26th June 2018 Anna Rogers speaks with Professional Pensions on key issues for risk reduction
What are the key legal issues facing schemes conducting and considering buy-ins or buyouts at the current time?
Anna Rogers: To my mind the main risk is future-proofing. That can take all kinds of forms. One issue is that benefits may need to change in future, especially for schemes which have an ability to change the index used for their pension increases from RPI to CPI or something else. Bulk annuity contracts have had flexibility built in for years but it’s important to consider how it might actually work in practice and the interaction with scheme rules. For example, it’s a commonplace observation that it’s a lottery whether the lawyer drafting the rules in past decades phrased the definition of ‘index’ widely enough to allow for change, or whether such change was hard coded, or banned, or allowed at the trustees’ option. An issue that is coming to light now is the trustee might want to change to ‘RPI minus a margin’, or ‘CPI plus a margin’ and that may work for insurers too but those formulations, firstly, might not be allowed within the definition of Index because the replacement is not an index and, secondly, ‘RPI minus’ does not serve to displace the statutory requirement for CPI, so it would introduce a CPI underpin, which could cost more but, worse, could be problematic from an insurer’s point of view. At some point schemes with bulk annuity contracts are going to want to move to buyout and it is crucial that the trustees and sponsor are in the driving seat at that stage. If scheme benefits change in ways that can’t be insured then trustees won’t be able to get the clean break they want. There will be no competitive tension about the pricing of changes in benefits if they have not been pre-priced and committed to at the outset. And if the insurer can’t or won’t provide the desired benefit, that could present a real obstacle to a successful move to buyout.
The other issue that I’m not sure is being debated enough is, are these buy-ins reducing risk or actually increasing it? They are locking in deficits at current pricing. They transfer risk for the least risky liabilities of the scheme. I’m not qualified to advise on the financial issues but one thing I know after 33 years in pensions is that things change. No scheme could ever have a winding up deficit; inflation could never be below 3%; life expectancy can go on increasing forever. The certainties of our era may not hold good forever.
How are your schemes preparing for any future risk reduction exercise? What are the key areas you are working with clients on currently?
AR: We have a number of clients who are front loading the work in specifying the legal entitlements under the rules. This involves identifying the different sets of rules that now apply to the whole pensioner and deferred populations (as well as actives if any) and putting together working copies of the historic rules, with the amendments marked up on them. It’s obvious enough, but many schemes don’t have a set of documents like that to hand. The challenges tend to be that later amendments, for a PIE exercise for example, have only been made to the latest rules. Most current pensioners may in fact be governed by other sets of rules, which haven’t been amended. PIEs involve paying more now in return for a reduction over the longer term and if the legal documentation isn’t right for the long term, there is going to be extra cost. Other issues include discovering what pension increases and survivor pensions are actually discretionary.
To what extent has there been an increase in the use of liability reduction exercises among your schemes? What are the key considerations in this area?
AR: Most schemes are considering liability reduction exercises as business as usual now. Small lump sums, early retirement and transfers to access pensions freedoms are becoming standard features often by way of initial one-off exercises which are then built in to scheme admin going forward. The key considerations are good communications and processes. Informed consent is the antidote to legal risk.
What do you believe will be the key risk reduction trends among the schemes you work with over the coming 18-24 months?
AR: Providing transfer value statements at retirement with paid-for advice, and reminding members or their options from 55 will become standard practice. If robo-advice becomes more widely available that will increase the trend. Trustees and sponsors are aware that members find it hard to make these financial decisions and a full fact find through traditional channels is a time consuming business. If the quality of advice could be standardised and delivered for a cheaper cost it would make a significant contribution to reducing the risk of yet another future mis-selling scandal.
This interview was published in Professional Pensions
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