MAJOR changes are evident in the world of pensions, not least in the pre-election 2014 Budget, which contains hidden implications for FDs of many organisations. I am not talking about pensions accounting standards which have been widely criticised as meaningless.My view is that they have contributed to the ultimate demise of some schemes, distortion of credit ratings, excessive PPF levies, and hurdles to M&A.
Nor am I concerned about the automatic-enrolment obligations or the wider macroeconomic or tax or pensions industry issues such as the predicted death of annuities. I refer to the consequences of an unpredicted cash outflow from pension funds after April 2015.
The relevant change is that some members of defined contribution (DC) schemes will be able to withdraw as much of their contributions as they like, and whenever they like. Many will do so according to their tax situations; many will not be able to resist the temptation of a cash lump sum. Less obviously, many members and deferred members of defined benefit (DB) or final salary schemes aged 55 or over are likely to transfer their funds out of DB schemes in order to enjoy these freedoms, but the consequences for employers – ie, the sponsors of those schemes – are unclear.
I have spoken with a number of people who are planning to exploit the new pension freedoms as soon as they can, and they are examples of DB members setting their sights on transferring out of their schemes in order to access large cash sums. There is likely to be a rash of demands for Cash Equivalent Transfer Value (CETV) quotes which, although seen as an administrative cost and burden to the schemes, raise one main issue. Schemes may be tempted to excessively discount these CETV quotes in order to mitigate their deficits opportunistically – good for the schemes but the members could be penalised, so this is risky if there should be an epidemic of claims for damages. Ultimately, large volumes of cash could be transferred from these schemes, so their investment levels may be reduced more than their liabilities will be transferred out. The resulting difficulties in maintaining confidence in deficit recovery plans and ongoing funding levels have implications for all stakeholders and balance sheets. For many organisations, the pension deficit is their largest single liability.
Trustees of DB schemes monitor their funding levels only at the triennial assessment date, so are effectively running blind. Opportunities to engage in funding and deficit recovery discussions based on up-to-date performance are missed, and the trustees are unlikely to take advantage of appropriate investment deals. Deficits are therefore not managed well enough. FDs should encourage more frequent fund monitoring, with appropriate actions by the investment managers and trustees. The information flow should run in both directions as the strength of the employer covenant will determine the risk appetite of the trustees, typically cautious and so detrimental to the employer. It is the duty of the FD to present the relevant information to encourage the trustees to take a more favourable view.
Given the risk to the employer’s health caused by DB schemes, there is an obligation to review the performance of the trustee board in the same way as for other areas of the organisation. The regulator is also applying particular scrutiny to DC schemes, seeking to ensure effective oversight is in place to deliver ‘good member outcomes’.
Auto-enrolment can only add to this pressure. The FD should treat pension schemes in the same way as any other business project or investment and must take independent advice, not relying on the advice obtained by the trustees.
The imminent changes in the pensions world, in some ways as profound as Gordon Brown’s 1997 raid on pension funds when he abolished Advance Corporation Tax, suggest that now is the time for FDs to reassess their pension strategies. ?
Last month the SFD was at Stamford Bridge to see Liverpool lose in the second leg of the Capital One Cup semi-final.