occupational pensioners’ alliance
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Occupational Pensioners’ Alliance. Scheme Specific Funding Huw Evans Adrian Bourne 23 October 2008. Pension Scheme Funding. Stage 1 – Foundations Stage 2 – Analysis and Decisions Stage 3 – Putting it all together. Stage 1 - Foundations. Legislation Code of Practice - PowerPoint PPT PresentationTRANSCRIPT
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Occupational Pensioners’ Alliance
Scheme Specific Funding
Huw Evans Adrian Bourne23 October 2008
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Pension Scheme Funding
Stage 1 – Foundations
Stage 2 – Analysis and Decisions
Stage 3 – Putting it all together
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Stage 1 - Foundations Legislation
Code of Practice
Statement of Funding Principles
Balance of Powers
Potential Trustee / Employer conflicts
Funding process and Valuation Action Plan
Sponsor Covenant
Regulator Supervision
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EU Directive
sufficient and appropriate assets to cover the scheme’s technical provisions
Pensions Act 2004
• Statutory Funding Objective = sufficient and appropriate assets to cover the technical provisions
• Take account of specific characteristics of the scheme and sponsor
Technical provisions means the amount required, on an actuarial calculation, to make provision for the scheme’s liabilities
Stage 1
Legislation
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Objective assessment of employer’s covenant
Method and assumptions for technical provisions - trustees’ responsibility
Assumptions taken together should be prudent, but some risks are acceptable
Shortfall eliminated as quickly as the employer can reasonably afford
Stage 1
Code of practice
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• Explanation of the calculation of the Technical Provisions
• Details of Recovery Plan to meet the SFO
Employeragreement / consultation
Consideration of natureand circumstances of the scheme
SOC: Schedule of
Contributions
SFP: Statement of Funding Principles
RecoveryPlan
Actuarialadvice
Formal valuations can still be only
once every three years, but need
interim annual reports
Typically trustees and employers
must agree a Statement of Funding
Principles
Actuarial advice and guidance to the
trustees (and employers)
Stage 1
Statement of Funding Principles
Actuarial valuation
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Trustees Employer
Trustees’Actuary
Legislation /
Rules /Regulator
Legislation /
Rules /Regulator
Consult?
Agree?
Stage 1
Employer’s Actuary
Balance of Powers
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Trustees with senior management positions
Separate advisers?
Sharing of information and confidentiality
Need for constructive dialogue with Company
Stage 1
Code of Practice
• Any conflicts of duty or interest need to be recognised as soon as possible and dealt with appropriately
• Where appropriate, the Trustees should obtain legal advice as to how to manage these conflicts
Potential Trustee / Employer conflicts
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2. How should the fund be invested?
Benefits paid
Assets
Funding target Investment returns
Contributions
Existing assets
+
+
= Benefits
3. How fast shouldwe turn on the tap?
Stage 1
1. How high to aim
for?
Stage 1
Funding process
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Recovery Period
Other forms of member security
Investment strategy
Funding target
Technical Provisions (and other subsidiary targets)
How fast do you want to get back on track when below target?
More return-seeking assets like equities would mean lower expected contributions but more risk that the actual contributions required will exceed the expected value
For example, escrow arrangements or other forms of
contingent funding
Stage 1
Funding considerations
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Stage 1
Responsibilities
Dialogue withCompany
Timescales
Meetings
Sub-committees
Action Plan
Practical process
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How and where does covenant fit in?
Actuarial
assumptions
Investment
Risks
Covenant
Investment returns/VaR: What are the financial consequences if assumptions prove incorrect?
Recovery plans: What is the range of contributions that the sponsor can afford to make?
Technical Provisions: How might covenant strength align to confidence levels?
The Regulator expects trustees to have a good
understanding of the position of the scheme as an
unsecured creditor of the company
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Revision : What to expect of TPR under SSF- the Code of Practice
Para 57 – It is essential for the Trustees to form an objective assessment of the employer’s financial position and prospects as well as its willingness to continue to fund the pension plan’s benefits (the employer’s covenant).
Para 59 – The employer is obliged … to provide the trustees with such information as they … reasonably require … This includes information reasonably required to assess the employer’s covenant.
Para 92 – … trustees should consider … the ability of the employer to cope with the financial consequences of assumptions not being borne out by experience.
Para 101 – Trustees should aim for any shortfall to be eliminated as quickly as the employer can reasonably afford. What is possible and reasonable, however, will depend on the trustees’ assessment of the employer’s covenant.
Focus on the employer covenant through out the valuation process
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Earnings and cashflow
Business risks
Balance sheet
How strong is the balance sheet?
What is the nature of the assets therein?
Insolvency outcome: What are the prospects of
insolvency and an indicative outcome for the scheme?
How profitable/cash generative is the
business? And how is cash utilised?
Are the trends positive?
Relationship covenant
What is relationship between the employer
and wider group?
Is there any structural subordination?What are the future
prospects for the company?
How predictable are the earnings and cashflow?
What is the default probability?
….and willingness
Ability to pay
How do we assess covenant? Backward and forward looking….art not a science!
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Particular focus on irrecoverable zone….
Self-sufficiency
0%
20%
40%
60%
80%
100%
120%
1 2 3 4 5 6 7 8 9 10Year
Upper quartile
Median
Lower quartile
95th percentile
What if the investments under perform?
At what point does the strain become to much on the covenant?
Assessment will aim to identify critical issues and when risk becomes too great
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Monitoring the covenant!
CommentaryAll indicators remain positive. In particular: Gross profit has improved slightly year on year
(“yoy”). Cashflow remains strong albeit net cash levels
have decreased yoy due to acquisition spending and pensions contributions.
There is also strong net cash coverage. Similarly facilities headroom has also
decreased but remains at a level that is not covenant weakening.
The ratio of net cash as % of nwc remains strong and is explained in more detail on page X.
Revenue growth is buoyed by acquisitions but importantly the gross profit margin and PBT as a % of revenue ratios have both been maintained.
Headline PBT has also improved. Source data and explanations are set out on
page [ ].
Risk weighting Weak Negative Moderate Positive StrongFinancial statement indicators
BalanceSheet
Income Statement
Cash Flow Statement
Gross profit margin: 6.2%
(6.2%)
PBT : £77m (£76m)
Facilities headroom:
£641m (£785m)
Net cash: £246m
(£391m)
Annual BBPF deficit contrib
cover by h’room: 40.1x
Net cash as % of nwc:
27.6%
Revenue growth: 25%
PBT as a % Rev : 1.3%
(1.2%)
Figures in brackets represent six months to June 2007 results
Net assets: £550m (£513m)
Net cash coverage of
deficit contrib: 2.3x
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Buy-out cost
PPF FRS17
Liabilities
Technical provisions
Unlikely to investigate further
Very likely to investigate further
May investigate - maturity?
Stage 1
Pensions Regulator’s “targets and triggers”
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Pensions Regulator’s approach
Hands-off so long as they think things are moving to a conclusion
Work to bring parties together
They appears very keen to stay as a referee rather than a player
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Stage 2 – Analysis and Decisions
Establishing the funding plan
Integrated funding and investment
Assumptions
Recovery Plan
Contingent assets
Buy-out
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Funding level
Time
Buy-out
Gilts
Corporate bonds
Mixed portfolio
1. How much?
2. By when?
{4. Risk tolerance
A B C
3. Journey plan(balance of contributions + investment returns + risk tolerance)
?
?
Stage 2
Establishing the funding strategy
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Stage 2
Initial fundamentaldiscussions
Trial high-level investment strategy and technical
provisions
Refine investmentstrategy
Finalisevaluation
New trial
Resulting level of contributions, funding levels over time and
risk
Model the future-scenario orstochastic
Results acceptable
Results unacceptable
Integrated Funding and Investment
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Financial assumptions
Pre retirement discount rate Post retirement discount rate Inflation Salary increases Pension increases
Stage 2
Demographic assumptions
Mortality after retirement Mortality in service Rates of leaving service Rates of early retirement Rates of ill health Promotional salary scale Marital statistics
Assumptions
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Fundamental questions
What is the appropriate approach to setting discount rate for the Scheme?
1. to assume current investment strategy maintained?
2. to anticipate gradual switch from equities to bonds?
3. to ‘match’ assets to liabilities assuming lower discount rate after retirement (bond-based) and higher discount rate before retirement (equity-based)?
What is meant by prudence?
– Acknowledging that real life is variable
Stage 2
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Stage 2
Mortality assumptions
Need– “base table”: a snapshot of the mortality rates
expected over the year following the valuation
– “improvement factors”: i.e. how mortality rates will change in future
Never enough data to be confident of either No single “right” answer “cohort projections” are pretty arbitrary and rather
old by now tPR guidance reflects pushback on consultation doc
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Stage 2
Mortality beliefs
Total pace of improvement slows as deaths from heart disease and stroke become less common and other causes of death prove more difficult to eliminate.
Generations born in the post-war years continue to experience less rapid improvements as lifestyle-related illness take their toll.
As per “trend reversal”, but the pace of change in circulatory disease mortality also reduces sharply.
Typical justifications tend to focus on trends in cigarette smoking and/or rising obesity levels.
Who can tell what’s going to happen in the future… obesity, bird flu, climate change
…this whole mortality improvement thing is over-hyped
Medical advances continue to accelerate.
As each major cause of death is reduced, resources are re-deployed to tackle the remaining causes that have become more significant as a result.
Trend Reversal
Continued Acceleration
No Future Improvements
Extreme Trend Reversal
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Factors to consider: Strength of employer Balance of powers Trustees’ and Employer attitudes to risk Financial strength of scheme Maturity of scheme Investment strategy Consider buyout position Less prudent assumptions in recovery plan? Contingent security
“Agreed process to get back to full funding on the agreed assumptions”
Stage 2
Recovery Plans
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Trustees may consider less stringent funding objectives and/or longer recovery periods if the Employer were to provide contingent security
Contingent security could also influence the Trustees’ thinking on investment strategy (for example may be acceptable to retain a higher proportion of equities)
Could reduce PPF levy in future (but no effect in current funding position)
Stage 2
Contingent Assets
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Who cares about the buy out funding level?– Members and Trustees – level of benefits that would be provided if
Company were to become insolvent– Actuary required to assess buy out level both now and over the next 3
years– The Pensions Regulator – likelihood of having to call on the PPF in the
future– Shareholders / potential buyers – cost of extinguishing DB liabilities
Therefore you can’t ignore the buy out funding level
However…an alternative funding measure would be to concentrate on a closed fund positionclosed fund position or or self-sufficiency positionself-sufficiency position based on based on matching investments such as bonds
Stage 2
How important is buy out?
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Valuations go badly when…
Employer engages late in the process
Employer goes AWOL during process
Employer disagrees with covenant assessment
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Valuations go badly when…
Trustees fail to position themselves for a negotiation
Trustees start with an unrealistic negotiating position
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Valuations go badly when…
Agreements in principle are unpicked while drafting of the Statement of Funding Principles
Technical Provisions are set too high: consider other funding objectives
Conflicts are not managed properly
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Stage 3 – Putting it all together
Documentation
Beyond the valuation
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Valuation report
Contingent funding detail(if needed)
Schedule ofcontributions
Recovery plan(if needed)
Documentation
Stage 3
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Communication to members
Finalise investment position eg diversification of return-seeking assets
Review scheme options – commutation / early retirement / transfer values
Project review and lessons learnt for next time
Monitor progress against funding plan
Stage 3Stage 3
Beyond the valuation