welfare of large chunks of the population.

If there is no coherent strategy, it will inevitably be the taxpayer of the future, our children and grandchildren, who picks up the tab.

Current liabilities are huge. There is a total of approximately £1 trillion of private defined benefit pension liabilities in the UK. According to one recent report, unfunded public sector pension schemes have an accumulated liability of £1.1 trillion. Add in the state pension, defined contribution, local government and other assorted occupational pension liabilities and these numbers mushroom.

The underlying drivers pushing this issue comprise increased longevity, ongoing ad-hoc regulatory changes, economic crisis and more general societal changes, including the ageing of the baby boomers.

Over the past decade, policymakers in many countries have shifted the longevity risk in future pension provision away from the state and on to firms and individuals.

As firms move away from pension provision, this risk is by default pushed down on to the part of the system least able to deal with it – the individual. It is all but certain that this unplanned move will haunt future generations.

Many corporate sponsors of final salary schemes have pension-related problems. In 2007, British companies were putting £33.6bn into their pension schemes to help plug deficits, so it is hardly surprising that companies are looking to offload pension risk.

We cannot afford to brush this under the carpet, nor can we afford to get it wrong. A national debate is the right place to start.

This Government, or the next, needs to grasp the nettle without any further procrastination.

A new report from Policy Exchange today revealed the true extent of the public sector pension debt, which until now has been kept hidden and out of official figures. The cost of these schemes is much larger even the publicly acknowledged national debt. Taken into account with net public sector debt, this second national debt brings the total the Government owes to £1.854 trillion, or 150 per cent of GDP.

Public Sector Pensions: The UK’s Second National Debt reveals that:

Using the Government’s own calculations, the accumulated liability of unfunded public sector pensions schemes is estimated to be greater than the national debt. If proper financial methods are applied, the true figure is vast - £1.1 trillion, or equivalent to 78% of GDP. (Page 5 & 33)
The cost of servicing the debt each year to pay for these unfunded schemes in now £45.2 billion. Even on the Government’s own figures, in 2005-6, the interest paid on the unfunded liabilities exceeded the interest paid on the National Debt for the first time. (Page 35)
The Government has been using financially indefensible methods to work out its liabilities and how much workers need to contribute to the schemes. (Page 32)
The Treasury has been subsidising pensions promises. The result is that someone who has been in the public sector for their whole career can now leave with a pension higher than the average they received when working. Neither the Treasury nor Parliament explicitly recognise they are paying this subsidy, which accounts in part for the rapid growth in liabilities. When added to the known subsidy, this means each of the five million employees in unfunded schemes receives a pension payment of £5,700 per year. (Page 42)
Younger workers and those on lower salaries are subsidising older workers and high fliers. (Page 18)

Neil Record, author of the report and renowned pensions expert, said:

“The Government has allowed public sector pension liabilities to run out of control, with the Treasury spending contributions received for the next generation’s pensions to the pay the current generation of pensioners. The Government’s accounting for these pensions has been arbitrary and opaque, making it all but impossible to understand.

“Public sector workers deserve security in retirement. But the worry is that in denying the extraordinary generosity of the current schemes, the Government is creating an apartheid, when compared to those of the private sector. This could lead to high quality public pensions being completely abandoned - I want to avoid that.

“The Bank of England has already moved to make its schemes 100% funded. If the Government were to do the same, the changes would be costly – but the reality is this isn’t money that would otherwise have been saved, and we urgently need to bring transparency to the cost of these schemes.”

The report makes a number of recommendations that would make the total costs of public sector pensions much clearer. These include:

For public sector employers that make pension provision for their staff to pay (jointly with employees for contributory schemes) a cash amount each year equivalent to the full market value of the pension benefits (i.e. current service cost) accrued by staff in that year.
For annual cash pension contributions to be used to buy index-linked gilts of sufficient value to fully pay for all pension promises made in that year. The index-linked gilts should be purchased and issued at market prices.
For a new body to be established (the Public Sector Pension Fund or similar) to receive contributions, to buy index-linked gilts, and to pay public sector pensions. The Public Sector Pension Fund should be required to break even, and charge public sector employers and employees accordingly.
For the existing public sector pension liabilities to be ring-fenced by the Treasury and allowed to run off over their remaining life. All outstanding public sector pension obligations should be met in full.
That the new arrangements should begin after a transition period starting from the date these (or similar) proposals become Government policy. This will allow for the establishment of the Public Sector Pension Fund, and for negotiations over the future shape of pay and pension packages.

Notes to Editors:

Net public sector debt was £754.0 billion at the end of April 2009 http://www.statistics.gov.uk/cci/nugget.asp?id=206

A full copy of Public Sector Pensions: The UK’s Second National Debt is attached.

This report was supported by Pension Corporation.

About Pension Corporation

Pension Corporation is committed to helping facilitate a debate around pensions, including public sector pensions, through its own published studies and research, sponsorship of other reports, public debates and other initiatives.

For further information please contact Amy Fisher on 07799 624 594 or amy.fisher@policyexchange.org.uk

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, today announces that the Trustees of the Warwick International Group Pension Scheme have agreed a pension insurance buyin agreement, to insure members’ benefits with Pension Insurance Corporation (“PIC”). The transaction relates to retired pensioners only and the liabilities are valued at approximately £57m. PIC will in due course also take over responsibility for the administration of these pensions.

The pension insurance buy-in means that the insurance policy will be held as an asset by the Warwick International Group Pension Scheme and will offset liabilities, bringing greater security to members’ benefits. The pensioners remain members of the Scheme.

A pension insurance buy-in is a key step towards fully de-risking a pension scheme. By reducing the overall level of pension risk and investment volatility faced by a scheme, it allows flexibility for sponsor and trustees to explore other options.

Warwick International is a leading supplier of speciality chemicals, headquartered in the UK with chemical distribution companies throughout the world. Warwick was acquired in August 2008 in a management buyout backed by Close Brothers Private Equity Capital (CBPE Capital LLP).

Pension Insurance Corporation is fully authorised and regulated by the FSA.

Phil Kelsall, as Chair of the Trustees, said:

“We are delighted to have appointed Pension Insurance Corporation as our partner in this insurance buy-in. For us, this is a crucial step in de-risking the Pension Scheme and increases the level of security for our scheme members. We were able to secure the insurance contract at a price within our funding provisions, so this seemed to be particularly good value.”

Steve Williams, Finance Director, Warwick International Group, said:

“We are pleased that the pension scheme Trustees have secured this insurance contract, which we believe represents the best outcome at this point for the members of the pension scheme. It adds a new level of security to members’ benefits by reducing the scheme’s exposure to risk.”

Edmund Truell, Group Chief Executive of Pension Corporation, commented:

“We are delighted to have been able to help the Trustees of Warwick International Group Pension Scheme increase the level of security of members’ benefits. Pension Corporation is clearly in the market to write new business and has the capital to do so. We maintained a conservative investment stance throughout 2007 and 2008 which, together with disciplined pricing, places us in a strong position to work with trustees today to help them achieve their aims. We look forward to further transactions in the near future.”

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Key points

The economic crisis has highlighted not only weaknesses in financial markets and regulation but also in existing pension systems in many countries. The UK provides a powerful example for this.
Traditionally the British pension system has been characterised by a partnership between public and private sector, with the former providing a safety net for all, while the latter enabled those on average or higher incomes to enjoy a relatively high quality of life in retirement. For the majority of pensioners and pensioner couples, state benefit income was the main source of income in retirement though. Despite this, state pension spending is low relative to that in most other OECD countries.
Even before the crisis, British pension arrangements appeared unstable, with the government introducing reforms to, among other things, boost private pension savings for those on low to medium incomes (Personal Accounts). The key development in the private sector was the closure of defined-benefit (DB) pension schemes, with most employees moved to defined-contribution (DC) schemes instead. This trend was not repeated in the public sector. The UK’s public finances were in relatively good shape.
The crisis has affected all parts of the British pension system. First, unemployment has increased, potentially leaving more people with broken employment records. Second, the net funding position of UK DB pension schemes deteriorated sharply, encouraging the CBI among others to warn that corporate sponsors should not be forced to close the funding gap as this could exacerbate the crisis. Third, the value of assets in DC schemes dropped equally sharply, leaving those close to retirement with substantially reduced wealth. The Bank of England’s decision to lower interest rates and use quantitative easing further penalised savers and those who were considering purchasing an annuity. Fourth, the public finances have deteriorated dramatically, leaving the UK with one of the biggest structural deficits of any developed country. Fifth, in an effort to protect disposable incomes, households have cut back on retirement savings.
The crisis has left all aspects of the British pension system in a weakened state and it is unlikely that it will return to its pre-crisis status once the economy recovers.
The first reason for this is the perilous state of the public finances, with future governments – of whatever hue – required to cut spending and raise taxes to return its finances onto a sustainable path. This could jeopardise the current government’s policy to link the basic state pension to earnings growth by 2012. It could also provide the background to more radical public sector pension reforms.
Equally, the crisis will most likely encourage the remaining corporate sponsors of DB pension schemes to close these down and offer other arrangements to their employees instead. Personal Accounts, which are scheduled to be launched in 2012, could provide a useful benchmark.
There are also question marks over Personal Accounts themselves. When launched, the government believed that individuals would have too much inertia to actively opt out of these accounts. However, with households facing a substantial hike in the tax burden, individuals might conclude that they cannot afford to help the government reduce its debt burden and save for retirement at the same time. As a result many more people than previously expected might opt out, undermining the rationale of the 2006 pension reforms.
The bleak outlook should not only be seen as a challenge but also as an opportunity to create a more efficient and equitable pensions landscape. This would require a new division of responsibilities between the state, business and individuals.

Executive summary

This paper focuses on an issue, which so far has received relatively little attention by policy makers and the media, namely that the economic crisis has highlighted inherent weaknesses in existing pension systems in many countries. Using the example of the UK, the paper argues that the economic crisis will usher in further changes to the future provision of pensions, with the role of the private and public sectors likely to evolve in the years ahead. To support this argument, the paper first presents the pension landscape in the UK prior to the crisis, which was dominated by the closure of defined benefit pension schemes in the private sector and the government’s reform efforts. The paper then describes the impact of the economic crisis from both a macroeconomic and financial perspective on all aspects of the pension system, from the government’s deteriorating public finances to the collapsing funding position of occupational defined-benefit and defined-contribution schemes. The paper concludes by suggesting that the crisis has left the British pension system in a weakened state and that it is unlikely that it will return to its “pre-crisis” status once the economy recovers from the crisis.

Read the full paper here.

The public sector pay structure must be considered alongside public sector pensions, according to a new study published today by Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds.

The study, “Evaluating public and private sector pensions: the importance of sectoral pay differentials”, authored by Dr Frank Eich, Pension Corporation’s Senior Economist, suggests that either public sector employees in areas like London do not realise how generous their pension promise really is, or they discount the full value of the promised pension given scepticism about its delivery.

The study shows that median gross weekly pay in the public sector was 14% higher than in the private sector in 2007/08. Despite this, as public sector pay is relatively unresponsive to market forces there are higher public sector vacancy rates and therefore lower service levels in high cost areas, such as London and the South East. These vacancy rates are not helped by the pension promise.

Frank Eich, Senior Economist at Pension Corporation, commented:

“This study shows that it is difficult to generalise around “gold plated” pensions and better pay in the public sector, because of varying wage differentials by region and skill group. This means that any review of public sector pensions must look at their impact on the labour market and seek to get rid of the distortions that exist there. Pension promises ought to be viewed by all concerned within the context of pay settlements.”

Key facts:

In 2007-08 median gross weekly pay in the public sector stood at £522, 14% higher than the private sector; a similar gap has existed for more than a decade
Median pay for senior private sector workers in London is around 50% higher than for their public sector counterparts
For females, the highest median annual pay in 2008 was in education, which is mainly in the public sector and in which nearly a quarter of females working full-time are employed; hence the aggregate income distribution appears to be relatively generous for females in the public sector
Female median full-time weekly pay in the public sector is nearly a third higher than in the private sector
The banking, finance and insurance industries had the highest proportion of people with a degree or equivalent at 34% in 2007. This was followed closely by public administration, education and health at 31%
Nearly 50% of employees in public administration, education and health were educated to at least A-level standard, a higher proportion than even in banking, finance and insurance
The construction, distribution and transport and communication industries employed the smallest share of people educated to at least A-level standard

Key Findings:

Median pay is higher in the public sector than in the private sector, but using this to assess relative pay levels is misleading : as lower paid jobs are mainly in the private sector; for example 45% of all full-time employed males worked in the manufacturing, transport, and wholesale and retail industries, mostly private sector, in 2007/08
A more meaningful comparison ought to take into account characteristics such as educational attainment, occupation, gender, location and age
Higher median pay does not necessarily imply that public sector employees get a better pay deal during their working lives
Wage differentials between the public and private sector vary across the UK, with the private sector offering relatively more generous wages in low amenity / high cost areas to attract staff. This makes it difficult for the public sector to deliver a similar quality of service nationwide
There is evidence that public sector pay is relatively uncompetitive in the South East, which helps to explain relatively high vacancy rates in the education and health sectors. Significantly, females in the public sector appear to be doing relatively badly, perhaps demonstrating why the NHS in the South East has difficulty attracting and retaining nurses
Reported problems of recruiting and retaining staff in the education and health sectors in parts of the UK suggest that the beneficiaries do not fully realise how generous their pension promise really is
However, it is possible that public sector employees discount the full value of the promised pension given scepticism about its delivery

Edmund Truell, Group Chief Executive of Pension Corporation, said:

“Pension Corporation is committed to leading the debate on public sector pensions, and I am delighted that this study throws light on some of the more complex areas of the subject. The public sector pensions debate which Pension Corporation is sponsoring at the London School of Economics in June will further illuminate this area. I also look forward to future studies on public sector pensions published or sponsored by Pension Corporation.”

About Pension Corporation

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

“Evaluating public and private sector pensions: the importance of sectoral pay differentials” is available for download here.
Pension Corporation, 3rd Pensions Tomorrow seminar, “Public Sector Liability”, London School of Economics, Wednesday 17 June. For further details please contact Jeremy Apfel at apfel@pensioncorporation.com

The level of attention given to pension schemes during a pre-pack insolvency should be raised, Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, has highlighted in a memorandum to a House of Commons enquiry.

Pension Corporation’s written memorandum was to the House of Commons Business and Enterprise Committee, and is published in its latest report, “The Insolvency Service, Sixth Report of Session 2008-09”.

Whilst the increasingly used pre-packaged administration complies with the Enterprise Act requirement to achieve the best possible results for creditors, the result is often the admission of the pension scheme to the PPF and the reduction of member benefits.

Pension Corporation believes that this is unfair and that if the scheme does not have sufficient assets, equity or debt in the new business could be given to the scheme prior to an insolvency event. At a minimum, a statutory duty to consider securing benefits above PPF levels before an insolvency event should be considered.

Edmund Truell, Group Chief Executive of Pension Corporation, commented:

“In insolvency, pension schemes are usually the largest unsecured creditors and by that point it is generally too late for them to make any significant recoveries from the business.

“Insolvency can be both shocking and frightening for pension fund members, given the likelihood of a resultant reduction in their pension. We believe that it is vital to protect pension fund members during this process. With pre-pack administrations in particular, the level of attention given to pension schemes should be raised and a statutory duty to consider securing benefits above PPF levels before an insolvency event should be considered.”

Notes to Editors:

The text of the submission by Pension Corporation is below
For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Memorandum submitted by Pension Corporation – Page Ev49

Overview

In the current economic environment we are seeing an increasing number of insolvencies and as a result of this, the increasing number of cases of pre-packaged administration.
An increasing number of insolvencies inevitably leads to a rise in the number and size of the pension schemes going into the Pension Protection Fund’s assessment period, without necessarily going into the fund at the end of this process.
This is an uncertain period for scheme members during which they receive lower pensions than those to which they may be entitled, depending on the funding levels in the scheme.
It is vital to protect what is usually the largest unsecured creditor and consider whether the pension scheme debt can be secured above the PPF level, protecting members and reducing the cost for other levy payers.

Pension Corporation and the Market

Pension Corporation is a major participant in the UK pension insurance industry, specialising in pension risk transfer solutions for defined benefit pension funds in the UK. Since its inception, Pension Corporation has developed innovative, affordable solutions for pension schemes and had a 22% market share in 2008.
Pension Corporation underwrites pension risk management solutions for defined benefit pension funds including: Pension insurance buy-outs, Longevity risk insurance, Pension fund stewardship, Asset and Liability Management.
The pension insurance market is a large, fast growing and dynamic market, which exceeded £8 billion in 2008, more than double the business written in 2007. This figure is less than 1% of the potential market of DB pension schemes, which is estimated at £1 trillion.
The market is being driven by increasing numbers of sponsors looking to remove risk from their balance sheets, and Trustees looking to secure their members’ benefits for the very long-term.

Defined Benefit Pensions.

Defined benefit pension funds remain a live and worryingly important issue for many companies.
From a corporate perspective, being a scheme sponsor means maintaining an open-ended commitment for a very long period. This can have dramatic effects on its share price, limit strategic options including refinancing and debt restructuring, and ultimately damage the very security of the commitments it is pledged to maintain.
The security which the members are seeking, by paying into a pension fund, can in some cases act as a corporate straightjacket when companies are looking at takeovers, mergers or other re-structuring.
This can have immediate consequences for the survival of a company. It can also impact adversely the security and level of retirement benefits available to members.
In a recent survey by PWC, 90% of Finance Directors stated that they are concerned about the risks their pension scheme poses to the business; 30% intend to use contingent assets to offer trustees security, while enabling the company to limit cash contributions.
Given the level of concern with which pensions are viewed by many companies, it is not surprising that an insolvency event, with the ability to “dump” the scheme on the PPF, is often seen by struggling companies and their advisors as the only option.
This results in members receiving lower benefits—even if the scheme is funded above the PPF level, during the PPF assessment period only PPF level benefits are paid. It also has a knock-on impact for all other companies with a DB scheme, in that the PPF levy increases.
The PPF levels, for pension scheme members who have not yet reached normal pension age will, on reaching it, receive 90% of their pension, capped at around £28,000.

Pre-packaged Administration and Defined Benefit Pensions

In insolvency, pension schemes are usually the largest unsecured creditors. Unsecured creditors rarely make any recoveries from the business. Members are often shocked and frightened by the insolvency of the scheme sponsor and the resultant reduction in their pension.
This was recognised in the Pensions Act 2004, which established the PPF and gave them the ability to take on the creditors’ rights the scheme has, in order to best protect members and levy payers. However, by the time an insolvency event occurs it is usually too late for the unsecured creditors to make any significant recoveries.
The increasingly used pre-packaged administration, which allows companies to be sold on quickly, gives the insolvency practitioner and the directors of the company time to pre-arrange the value and terms of any sale.
Whilst this complies with the Enterprise Act requirement to achieve the best possible results for creditors, whilst keeping the business as a going concern, the result is often the dumping of the pension scheme on the PPF.
Consideration should be given to making it a statutory requirement that before any insolvency event, consideration should be given to ways to secure the PPF level of benefits other than via sending the scheme to the PPF. For example, if the scheme does not have sufficient assets, equity or debt in the new business (sometimes given to the scheme but only when the scheme enters the PPF assessment period eg Heath Lambert) could be given to the scheme prior to an insolvency event.
The scheme’s assets may then be sufficient to allow the scheme to compromise its debt above the PPF level and purchase an annuity for members.
This would have a number of advantages:
1. There would be no additional calls on the PPF and no resultant levy increases.
2. would not enter the PPF assessment period, members’ benefits would not have to be reduced and the costs associated with this would not fall on the scheme.
3. Members would receive benefits from an FSA regulated insurance company, at least and usually above the PPF level of benefits.
The PPF’s own figures show that 30 schemes which had previously entered into the PPF’s assessment period have now come out of it due, in the main, to their funding levels allowing for greater benefits than those which would be paid under the PPF. The PPF currently has 291 schemes in the assessment period, with a total of 122,622 members.
The PPF assessment process lasts for around two years, during which, irrespective of the actual level of funding in the pension fund, the scheme members have their benefits cut to the levels of the PPF. During this process there is a great deal of anxiety placed on the scheme members as they wait to find out what their levels of benefits are. The administration burden and cost of reducing benefits is also high.
In volatile market conditions when asset valuations are constantly changing, this two year period could mean the scheme missing out on options to secure the members’ benefits for the long term.
The level of attention given to pension schemes during the pre-pack insolvency should be raised and a statutory duty to consider securing benefits above the PPF level before an insolvency event should be imposed.

16 February 2009

London, 27 April, 2009 - Pension Insurance Corporation, a leading provider of risk management solutions to defined benefit pension funds, today announces that it is to insure the Retirement Benefits Scheme of Food from Britain (“FFB”). FFB was a Food Industry Export Promotion Agency, primarily funded by the Department for Environmental Food and Rural Affairs (DEFRA), and is currently being wound up.

The Trustees, working with their advisers, and after a rigorous vetting process of a short-list of several potential providers, selected Pension Insurance Corporation on the basis of its overall capabilities, flexibility and competitive pricing. Pension Insurance Corporation has insured the benefits of around 35,000 pension fund members over the past 12 months.

The Trustees utilised a number of different evalution criteria and were impressed by Pension Insurance Corporation’s strong solvency position and its conservative approach to capital management. The Trustees were advised by Mercer Limited and legal advice was provided by CMS Cameron McKenna LLP.

The relevant current and future pensioners of the scheme will be issued individual insurance policies by Pension Insurance Corporation in due course as part of the winding up of the Scheme.

John Bevington, Chairman of the Trustees, said:

“We sought a provider whom we considered would provide longevity and effective support to our scheme members, whilst also being financially resilient and secure. Pension Insurance Corporation has a strong solvency position, with a current year-end solvency ratio of 232%. It enacts a highly prudent risk policy, assuming that 50% of any spread between the corporate bonds and LIBOR is in respect of expected defaults. We were also impressed with the expertise of the Board and the calibre of the investor partners. Within our short-list, the Pension Insurance Corporation team demonstrated the most comprehensive understanding of all our requirements and we are confident we made the right appointment.”

David Ellis, Principal at Mercer Limited, said:

“The transaction demonstrates that it is still possible to complete a successful bulk annuity deal despite difficult markets. Mercer worked with the Trustees to carry out a competitive tender process and, after considering a number of proposals, the Trustees decided that Pension Insurance Corporation offered the best solution for Scheme members.”

John Coomber, Executive Vice Chairman of Pension Corporation, commented:

“We are pleased to work with the Trustees of the Retirement Benefits Scheme of Food from Britain in order to achieve security and stability for their members’ benefits.”

Edmund Truell, Chief Executive of Pension Insurance Corporation, commented:

“We are delighted to have concluded our second insurance transaction of 2009 and expect to close others in the near future. In what is clearly a difficult period, Pension Insurance Corporation remains well placed to provide risk transfer solutions to the trustees and sponsors of defined benefit pension funds.”

Notes to Editors:

For further information please contact:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

About Pension Corporation