If I could like that post more than once- I would! So I am giving it a super like


The Pensions Regulator’s statement – taking things too far

Towards the end of April the Pensions Regulator (tPR) released its first annual statement on the funding of pension schemes. Despite its reporting in the press, I can’t see how this gives any additional slack to employers. However, it does provide perhaps the clearest steer yet on how the Pensions Regulator expects The Occupational Pension Schemes (Scheme Funding) Regulations 2005 to be applied in practice.

It’s fair to say I’m not tPR’s biggest fan. This is largely because I strongly disagree with how they say we should do things (more to come) but also because when I’ve had to deal with them they’ve not been particularly effective (e.g. lack of guidance/help when asked by trustees or making comments that add advisor fees rather than any value). They have of course done some good things. The focus of this blog though is on the difference between the law and how tPR would like us to implement the law. A key quote from tPR’s statement:

“It is a requirement for trustees to calculate technical provisions based on prudent assumptions in relation to their assessment of the employer covenant”

Let’s have a look at what the law says on how schemes should be funded:

“(4) The principles to be followed under paragraph (3) are—

(a)the economic and actuarial assumptions must be chosen prudently, taking account, if applicable, of an appropriate margin for adverse deviation;
(b)the rates of interest used to discount future payments of benefits must be chosen prudently, taking into account either or both-
(i)the yield on assets held by the scheme to fund future benefits and the anticipated future investment returns, and
(ii)the market redemption yields on government or other high-quality bonds;”

No mention of employer covenant there. The whole notion of allowing for employer covenant in calculating the technical provisions has been made up by tPR. It is not law and therefore not necessarily a “requirement”.

Another key statement:

“In the regulator’s view, investment outperformance should be measured relative to the kind of near-risk free return that would be assumed were the scheme to adopt a substantially hedged investment strategy.”

This time they at least preface this with the comment that it is their view. It is quite clear from everything tPR has said over the last couple of years that their view of the future is that all schemes should invest in wholly bonds and be funded on a “self-sufficiency” basis. This is again a significant interpretation of the law and is inefficient, damaging to the long term future of pension funds and unnecessary.

TPR’s continued comments have pushed trustees to use more and more prudent assumptions and focus on short-termism instead of running schemes taking into account their long term nature. This has only accelerated further the trend of the closure and wind-up of both pension schemes AND employers. This goes completely against the tag line on their website:

Committed to increasing confidence and participation in work-based pensions

If this really is what they are committed to do then shouldn’t they be encouraging good pension provision rather than pushing funding so high that it puts employers off (any that aren’t already that is) for good?

A look at tPR’s mandate perhaps gives the biggest clue as to the why they have chosen to regulate pensions like this. From their website:

“The Pensions Acts of 2004 and 2008 give The Pensions Regulator specific objectives:

– To protect the benefits of members of work-based pension schemes
– To promote, and to improve understanding of, the good administration of work-based pension schemes
– To reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund (PPF)
– To maximise employer compliance with employer duties (including the requirement to automatically enrol eligible employees into a qualifying pension provision with a minimum contribution) and with certain employment safeguards”

The third bullet above around protecting the PPF is the only meaningful reason I can think of to allow for employer covenant when calculating technical provisions. It is nothing to do with the first bullet about protecting member’s benefits which would be better served with a significantly lower or significantly higher funding benchmark for all employers no matter what their strength*.

Isn’t this the biggest conflict of interest in pensions?

The difference between tPR’s approach to scheme funding and what the law says is huge. For me this is taking things too far as tPR is there to ensure that the law is abided by, not to write the law. It is after all an unelected quango.

* I will perhaps write a further blog on this but the higher level is obvious in that any funding level less than buy-out is not protecting members adequately and anything less than buy-out of PPF benefits provides no protection whatsoever. The lower level reflects the fact that protection already exists via the PPF and that capital can be better spent by employers than tying it up in the pension fund.

These are my personal thoughts and do not necessarily represent the views of First Actuarial LLP.

First Briefing – New IAS19, January 2012


The International Accounting Standards Board (“IASB”) has made a number of changes to IAS19: Employee Benefits. The new version will be effective for accounting periods beginning on or after 1 January 2013 and the key changes are:

  • all companies will be required to immediately recognise all gains and losses on the balance sheet (now referred to as the Statement of Financial Position) in the year they arise. The option that currently exists to spread gains and losses – the “corridor approach” – will be removed;
  • a new presentation approach, with the benefit cost being split between service cost, finance cost and remeasurement components;
  • more guidance on the treatment of expenses; and
  • a large number of additional disclosure items will be required. Additional information will also be required about multi-employer plans.


The IASB is carrying out a fundamental review of its accounting standards. They are making a number of “improvements” that will affect the accounting treatment of defined benefit pension plans, as set out in IAS19.

The proposals affect the consolidated accounts of companies listed anywhere in the EU. They do not affect those companies who only report under the UK accounting standard, FRS17.

The new standard will be effective for accounting periods beginning on or after 1 January 2013, but earlier adoption is permitted.

For a company with a 31 December year end:

  • the new standard will first apply for the 2013 accounts; and
  • the 2012 profits and balance sheet shown in the 2013 accounts will need to be restated as prior year comparators.


A key feature of the current IAS19 is that it provides companies with a choice as to when they recognise, on the balance sheet, actuarial gains/losses arising on the assets and liabilities (known as defined benefit obligations).

In the UK, most companies choose to recognise all gains/losses in full in the year they arise. The amounts are recognised in ‘other comprehensive income’ (“OCI”). However, some companies currently choose to adopt the corridor approach. Under the corridor approach, the impact on the balance sheet of actuarial gains/losses is smoothed because actuarial gains/losses above the corridor (defined as 10% of the greater of the defined benefit obligation or the fair value of the assets) are recognised in the profit and loss account.

Under the new standard, actuarial gains/losses are renamed ‘remeasurements’ and must be recognised in full in the balance sheet, through OCI, at the time they arise.

Comment – For the minority of companies that currently use the corridor approach, the move to immediate recognition may lead to a significant change to their balance sheet and substantially more balance sheet volatility.


The new IAS19 includes a new presentation approach, which is designed to provide greater consistency between different organisations. The benefit cost is to be split between the service cost, finance cost and remeasurement components.

Service cost

The service cost combines the current service cost (the cost of benefits accrued in the current period) and benefit changes (past service costs, including curtailment effects and gains/losses from non-routine settlements).

The service cost will be shown as an employment cost in the profit and loss account.

Finance cost

The most significant of the presentation changes relates to the way the finance cost component of the profit and loss is to be calculated.

The key difference relates to the treatment of assets. Currently, the expected return on the actual assets held by the plan is used. Under the new IAS19, the actual asset allocation will have no influence on the amount credited to the profit and loss. Instead, the discount rate, used to value the defined benefit obligation, will be used to determine both the expected increase in the value of the assets and the interest on the defined benefit obligation. This approach – a net interest approach – effectively assumes an expected rate of return on assets equal to the discount rate.

Comment – This change will raise the reported pension costs for most companies. As most pension plans invest in assets that are expected to yield a higher return than the return on high quality corporate bonds (the latter being used to determine the discount rate), this proposal will result in a higher financing cost in profit and loss. It may also lead to some companies reviewing their investment strategy because it could reduce the incentive to hold riskier growth assets such as equities.


The remeasurement of the assets and the defined benefit obligation will be reported under OCI. It will consist of a combination of:

  • gains and losses arising from experience adjustments and changes to the actuarial assumptions, with those arising from changes in the demographic assumptions being shown separately from those arising from changes in the financial assumptions;
  • the difference between the actual return achieved on the assets (net of investment management expenses) and the return implied by the net interest income; and
  • the effect of any changes to asset ceilings that apply when a company has a surplus that cannot be fully recovered.


The new IAS19 also clarifies the treatment of expenses. Investment management expenses should be recognised as part of the return on the plan assets. Other administration costs of running a pension plan should be recognised when the administration service is provided.


A number of additional disclosures will be required to help readers of the accounts understand the characteristics of the defined benefit plans and the associated risks (including the amount, timing and uncertainty of future cashflows).  For a summary of the main additional disclosures required, please see our full briefing.

Comment – Preparation of these new disclosures is likely to increase the time required to prepare the accounts, together with the associated costs. The costs of complying with the new IAS19 could prove particularly onerous for smaller pension plans.

Multi-employer plans

For companies that participate in a multi-employer plan for non-associated employers, a number of additional disclosures will be required to ensure that any extra risk the company may face as a result of actions taken by other employers participating in the plan are made clear.

Where a company participates in a defined benefit multi-employer plan, it should usually account for its share of the plan in the same way as for any other defined benefit plan. However, companies may not always be able to identify their share of plans with sufficient reliability for accounting purposes. In these cases, companies should continue to account for their plans as if they were defined contribution plans.

There are also new disclosures required where the plan is being accounted for as if it were a defined contribution plan.

A summary of the additional disclosures relating to multi-employer plans can be found on our full briefing.

Next steps

Companies should review how profits and balance sheets will be affected by the new rules and consider whether to adopt the new standard early.

Companies may also need to understand any impact on other areas, such as the investment strategy of their plans and any de-risking measures currently being considered.

For more detail please see our full First Briefing on the “New IAS19, January 2012” . This can be found along with past briefings on our website. Alternatively for further information please contact us.

Investment Briefing: Current opportunities in Bond Markets, December 2011

Recent market conditions present opportunities to long-term bond investors. In this briefing we consider two particular opportunities that we believe are relevant to pension schemes, which are briefly summarised here.

Switching from fixed-interest gilts to corporate bonds

The yields on long-term fixed-interest gilts has fallen sharply in recent months which has resulted in a widening of the ‘credit spread’ (the additional yield offered by corporate bonds over gilts). This represents an opportunity for long-term investors to lock into the additional yield (which currently stands at an additional yield difference of over 2% pa) by switching from fixed-interest gilts to investment grade corporate bonds.

For longer-term investors (those with an investment horizon of at least three years) we consider the current additional yield to be attractive and more than sufficient to offset the slightly higher risk of default of investment grade corporate bonds.

Trustees should be aware that if economic conditions continue to deteriorate or if we enter another financial crisis, gilt yields could fall further and corporate bond yields could rise. For those investors currently making the switch from gilts to corporate bonds, this may lead to lower relative returns (or even negative returns) in the short term.

Switching from fixed-interest gilts to index-linked gilts

As a result of recent developments, trustees of pension schemes that have a significant holding in fixed-interest gilts (but whose liabilities are predominantly linked to RPI inflation) have an opportunity to hedge their inflation exposure at a relatively attractive level.  One way to achieve this would be to sell fixed-interest gilts and buy index-linked gilts.

The expected long term Retail Prices Index (RPI) inflation implied by gilt yields (the difference between the yields on fixed-interest gilts and index-linked gilts) has fallen from around 4% pa at 30 June 2011 to just over 3% pa at 30 November 2011.

Therefore, if one thinks that RPI inflation will be greater than 3% pa over the long term, then buying index-linked gilts rather than fixed-interest gilts at current prices would appear more attractive.

Trustees wishing to consider a switch from fixed-interest to index-linked gilts should also note that index-linked gilts have a longer duration than fixed-interest gilts with similar maturity dates which may mean they provide a better match to a pension scheme’s long-dated liabilities.

Further information

For more detail including charts and background information on the investment opportunities summarised here, please see our full First Briefing on the “Current Opportunities in Bond Markets, December 2011“.

This can be found along with past investment briefings on our website.

The views expressed in this briefing note are based on market conditions at the time of writing. As market conditions change so will the relative attractiveness of the options considered.

This briefing summary should not be construed as investment advice. If you wish to consider its applicability to your particular pension scheme or wish to discuss any aspect of your investment strategy please contact us.

Cross Keys Homes awarded Pension Quality Mark Plus

Cross Keys Homes, Peterborough’s largest housing association, has become the first employer offering its staff membership of the Defined Contribution section of the Social Housing Pension Scheme (SHPS) to obtain the Pension Quality Mark.

Lisa Glendye, head of HR at Cross Keys Homes, said: “We are delighted to have been awarded the Pension Quality Mark Plus. It further endorses our commitment to always striving to improve our employees pay and benefits package despite, these difficult times. Cross Keys Homes recognises the importance for staff to have the opportunity of a sound pension when they retire”

Logan Anderson, Head of Customer Relations at The Pensions Trust who administer SHPS said: “We were pleased to support Cross Keys’ application for the Pension Quality Mark Plus”.

“Cross Key Homes has received the Pension Quality Mark Plus because of the excellent level of pension contributions they offer as an employer, and because of the high standards of governance and quality member communications provided by the SHPS DC section. We would urge all other employers using the SHPS DC section to apply for the Quality Mark to demonstrate their commitment to providing employees with access to good quality workplace pensions” added Alexandra Kitching, Head of the PQM Team at the NAPF.

“This was a great example of co-operation by Cross Keys, SHPS and the Pension Quality Mark team” commented Alan Smith, the First Actuarial Founder who advises Cross Keys.

“As a result of this, other Housing Associations participating in the SHPS DC structure should find it a lot easier to get the Quality Mark and provide tangible evidence to their staff of the value of their pension arrangement”, he concludes.

Further Information

For further information please contact us.

First Actuarial Strengthens Investment Consulting Practice

Mike Smaje has joined First Actuarial LLP as Director of Investment Services. Formerly a senior investment consultant and actuary with Towers Watson, Mike has 19 years’ industry experience. He will be based in First Actuarial’s Leeds office.

First Actuarial Founder, Michael Hulme-Vickerstaff commented:

“We are delighted to welcome Mike on board. His experience will be a tremendous asset to us in meeting the growing demand for investment services from our clients.”

Fair and Sustainable Public Sector Pensions

Ahead of the planned strikes on Wednesday I thought I’d post a few thoughts on public sector pensions. I think of myself as being one of the few people that aren’t firmly on one side of the argument on this. I’m a taxpayer on one hand but defender of defined benefit pensions on the other. I’m therefore hoping that this post will perhaps dispel some of the various mistruths out there and perhaps get to the heart of the real dispute.

Why should the government provide good pensions to the public sector?

This seems a reasonable place to start in the debate. There are many shouting that they are too generous but is this just envy? The government should look to provide good pensions to those in the public sector for several reasons:

  • It is reasonable for a government to be paternal and want to look after the workforce in old age.
  • The government should lead by example, how can it expect others to provide if it doesn’t?
  • It reduces potential costs in means tested benefits.
  • Most importantly, it has a comparative example in doing so.

The government is much more able to take on the risk of defined benefit pensions than any other organisation. It can also provide them in a large scale efficient unfunded manner and is not subject to the horrendous number of legislative hoops that are in place for the private sector.

What is being provided? Isn’t it a gold plated benefit?

Public sector schemes generally provide benefits of either 1/80th of final salary for each year worked as a pension plus 3/80ths of final salary for each year worked as a lump sum OR 1/60th of final salary for each year worked as a pension. These benefits are generally payable at 60 or 65 with the majority currently still being payable at 60.

For example, if you joined at age 20 then retired at 60 you might get a pension of 40/80=half of your final salary plus a tax free cash sum of 1.5 times your final salary or, alternatively, a pension of 40/60=two thirds of your final salary but no lump sum.

Some schemes such as the police and armed forces are significantly different to reflect the nature of their roles.

Is this gold plated? Mostly it’s the same as what the private sector used to provide so arguably it’s not. However, retirement at age 60 without reduction is something that is very rare to see in the private sector and has been for some time. Arguably therefore the retirement age is the only thing that makes these schemes gold plated. It is often argued that the average pension is only £4,000 a year so how can they possibly be gold plated. The average pension is irrelevant. All it tells you is that there are quite a lot of low paid workers, quite a lot of part-time workers and quite a lot of people who don’t spend their entire career in the public sector.

What do these pensions cost?

Putting a value or cost on pensions is very difficult and there is no area in the pensions world that suffers quite as much in terms of bad calculations of cost as public sector pensions.

The “problem” with public sector pensions is that the majority of them are not funded. This means that the contributions paid just go to the treasury along with taxes raised and pensions are paid each year out of this pot as they fall due. This is instead of a funded scheme, which is the norm in the private sector, where contributions are paid into a pot that is invested and topped up as appropriate and pensions then paid out from this pot.

This “problem” leads to some horribly bad numbers being produced on the cost of public sector pensions.

The first is that the cost is often given as the pension outgo this year less contribution income this year. This tells us very little if anything about “cost”. If this was how we calculated cost then it would be more expensive to remove all public sector pension accrual than doubling their benefit accruals as the contribution income would fall to zero if accrual ceased.

The other awful number often quoted is when an attempt is made to “capitalise” into one number all future public sector pension promises. As it is an unfunded scheme this number is utterly meaningless. It’s as silly a number as putting a single figure on what we will spend on healthcare in the next 80 years! However, it is made even more meaningless by assuming that, if it were funded, the money would be invested in government debt i.e. the government would issue debt only to buy it back and that therefore the way to value the benefits is by using index linked gilt yields – nonsense!

Of course cost is also very difficult in the private sector. The problem with pensions in general is that they are paid a long time into the future, a future we know nothing about. Because of this, to determine the cost of benefits accruing we need to use a discount factor so that we can compare the value of money today vs money tomorrow.

Up until now this has been done for public sector pensions in the same way as would be done when evaluating any government capital project (e.g. building a bridge) by using a Social Time Preference Rate or, more specifically for pensions, the SCAPE (Superannuation Contributions Adjusted for Past Experience) approach (see here appendix D for more on this). This is a real (i.e. above inflation) discount rate of 3.5% pa. Following the Hutton Review it has been agreed to use a rate in line with expected economic growth agreed at 2% pa real. This drop in discount rate leads to a significant increase in the perceived cost of public sector pensions (see below).

In the private sector there are a myriad of different approaches used but the 3 main approaches are that: the actual expected cost is determined using rates in line with the expected return on the assets held; the funding cost is determined using a prudent expectation of the return on the assets held; and the accounting cost is determined using a corporate bond yield.

When considering the private sector we should also include defined contribution (DC) schemes as the majority of private sector pensions are now DC. A DC scheme being little more than a tax advantaged savings scheme with strings attached. In determining the cost to an individual of replicating a DB pension in one of these schemes we can again use the expected return on the assets likely to be held but also need to factor in the fact that they will need to buy an annuity from an insurer at retirement.

The chart below shows an approximate comparison of the cost as a percentage of salary of providing a pension of 1/60th of final salary payable from age 60 in the public sector and private sector (including an individual in the form of a DC scheme). It allows for above RPI inflation salary rises of 1% pa, CPI inflation increases in payment and makes many other assumptions (available on request) – it is not designed to be definitive. It does however potentially under rather than overstate the private sector costs (particularly at the moment with bond yields so low).

pension cost comparison
[Click to see a larger version]

The chart clearly shows the “comparative advantage” I mentioned earlier that the government had over the private sector in providing pensions with the SCAPE method discount rate. However, it also shows that this has largely been eroded when compared with private sector DB with the discount rate change. Finally, it shows where the problems stem from as the costs, on a DC basis which is the setup of most private sector schemes now, are substantially higher. This is an even bigger problem because the contributions being made to DC schemes are substantially less than were/are made to DB schemes. Workers in the private sector doing similar jobs to public sector counterparts on similar salaries are therefore looking across with some envy about where they perceive their taxes are being spent.

The change in public sector discount rate will increase the cost of benefits by around 50%! But private sector funding costs in the short term are around 10% higher still and for an individual in DC the cost is about 25% higher on average. When people talk about pension apartheid this is what they mean.

What’s proposed to change?

Very broadly:

  • Contributions are to increase by 3% (but with little or no impact on lower earners)
  • The accrual rate will be set at 60ths
  • The new scheme will be based on average salary earned increased by average national earnings rather than final salary
  • Retirement age will be linked to state pension age (65-68 depending on date of birth) rather than 60

However, a transition period is to apply such that those within 10 years of retirement at April 2012 will not be impacted and those within 14 years will have a lesser impact.

Additionally, this is a cost envelope only and benefits can be amended for each scheme provided the revised benefit is no more costly.

Why is this happening?

There is much talk about fair and sustainable pensions. Both fair and sustainable are pretty difficult concepts though when it comes to pensions.

I think there are 3 points to address separately about why this is happening: the contributions rise, the benefit changes and the transition period.


I’ll deal with the latter of these first as it’s easiest. The transition has been offered as members do not understand the proposed reforms/how they will operate and the government has inadequately communicated this. In my eyes they’ve taken something that had an automatic in built simple transition and suggested a complicated “transition” that has introduced potential cliff edges.

So if you are due to retire before 1 April 2022 you no longer need to worry about your benefits provided agreement is reached before the year end and the deal isn’t revoked. (So no need to strike!)

Even if the transition weren’t in place if you only had e.g. 5 years until retirement then you will only have 5 years on the new benefit structure. Your old benefits would be protected on the old structure! For example if the new benefits were worth 20% less (not necessarily the case) and you already have 20 years service then you’d still get 96% of your original entitlement. If you are 1 year away then you’d get 99% and 10 years away 93%. Automatic transition!

Conclusion: The transition period offered is a bad idea and the money would be better spent elsewhere.

Benefit changes

When considering sustainability we need to note that the current benefits are sustainable – particularly as “cap and share” that was introduced following the last set of changes means members could expect to have to increase contributions in the future if the cost rose. However, what we really mean when we talk about sustainability is what level of benefit are we prepared to sustain?

What do we mean by fairness? Well the definition being applied seems to have 2 parts attached to it. Firstly that for it to be fair the changes should have greater impact on the higher rather than lower paid and secondly that pension benefits accruing should be fair to the tax payer. The first aim is I think achieved by the career average structure which for a given total cost should ensure greater benefits for the lower paid who generally don’t have such high salary growth. The second is much more subjective but it’s worth referring to notes on costs above noting just because it costs the government less doesn’t mean it should provide more as it should be using the comparative advantage to reduce costs.

One point that has clear sustainability merits is linking retirement age to state pension age as this should help ensure stability of cost going forward. I think it’s also reasonable to suggest that taxpayers aren’t getting the best value out of providing pension benefits as they stand. The number of opt outs suggested due to contribution rises shows that member value is nowhere near as high as cost on any measure. This is partly due to the mistrust members have with pensions and governments.

Conclusion: much of what is proposed is perfectly reasonable but much work needs to be done on communicating the value of benefits to members.

Contribution rises

There is an element in this that is about fairness and attempting to address the fact that the perceived total reward in the public sector is too high. Increasing member contributions has the effect of addressing the balance without talking about salary cuts. By ensuring the lower paid are affected less, the approach to increasing contributions is also arguably fair. However, I get the feeling that the increase in contributions is probably the overwhelming problem with the proposed reforms. This is the one that hits members pockets directly today and, assuming the government does want to encourage membership, is exactly the same as a pay cut.

However, we are in a financial black hole. As well as being the only thing that hits member’s pockets today, it’s also the only think that provides extra income to the government today. This is why it is being done. The contribution rises have very little to do with fairness and sustainability but everything to do with the deficit that exists in public finances. There is nothing wrong with this but it needs to be communicated as such.

Higher contributions or lower salaries
Higher contributions or redundancies

If the contribution rise doesn’t go ahead then the finances need to be filled by something else. This is why this area of change is not negotiable. This message has not been communicated though.

Conclusion: it’s going to happen but needs to be communicated why.

Other points of note

  • Just because your normal retirement age is 68 doesn’t mean that’s when you have to retire.
  • After the changes public sector schemes will still be very good and the envy of private sector workers.
  • We need to think hard about our ageing workforce. Some jobs just can’t be done at 68. Is it time to introduce positive age discrimination to get older workers into jobs they can do?
  • We need to attack things from the other angle and remove the barriers to private provision so that DB schemes can once again exist for private sector workers – much of the problem is due to bad regulation.

These are my personal thoughts and do not necessarily represent the views of First Actuarial LLP.

First Briefing – PPF Levy 2012/13, November 2011


In the PPF Levy 2012/13, June 2011 Briefing we looked at the new framework proposed by the PPF for the 2012/13 levy. The PPF has now issued the draft levy determination for the 2012/13 levy year. The determination provides detail on the proposed operation of the levy, sets out the levy parameters and proposes changes to the certification process for certain contingent assets. Consultation on the draft determination closed on 2 November 2011 and the final determination is expected to be published before the end of 2011.

This Briefing builds on our previous Briefing by highlighting new information that is contained in the draft determination. It also covers the actions that trustees and employers can take to manage the levy and the timescale by which those actions need to be completed.

Levy estimate

As part of its funding strategy, the PPF determines the total amount of levy it needs to collect to meet its liabilities. This is known as the levy estimate. The levy estimate is set at £550m for each of the 2012/13, 2013/14 and 2014/15 levy years. This is a £50m reduction from the levy estimate for 2011/12 of £600m.

Levy calculation

The total PPF levy is the sum of the Scheme Based Levy (“SBL”) and the Risk Based Levy (“RBL”).

Scheme Based Levy

SBL = Scheme based multiplier * PPF Liabilities.

Risk Based Levy

RBL = Underfunding Risk * Insolvency Risk (referred to as the Levy Rate) * Levy Scaling Factor.

To protect schemes with the weakest employers and the weakest funding positions, the Levy Rate is subject to a cap and the Risk Based Levy is also subject to an overall cap.

Investment risk

As discussed in the previous Briefing, the underfunding risk for levy years from 2012/13 onwards will reflect the investment risk posed by the scheme’s asset portfolio. The PPF has now updated the stress tests it uses to assess investment risk.

Levy Rate

The PPF has also updated the methodology for deriving insolvency probabilities, reflected in the Levy Rate, to align it with market practice.

Dun & Bradstreet (“D&B”) will still be providing the failure scores for employers and these failure scores will still run from 1 to 100. However, for 2012/13 onwards, there are two changes being made:

    1. Failure scores will be collected on the last working day of each month (from 28 April 2011 to 30 March 2012) and then averaged.

    2. Rather than allocating a probability of insolvency to each failure score, the average failure score will be mapped to one of 10 levy bands. Each band will correspond to a different Levy Rate.

Distribution of levy between SBL and RBL

For levy years prior to 2012/13, the total PPF levy was calculated so that 20% of it comprised the SBL and the remaining 80% comprised the RBL. With effect from the 2012/13 levy year, this is changing so that the fixed 20%:80% distribution no longer applies, although this is subject to the proviso that the SBL cannot exceed 20% of the overall levy.

For the 2012/13 levy year, 89% of the levy is expected to come from the RBL, with the remaining 11% coming from the SBL. The SBL element of the 2012/13 levy purely reflects the cross-subsidy arising as a result of the cap on the RBL.

Contingent assets

The PPF is proposing to change the certification process in relation to Type A contingent assets. As a reminder, Type A contingent assets are parental or group company guarantees that are PPF-compliant.

What is changing?

From the 2012/13 levy onwards, schemes will be required to certify on Exchange that the guarantors could be expected to meet their full commitment under the contingent asset if called upon to do so at the date of the certificate. The PPF will also be taking active steps to satisfy itself that the financial strength of guarantors entering into Type A contingent assets arrangements is such that the reduction in levy resulting from recognition of that asset is consistent with the reduction in risk.

Winners and losers

The changes being made to the levy calculation will result in winners and losers.

It is expected that well-funded schemes and schemes with lower risk investment strategies will be the winners from these changes. The losers are likely to be very strong employers whose schemes are not particularly well-funded.


There are a number of actions that can be taken by trustees and employers to help manage the levy. These include:

By the last working day of each month from 28 April 2011 to 30 March 2012:

  • Monitor D&B Failure scores by supplying any necessary information to D&B.

By 5pm on 31 March 2012:

  • Ensure information input into Exchange is correct. In particular, it is crucial that the asset breakdown provided reflects the actual asset distribution held by the scheme.The Section 179 valuation information should be the latest available.
  • Certify / recertify contingent assets – Certificates to be provided via Exchange.

By 5pm on 10 April 2012:

  • Certify / recertify Deficit Reduction Contributions (“DRCs”) – Certificates to be provided via Exchange.

Further information

For more detail please see our full First Briefing on the “2012/13 PPF Levy, November 2011” which also includes:

  • A table of the stress tests used by the PPF for the 2012/13 levy;
  • A table detailing the levy bands corresponding to D&B failure scores for determining the Levy Rate;
  • Information on the levy parameters;
  • Further information on how changes to contingent assets will be taken into account for the 2012/13 levy; and
  • More actions that can be taken by trustees and employers to help manage the levy.

This can be found along with past briefings on our website. Alternatively for further information please contact us.

First Briefing – Resticting Pension Tax Relief


In the “Restricting Pensions Tax Relief, Oct 2010” Briefing we covered the Government’s proposals for changes to the pension tax regime insofar as they were known at that stage. Legislation has now been enacted to effect those changes and this Briefing provides an update on the position and focuses on some of the finer detail.

Restrictions apply on the amount of pension savings made to a registered pension scheme that benefit from tax relief. There are limits on both the annual amount of savings that can be made (the “Annual Allowance”) and the total value of benefits that can be taken over an individual’s lifetime (the “Lifetime Allowance”). For the tax year commencing 6 April 2010, these amounts were £255,000 and £1.8m respectively.

What has changed?

With effect from 6 April 2011, the Government has reduced the Annual Allowance (the “AA”) from £255,000 to £50,000. Individuals whose pension savings are below this limit will continue to benefit from tax relief at their marginal rate on all the pension contributions they make. Individuals whose pension savings breach this limit will be subject to a tax charge, which effectively claws back tax relief granted on the pension savings in excess of the AA.

The Lifetime Allowance (the “LTA”) is also being reduced from £1.8m to £1.5m, although this change isn’t taking place until April 2012. This has given the Government time to design a protection regime for those who already had pension benefits in excess of £1.5m when the changes were announced or who were hoping to build up pension benefits in excess of that level.

Will the allowances be increased each year?

There is provision in the legislation to enable the Government to change both the AA and the LTA in future. However, the Government has not committed to doing so. Even if they do, in the case of the AA, there is no guarantee that it will be increased.

Are there any other changes to the way in which the Allowances will operate?

With the exception of the reduction in the level, the Government has kept the operation of the LTA largely unchanged. From April 2012, however, the trivial commutation limit is being de-linked from the LTA, so that it will no longer be set as 1% of the LTA. It will instead be a flat amount of £18,000. Again, there is provision in the legislation for the Government to change this amount in the future should they wish to do so.

There have however, been a number of changes made to the way in which the AA operates, explored below.

Over what period does the Annual Allowance apply?

The AA applies over the tax year. However, the period over which schemes measure the increase in pension benefits is known as the Pension Input Period (“PIP”). This may be different to the tax year. For an individual, the total pension savings made over all PIPs ending in a tax year are assessed against the AA applying in that year.

What is the Pension Input Period?

The rules surrounding PIPs are complicated and different schemes can (and will) have different PIPs. Indeed, different members within the same scheme may have different PIPs. The PIP that applies for each individual will depend on when the individual started accruing benefits under the arrangement and whether or not a nomination has been made to change the PIP from the default.

How is the amount of pension savings calculated?

Defined Contribution arrangements

For Defined Contribution (“DC”) arrangements, the amount of pension savings is the total pension contributions made by the individual and their employer to the DC arrangement during the PIP. If an individual has more than one DC arrangement, the total contributions made to all those arrangements with a PIP ending in the tax year need to be combined and compared against the AA. This is no different to how DC pension savings were valued before 6 April 2011.

Defined Benefit arrangements

For Defined Benefit (“DB”) schemes, it is less straightforward. The contributions paid into the scheme are not relevant for the purpose of carrying out the test against the AA; it is the increase in the value of the benefit over the PIP that is important.

Previously, for active members, the increase in the value of the benefit for the purpose of the AA test was calculated by determining the difference between the benefit the member would have received had they become entitled to payment of it at the end of the PIP and the benefit the member would have received had they become entitled to payment of it at the start of the PIP. This difference was then multiplied by a factor of 10. For deferred members, the benefit at the start of the PIP was adjusted for revaluation before the calculation was undertaken.

With effect from 6 April 2011, the increase over the PIP in the benefit the member would have received makes allowance for the benefit at the start of the PIP to be revalued to the end of the PIP in line with the increase in the Consumer Prices Index (“CPI”). In addition, the factor has changed from 10 to 16.

Where the change in the value of the accrued benefits is negative, this is set to zero. In other words, the member is deemed to have not made any further pension savings over that PIP.

Can unused AA be carried forward?

Whether an individual will incur a tax charge for breaching the AA in a particular year will depend on whether they have any unused AA from previous years. Unused AA from up to three previous tax years may be “carried forward” and offset against excess pension savings made in a particular year. For the purpose of the carry forward calculations, the AA is assumed to be £50,000 in each of the previous tax years.

What about those individuals whose PIP for 2011/12 started before the changes were announced?

Transitional protection applies for anyone whose PIP(s) started before 14 October 2010 (the date on which the Government first announced that changes to the pensions’ tax regime would be taking place), where the PIP ends (or has ended) in the 2011/12 tax year, and where the pension savings made exceed £50,000.

What are the charges that will be incurred for breaching the AA?

Where a member does incur a tax charge, the amount will depend upon the rate of tax relief that the member received on the pension savings. The charge will be tailored in order to recoup the full marginal rate of relief that the individual initially benefitted from when the pension savings were made.

What will happen if an individual cannot afford to pay the tax charge?

An individual can only pay the tax charge from their pension savings, rather than income, where the charge exceeds £2,000. Schemes will only have to offer members the option of paying their tax charge from their pension savings where the member has breached the AA limit outright in that scheme.

Next steps

Now that the main legislation has been finalised, the Government has issued draft regulations to ensure that vehicles like Employee Benefit Trusts and Funded Employer-Financed Retirement Benefit Schemes can not be used to make excess pension savings and avoid incurring tax charges.

HMRC issued draft guidance when the changes were first announced back in October 2010 and have stated that they hope to have updated the guidance to reflect the final legislation by late September, although at the time of writing, this is still outstanding.

Further information

For further information on pension tax relief and the AA test, including:

  • The LTA protection regime
  • Which members are exempt
  • How increases in accrued pensions are determined upon early and late retirement
  • How AVCs are valued
  • Transitional protection

please see our full First Briefing:

“Restricting Pension Tax Relief, October 2011”

This can be found along with past briefings on our website. Alternatively for further information please contact us.

Press release – sixth straight year of substantial growth and new partner

First Actuarial announces substantial growth and a new partner

First Actuarial, a leading independent provider of pension consulting services, announced revenue growth of 22% for the year ended 31 July 2011, and the promotion of Kate Bailey to partner.

Consistent growth

This is the sixth year of double digit revenue growth for the firm since it was established in 2004. Revenue for the year ended 31 July 2011 was £11m, up from £9m in 2010.

Managing Director Keith Williams said “Our success is down to our staff, and their focus on keeping all our clients highly satisfied. This is an exciting time for First Actuarial and we welcome our new clients who have chosen us for our straight talking, value for money approach.”

New partner

Kate Bailey The firm is also delighted to announce that Kate Bailey, a qualified actuary who joined the firm in 2005, has been admitted as a partner.

HR Director Hilary Salt added “We congratulate Kate and welcome her to partnership. Kate deserves this recognition for the unwavering commitment she has shown to her clients and the firm over the past 6 years.”

For more details (and jpeg of photo):

Keith Williams – Tel: 01256 340 074
Hilary Salt – Tel: 0161 868 1321

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