 By Peter Sayers, Consulting Actuary
Xafinity
Technical issues
Some of these will not be new but represent perhaps a change of emphasis. For example, in relation to scheme-specific funding, The Pensions Regulator has in the past been concerned with the adequacy of the allowance for future longevity improvements. Whilst this continues to be relevant, the regulator has more recently focused on the issue of employer covenant and the extent to which this is reflected within funding assumptions. Whilst equities have recovered from the depths of 2008 and 2009, company failures have typically lagged behind the market. Clearly, employer covenant will continue to feature throughout 2011.
The CPI issue
A new issue that arose in the latter half of 2010 was the change from RPI to CPI as the basis for the minimum statutory revaluation of deferred pensions and the indexation of pensions in payment under defined benefit arrangements. Consultants and pension lawyers have been trawling through scheme rules to determine the extent to which this will feed through to each scheme's own benefit structure. Where the rules explicitly refer to the RPI, that basis will still apply at least as regards past service benefits, unless the Government changes its mind and allows such references to be treated as if to the CPI. However, where future increases and/or revaluation for a scheme will be CPI-based, this will need to be reflected within actuarial calculations, both as regards scheme funding and for individual member calculations such as transfer values. Actuaries will need to advise trustees on this. A problem here is the non-existence of CPI-linked bonds to use as a benchmark and only a fledgling market in CPI-based swaps. As a result, actuaries are likely to derive their CPI assumptions by first making assumptions for RPI inflation and then deducting a margin. This leads to the question of what margin will be appropriate, both on a neutral basis and allowing for a degree of prudence? Historically, there has been significant variability between CPI and RPI measures of inflation, primarily as a consequence of major housing costs being omitted from the former but included within the latter. Hopefully the actuary's life will become easier here if owner-occupier housing costs are included within the CPI, as recommended by the Consumer Prices Advisory Committee.
Whilst scheme rules might simply imply statutory revaluation and indexation, there is a potential problem if member literature - for instance, the scheme booklet and individual benefit statements - has explicitly referred to the RPI. In relation to company accounting under FRS17, it is worth noting here the recent guidance (Abstract 48) from the Accounting Standards Board's Urgent Issues Task Force. This points out that in such cases a constructive obligation may exist to provide RPI-based increases and/or revaluation, which would need to be reflected within the accounting figures. This will need to be raised by actuaries advising corporate clients. Similarly, in such cases should scheme actuaries advise trustees that, on prudence grounds, scheme funding should include a RPI allowance based on member literature?
For actuaries involved in asset-liability modelling, the current lack of CPI-linked assets will present its own challenges!
Restriction of tax relief
The reduction in the Annual Allowance from £255,000 to just £50,000 from the 2011/12 tax year will have a major impact on senior executives. There may also be significant implications for others, particularly those with defined pension benefits if future service credits are given on redundancy or ill-health retirement, or where past service is particularly long.
The ability to carry forward unused Annual Allowance from the previous three years will, of course, often assist in avoiding a tax charge arising following isolated spikes in accrual, as will the exemption on serious ill-health retirement.
Many employers with defined benefit arrangements in particular will nevertheless be looking for actuarial advice on how to deal with the issue, given that it is tax-inefficient, from a member's perspective, for the annual allowance to be breached. This includes:
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Should the value of annual accrual be limited across-the-board to £50,000, or should any adjustment reflect a member's individual circumstances from year-to-year - for instance, allowing for unused Annual Allowance from previous years?
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Should regard be had to other pension arrangements?
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Should there be a fundamental redesign of certain benefits, for example the provision of incapacity benefits outside the pension arrangements instead of enhanced early retirement?
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How should the remuneration packages of senior executives be adjusted, if pension provision is limited?
HM Treasury is also proposing that, where the Annual Allowance is breached, individuals may force pension schemes to meet the resulting tax charge (above a yet-to-be-decided amount) on the individual's behalf, with a corresponding offsetting adjustment to the member's ultimate pension benefits. Depending on the finalised legislation, trustees may need advice from their scheme actuary on the determination of the benefit offsets.
Sex equality
There is a high risk that the European Court of Justice (ECJ) will rule this year that the current ability for insurers to differentiate between men and women as regards premium bases or annuity rates is contrary to the principle of equal treatment enshrined in the Treaty on European Union. This follows a case brought by a Belgian consumers' organisation and would clearly have an effect on the cost of scheme buy-outs and buy-ins, and potentially the level of PPF levies.
Whilst the EU Treaty provides for non-discrimination as a fundamental right, article 5(2) of Directive 2004/113 currently allows Member States to permit proportionate differences in premiums and benefits "where the use of sex is a determining factor in the assessment of risk based on relevant and accurate actuarial and statistical data". The ECJ is being asked by the Belgian Constitutional Court whether this provision is compatible with the higher-ranking EU Law.
As usual, an Advocate General - in this instance, Juliane Kokott - has to advise the ECJ on how it should decide the case. In Kokott's opinion, delivered on 30 September 2010, the provision is not compatible and should therefore be declared invalid. She notes that direct discrimination on grounds of sex under EU Law is only permissible if it can be established with certainty that there are relevant differences between men and women which necessitate such discrimination. She goes on to state that the exception within the Directive was not based on any clear biological differences and that it is legally inappropriate to link insurance risks to a person's gender where differences between people is "merely linked statistically to their sex". She points out, for example, that life expectancy will be strongly influenced by the economic and social conditions of each individual.
Kokott recognises the problems that would arise if all existing policies had to be adjusted. Accordingly, she has suggested that, if the ECJ accepts her opinion, insurance companies should be given a three-year transitional period to comply, after which all future premiums would have to be neutral in terms of sex, as would emerging benefits.
Whilst the case is directly concerned with insurance premiums and benefits, Advocate General Kokott's logic could equally be applied to prohibit the use of sex-based actuarial factors in occupational pension schemes.
Professional Issues
It will not come as a surprise if I mention here the Technical Actuarial Standards (TASs) from BAS!
I suspect many actuaries will still be busy in ensuring compliance with TAS M, which applies to models used in the preparation of aggregate reports completed on or after 1 April 2011. There is also the Pensions TAS applying from the same date, which extends the requirements of the generic TASs to much of the "non-Reserved" actuarial work carried out for scheme trustees, as well as to advice to employers on scheme funding and on company accounting disclosures. From October 2011 the separate Transformations TAS will also apply.
It is difficult to argue against the BAS's Reliability Objective, that users of actuarial information should be able to place a high degree of reliance on the information's relevance, transparency, completeness and comprehensibility, including the communication of inherent uncertainty. However, the reams of paper generated by BAS seem at odd with the concept of principles-based standards. It is debatable how much added-value will actually be achieved for actuaries' clients. There is also the related issue of the extent to which compliance costs can be passed on to clients!
Finally, we also have new proposed Actuarial Profession Standards currently being consulted upon which are also due to come into force from 1 April. APS P1 relates to various ethical obligations on pensions actuaries that will apply in addition to the Actuaries' Code. APS P2 concerns "peer reviews" of scheme actuary work and will replace GN48; it in particular covers the extent to with the reviewer will need to consider compliance with the TASs. Clearly, actuaries will need to devote time to understand these new Standards once finalised.
Peter Sayers is an actuary at Xafinity Consulting.
ENDS
For more information:
Peter Sayers
Actuary
Xafinity Consulting
0118 918 5479
peter.sayers@xafinityconsulting.com
Jane Ward
Group Communications & PR Manager
Xafinity
0207 680 2631
jane.ward@xafinity.com
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