Independent Financial Advisers Glasgow News & Guides

Six months to go until Automatic Enrolment begins and new figures show that final salary pension scheme payouts will reach a record high and peak this year.

Statistics from the Department for Work and Pensions show that the average amount paid from Defined Benefit (DB) schemes will reach the highest ever level this year and the amount will fall thereafter.

The average DB pension in payment will peak at around £7,100 a year towards the end of 2012 and will fall to just above £2,400 a year by 2060, marking a significant shift in pensions saving.

Currently, around six million pensioners benefit from some form of DB scheme but only 10% of firms have final-salary schemes that are still open. Workplace pension reform will bring up to ten million people into pension saving from this year.

Starting in October, people working for the largest employers will be automatically enrolled into a workplace pension scheme. Smaller businesses will follow. Individuals, employers and the Government will all contribute to an employee’s pension.

The Financial Services Authority (FSA) has published a consultation paper outlining proposals to change the way pension transfer analysis is carried out. The proposed changes will clarify and update the current standards and aim to ensure that pension scheme members considering a transfer are given a fair assessment of what they will receive in retirement.

A pension transfer is where a pension is moved from a defined benefit (DB) scheme (such as a final salary pension scheme) to a personal pension scheme. On retirement, retirees can convert a personal pension fund into an annuity or draw money from the fund, known as income drawdown, to provide regular payments.

Current FSA rules already set out how to calculate the benefits of a transfer that will be given up when members transfer to a personal pension; this is a process called transfer value analysis (TVA).

The TVA process compares the pension benefits from the DB scheme with those that could be provided by the personal pension scheme. The FSA believes TVA is a complex process and requires the full facts to be presented to the member before any action is taken. The starting point is always that a transfer will not be in the client’s best interests.

The FSA is proposing changes to ensure that the assumptions advisers use for the comparison are applied consistently by all firms, take account of recent UK and EU legislation, and use reasonable growth rates for illustrating the results of the comparison to the member.

To ensure that TVA is carried out with a member’s best interests central to any decision, the FSA is proposing:

• to update the rules for calculating mortality to be aligned with those used by the Board for Actuarial Standards, and therefore making them consistent with annual pension statements that all personal pension holders receive once a year;
• to calculate annuities on a gender-equal mortality rate, in line with the European Court of Justice’s decision in March 2011 (see Notes to Editors 2);
• to introduce a Consumer Price Index (CPI) assumption for re-valuing pensions in deferment, reflecting legislative changes made by the government in 2011;
• to require CPI-linked benefits to be valued using the Retail Price Index (RPI)-linked annuity interest rate;
• that Limited Price Indexation (LPI) annuities will be valued on the same assumptions as RPI-linked annuities; and
• that the comparison provided to the member is illustrated on growth rates that take into account the likely returns of the pension fund assets as well as the transfer of risk from the DB scheme to the member.

Businesses would have to inject at least £300bn into their final salary (defined benefit) pensions if a new EU law goes ahead, causing knock-on damage to the UK economy and jobs market.

It would also lead to the closure of more final salary pensions in the private sector, the National Association of Pension Funds (NAPF) has warned.

The NAPF issued the stark warning in its response to the European Insurance and Occupational Pensions Authority (EIOPA) on the review of the Institutions for Occupational Retirement Provision Directive.

To enhance the security of occupational pensions across EU member states, EIOPA is proposing the application of a ‘Solvency II type capital regime’ to assess the solvency of pension funds.

Under this system, which has been designed for insurance companies, pension funds would be required to increase their funding levels, making the provision of pensions much more expensive. This would lead to employers paying more at an already difficult economic time, leaving them with less money for investment and job creation.

Joanne Segars, Chief Executive of the NAPF, said:

“The overall objective to make European pensions more secure is one which we support. But the introduction of Solvency II type rules will have the opposite effect.

“Faced with extra funding demands, many employers will revisit their pension arrangements. And what we are likely to see is the closure of more final salary pensions.

“The UK pension system already provides a strong system of member protection through the employer covenant, the work of the Pensions Regulator, and the safety net provided by the Pension Protection Fund. We do not need new solvency rules for pensions.”

The number of businesses that have closed their final salary pension to all of their staff has jumped by a third, the National Association of Pension Funds (NAPF) has revealed.

Its latest Annual Survey found that almost a quarter (23%) of pension schemes are now shut to both new staff and to future contributions from people who were already in the pension. This is up by a third from 17% in 2010, and was just 3% in 2008.

The survey shows more change is inevitable. Among those pension schemes which are closed to new staff but still open to existing staff, 30% expect to close the pension altogether in the next five years. They plan to then move staff into a ‘defined contribution’ pension, where the employer is exposed to much less risk.

Meanwhile, one in ten (11%) say they will keep the existing defined benefit pension scheme structure, but will make it less generous. This could include changing accrual rates or moving from a final salary to a career average structure.

The findings reflect an escalation in the decline of final salary (or ‘defined benefit’) pensions, as schemes that have already closed to new joiners shift their focus to existing members.

Final salary pensions have been increasingly strained by rising longevity, poor investment results, and red tape. Employers have been closing these pensions to try to manage risks and mounting costs. Only 19% of private sector schemes are now open to new joiners, compared with 88% ten years ago.

Proposed EU pension regulations would add significantly to business costs at a time when pension deficits are already holding back company performance, a new poll of business leaders has revealed.

The latest CBI / Towers Watson Pensions Survey, which covers firms employing 1.3m people, shows that the cost and uncertainty of managing defined benefit (DB) schemes - including ‘final salary’ - are holding back businesses’ activity and harming their ability to grow.

Two-thirds (69%) of business leaders are concerned about the prospect of the EU enforcing high deficit payments over a shorter period of time, under Solvency II-style rules being planned in Brussels to cover DB schemes.

At its worst, this could cost employers with DB liabilities hundreds of billions of pounds. It would divert money away from business investment in growth and jobs at a critical time, and harm prospects for investment in infrastructure. The CBI is urging the EU to reconsider its proposal.

The cost of running a defined benefit scheme – whether open or closed – remains a big concern to businesses. Close to three-quarters (71%) are worried about the level of funding, and firms fear that things will get worse, with over four-fifths (85%) of businesses concerned that market fluctuations could further harm funding levels.

Over two-thirds (69%) of companies say providing DB pensions is having a significant impact on their accounts, and close to half (45%) say they have less left to invest to grow the business, up from 38% in the 2009 survey.

Faced with rising pension costs, most employers have already taken action, be it closing their final salary scheme to new members, changing terms for existing members, or freezing the scheme altogether.

This is set to continue. Nearly a third (29%) of companies say their DB scheme is already closed to future accrual by existing members, and this is expected to rise to 43% in the next two years. Two thirds (64%) of employers who currently offer DB benefits to at least some employees are either planning to close their scheme completely or make changes to it within the next two years.