Pension Schemes Bill

Written evidence submitted by First Actuarial LLP (PS 14)

PENSION SCHEMES BILL Part 3 COLLECTIVE BENEFITS

1. We are grateful to have been given the opportunity to give oral evidence to the Public Bill Committee for the Pension Schemes Bill. The oral evidence covered high level principles of CDC schemes. We felt it appropriate to follow up with our opinions on the wording of Part 3 of the Bill.

Types of CDC scheme

2. In the table below, we set out two different visions of the design of a CDC scheme. The completed Pension Schemes Act and Regulations should be capable of accommodating both visions.

CDC as an alternative to defined benefit

CDC as an alternative to individual money purchase accounts

Focus is on a level target benefit outcome as the demonstration of inter-generational fairness

Focus is on a level contribution rate as the demonstration of inter-generational fairness

The same benefit accrual rate for all ages for a long period of time

The contribution is converted to target benefits on an actuarial basis which is age related and tracks current market conditions

Even benefit planned

(at a higher cost for older members and lower cost for younger members)

Even contribution rate planned

(resulting in a higher benefit credit per £1 at younger ages and a lower benefit credit per £1 at older ages)

Might plan the actuarial funding on a prudent basis

Best estimate terms for converting contributions into target benefits

If the actuarial funding is planned prudently and if transfer values are best estimate values, then the sum of transfer values would be less than the value of the assets

The sum of transfer values is kept close to the value of the assets.

In effect, the actuarial valuation is the device for sharing the pool of assets between members, fulfilling the role otherwise played by individual money purchase accounts.

Suitable for an employer sponsored scheme with single or connected employers, where membership is conditional on employment

i.e. for situations where cross subsidy can be tolerated

Suitable for a scheme which people join or leave individually at any time, whether employees or self-employed, and/or with multiple unconnected employers

i.e. for situations where value for money for each individual is important

3. The characterisation of the two types is deliberately polarised to show the opposite ends of a spectrum of possibilities. In practice, schemes might fall between the two columns. For example, a "CDC as an alternative to defined benefit" scheme could be planned using a best estimate basis and pay transfer values which sum to the value of the assets. Indeed, we would prefer it if it did.

4. We do not know what will be in the regulations to follow the Pension Schemes Bill. In their absence, the wording of the Bill does feel rather directed at the "CDC as an alternative to defined benefit" vision. We are concerned that the completed Act and regulations might not accommodate both visions. We think they should accommodate both. If CDC schemes are to be available to people other than employees of employers who happen to provide a CDC scheme, then the "CDC as an alternative to individual money purchase accounts" must possible.

5. In particular, we see a major role for CDC schemes to provide a new alternative to annuities for the provision of income with longevity protection in retirement, for those who saved in money purchase accounts before retirement, of which there will be many millions because of auto-enrolment.

Paying benefits and communicating benefits

6. We distinguish between a policy for paying target benefits and a policy for communicating target benefits.

7. The legislation and regulations on a target benefit payment policy should permit the preparation of a target benefit payment policy on a best estimate actuarial basis. A best estimate basis seeks to be even handed across the generations.

8. A target benefit communication policy might be deliberately cautious in what it leads members to expect, in order that actual outcomes exceed the prior illustrations more often than not. But a cautious communication policy should not form the basis of the payment policy, otherwise the benefits paid while the scheme is growing will be lower than they ought to be for inter-generational fairness.

9. We would encourage you to clearly distinguish between a policy for paying benefits and a policy for communicating benefits.

Member protection in a CDC scheme

10. In a CDC scheme, the target benefit policy is not an enforceable promise and therefore cannot be relied upon to protect members. It is the defined contribution which is the promise. To protect members, the contributions being put in for members needs to be spent on the members, fairly.

11. The law must be clear that the target benefit payment policy of a CDC scheme must be non-discriminatory in every respect, especially:

· Age

· Gender

· Between active and deferred members, including pensioners who retired from active status and pensioners who retired from deferred status.

12. The basis of deciding non-discrimination might take a benefit outcome focus (on the CDC as an alternative to defined benefit vision) or it might take a cost of target benefit focus (on the CDC as an alternative to individual money purchase accounts vision).

13. If a CDC scheme is being operated on the "alternative to defined benefit" basis and the target benefit payment policy is specified using a prudent actuarial basis and/or a high probability, the consequence is that not all of the contributions going in are planned to be spent on benefits, some are kept back in reserve. This may be acceptable in an employer sponsored scheme with significant employer contributions, such that the value of the target benefits exceeds the members’ share of the contributions. But it would not be acceptable to communicate the scheme as being worth the defined contribution of (say) 10% of salary, if only 7% is being allocated to a best estimate value of target benefits and 3% is being allocated to a prudent funding reserve.

14. We encourage you to focus on ensuring the requirements for non-discrimination are strong enough because this is the actual source of protection for members in a CDC scheme.

15. We also encourage the use of a governance framework which acts to protect members’ interests. Ideally this would be trustee based and include member representation.

Use of probabilities in expressing benefit targets

16. We do not think that using probabilities to express benefit targets is helpful. In our experience, the investment models used by different actuarial firms are very different from each other. It would not be appropriate for benefit payments to be dependent upon the model of the adviser chosen by the scheme.

17. It is one thing to make a decision or observation and then carry out a statistical analysis to illustrate the significance of it: the statistical analysis follows the decision, the decision having been made separately. It is quite another to reverse the process and say, "we want this level of probability, what decision goes with that?" Probability based analysis is not remotely firm enough to lead the decision making.

18. We note that amendments have been tabled to modify the references to probability targets to references to a range of probability. These seem like a step in the right direction, perhaps a range of probabilities would not lead the target benefit decision making quite so much.

19. Nevertheless, our position remains that probability based models are not firm enough to drive target benefit payment policy decision making. We think the references to probabilities in the Bill should be removed.

The wording of the pension schemes bill

Clauses 20 and 28

20. It seems odd to us that Clause 28 Policy for dealing with deficit or surplus is separate from Clause 20 Duty to set targets for collective benefits.

21. The target benefit is not an enforceable promise. The contributions going in are fixed, it is the target benefit which is varied to match the contributions and the return earned on them. Specifying how and when the target benefits will be varied is at the heart of a target benefit policy. We would incorporate Clause 28 into Clause 20.

22. We would remove Clause 20(2)(c) to take out the reference to probabilities.

23. We would make Clause 20 about the setting of a target for the payment of collective benefits. A policy for communicating target benefits could be made the subject of a separate, new clause.

Clause 26 Valuation reports

24. The Pensions Technical Actuarial Standard of the Financial Reporting Council would not use the word "valuation" in this context, it would use the word "planning".

25. We recommend removing the reference to an assessment of probability in Clause 26(1)(b), to be replaced with:

26(1)(b) valuing the target for the payment of collective benefits set following the previous planning report

26(1)(c) recommending an adjustment to the target for the payment of collective benefits in accordance with the policy for dealing with an excess or insufficiency of target collective benefits.

26. Thus the policy for varying the target benefit is part and parcel of the target benefit payment policy, and the actuary is required to include in the planning report the variation to the target benefits which keeps the scheme on track in accordance with the target benefit payment policy.

27. We recommend removing the reference to an assessment of probability in Clause 26(2)(b), to be replaced with:

26(2)(b) require the trustees or managers to obtain a certificate from an actuary certifying that, in the opinion of the actuary, the collective benefit targets have been set at a level that complies with the target benefit payment policy.

Clause 27

28. In Clause 27(1), remove "valuing assets, or assessing the probability of a scheme meeting a target in relation to a collective benefit".

Clause 29

29. In defined benefit schemes, levies are imposed on the scheme, not the employer. Surely any levy on a CDC scheme should be an imposition on the scheme, not the employer? A CDC scheme catering for individuals transferring in money purchase pots would not have an employer upon which to impose a levy. We would remove "or the imposition of a levy" from Clause 29(1). Re debts due from an employer due to an offence, it seems natural that it should be restricted "to a specified offence by the employer".

30. There should be no question of a debt on the employer in a CDC scheme, otherwise it is not defined contribution. Surely Clause 29(2) should be deleted?

Clause 30

31. We think a natural transfer value policy would be to arrange for the sum of transfer values for all members to be close to the value of the assets. The completed Act and associated regulations should accommodate such a policy.

November 2014

Prepared 5th November 2014