People in the UK are in danger not saving

The growing interest in liability-driven investment (LDI) has caused a flurry of activity among asset managers as they try to take advantage of the increase in demand.

Recent gains in the equity markets are not having any impact on pension scheme deficits which, according to the latest research, have increased by £1.5bn since January.

The Conservative Party manifesto for older people promises to give the older generation their dues with higher incomes, a solution to lost company pensions, huge discounts on council tax and support for the cost of long-term care, says shadow pensions minister Nigel Waterson

This month sees the official start of the new pensions regulation regime when the new Pensions Regulator takes over from Opra.

Schroders has appointed Michael Macdonald-Smith as new head of UK defined contribution (DC) business.

The DWP has launched a consultation period for further pension simplification. The consultation period will run until 5 May and will include the proposals to enable contracted-out payments to be included in tax-free lump sum payments and also to increase the limit below which small pensions can be paid as a lump sum.

Law Debenture has launched a pension trustee self-assessment form designed to highlight gaps and weaknesses in trustees’ technical knowledge.

The first edition of the relaunched High Net Worth quarterly magazine was received with much critical acclaim. Many readers used phrases such as “excellent”, “extremely useful” and “very interesting”, and were highly complimentary of the mix of issues covered.

According to the ABI the numbers of people who believe that they will have to work longer to pay for their retirements is increasing. The same survey showed that trust in the government over pensions is dropping with only 19% of respondents trusting their ability to deliver.

I have just been reading about a guy called David Bowler, who had trouble starting his car recently, even though he keeps it in his garage.

Open Annuities has warned financial advisers that delaying a decision between its open annuity (OA) product and alternatively secured pension (ASP) could prove costly to them and their clients, as the OA may offer better value.

The Sipp Provider Group (SPG) voted unanimously to merge with the Association of Pensioneer Trustees (APT) at its recent annual general meeting, bringing the concept of a single trade body representing practitioners involved in self-invested pensions a step closer.

The Inland Revenue has announced a change to the forthcoming legislation on scheme pensions.

Clerical Medical has released the next element of its Advice Matters series, developed to help financial advisers adapt to the new environment post-depolarisation and A-day.

PY Sipp Solutions (PYSS) and Seven Investment Management (7IM), are launching the first company self-invested personal pension (Sipp) designed specifically for executives.

Risk-sharing in occupational pension design was viewed as potentially key to the future success of company arrangements in Adair Turner’s Pensions Commission report of last year.

Pension experts have welcomed an about-turn by the Inland Revenue over securing pension benefits in its recent set of technical notes on pensions simplification.

As mentioned in last month’s article, several of the key protection elements of the Pensions Act 2004 come into effect on 6 April 2005. Many of them will have cost implications for employers.

A comprehensive report into self-invested personal pensions (Sipps) has found that Standard Life, AJ Bell and James Hay are rated as the top Sipp providers by independent financial advisers.

Things will move on apace on A-day and, with just over a year to go, activity is picking up. A couple of weeks ago, the Inland Revenue published yet more guidance in the form of an eight-page document containing more than 40 amendments to the proposed regime. The Revenue has also started to issue draft guidance notes to a readers’ panel for consideration and there have already been some draft regulations.

The sale of ailing business process outsourcing company Marlborough Stirling (MS) appears to be reaching its conclusion.

The Department for Work and Pensions (DWP), in partnership with the Chartered Institute of Personnel and Development (CIPD), has developed a website for employers.

Dunstan Thomas has launched Imago: Process Manager, strengthening its pensions administration solution portfolio.

James Hay has augmented its online services to make transactions easier for advisers and clients of its self-invested personal pensions (Sipp). There is also a new trading section on the site at www.jameshayonline

Looking at the role of wraps in Europe convinced Karen Forrest to set up financial consultancy firm Adnitor to specialise in this area and the risk has paid off with a growing business, says Gregor Watt

Under the new pensions act, trustees will be required to have a high degree of knowledge about their schemes but how many will be able to meet the new standards by April next year, asks Martyn Shaw

To toughen up on employers trying to avoid final salary scheme liabilities, the Pensions Regulator can serve contribution notices and issue clearance statements. Peter Murphy and Ian Cormican (below, right) report

Even if IFAs do not yet realise that wraps can help them to snatch back capital that they have been haemorrhaging to product providers for years, life companies do; they will be the losers as IFAs cherry pick their valuable clients and they can be expected to put up a fight, says David Ferguson

The trend in liability-driven investing is growing and some in the pensions industry believe it is here to stay, but trustees must consider whether it is in the best interests of scheme members, says Gregor Watt

The investment strategies pursued by UK pension funds have evolved from peer group benchmarks towards liability-driven strategies over the past decade, says Tarik Ben-Saud

1. Liability-driven investing is about establishing a transparent link between liabilities and assets and minimising uncompensated risks. For a scheme that is looking to outperform their liabilities, a wide range of asset classes and strategies will help get the best return for the risk taken.
   These may include: government and corporate bonds (fixed and index-linked), equities, hedge funds, commodities, property, private equity, swaps and potentially other derivatives.
   For schemes that have a low risk appetite, and hence a lower expected return, they may restrict investments to bonds and/or swaps. However, for most schemes, LDI will lead to more asset classes and a greater use of active returns – this diversification brings risk reduction without reducing expected returns.
   For schemes that may wish to adjust their asset allocation significantly if their funding level changes, less liquid asset classes such as private equity and property are less likely to be appropriate.
2. Taking an LDI approach is likely to mean a much closer relationship between trustees and their various advisers working together. In particular, actuaries, investment advisers and fund managers will need to communicate much more closely. The benchmark for an LDI scheme is to achieve a return in line with, or ahead of, their liabilities. The governance of schemes needs to ensure effective processes are in place for monitoring this total scheme objective and the risks taken to achieve it.
   This total scheme monitoring requires a detailed understanding of the liabilities and how their value will change in response to changes in market conditions. This monitoring is likely to be best performed by an LDI manager with the technology and systems to perform this analysis. Trustees may also ask their investment consultants to undertake independent checks to ensure that the calculation methodology is appropriate and robust.
3. LDI investment approaches should be aware that the benchmark depends on non-investment assumptions such as longevity that cannot be predicted with certainty. As such, there are some risks that cannot be removed completely in the capital markets.
   However, this does not invalidate the concept of LDI, but suggests that it is not worth incurring significant costs in achieving what is likely to prove to be spurious accuracy in liability matching. For most schemes, the LDI objective is going to be to outperform the liabilities, and the risks from demographic assumptions proving to be wrong will remain only a part of the total risk.
   Even schemes that are currently 100% funded on a realistic set of assumptions may wish to try and outperform their liabilities to build in a cushion against unexpected improvements in mortality.
4. The inaccuracies inherent in liability forecasts can mean that a segregated solution does not always bring benefits. An appropriate set of pooled funds can still produce a bespoke solution that is a good fit for the liability profile in a very cost-effective manner.
   In this way, pooled fund products can allow smaller schemes to access techniques that otherwise would not be available to them. For example, the cost-effective use of swaps for removing unwanted risks and the use of portable alpha to introduce active returns from other asset classes onto a liability benchmark.
   They also allow larger schemes to implement LDI investments at lower cost and lower risk – for example through better diversification of counterparty exposure in swaps transactions.
   Together with the focus and trustee education that will come out of the promotion of these products, they are likely to lead to a greater adoption of LDI.

1. Structurally, we see the next generation of liability-driven investing (LDI) as containing a mix of cash, bonds, fixed income derivatives plus alpha and beta products. The genuine LDI component will consist of the former categories, with alpha and beta being supplied by a range of diversified growth assets.
2. The main implication is a big increase in the governance budget might be required to manage such a structure, at least initially. Generically, we see many schemes as having a loosely managed risk mandate which operates within the governance budget. Next generation LDI approaches are more tightly risk managed, but potentially step outside of many existing governance budgets.
3. The availability of liquidity at ultra-long durations in the fixed income derivatives market makes such hedging a real possibility. We do understand the problems associated with model risk, but are nevertheless keen to progress adaptive solutions which reduce investment risk without raising the spectre of unnecessary model risk. However, it is always sensible to remember the uncertainty that will remain due to demographic factors.
4. We do believe that such products will encourage the use of LDI and we applaud these. Investing in pooled funds that are transacting strategically, directly with an investment banking counterparty is a question which we find needs to be answered by trustee bodies on a case by case basis.

1. LDI works best for pensioners. Their cash flows are more predictable than actives and deferreds, and are generally of a shorter timeframe. But LDI can be used for all classes. Gilts and bonds can be arranged to give a degree of accurate cash flow matching, although the most accurate matching would come from a combination of assets with a swaps overlay.
2. As you are investing to meet the liabilities, the monitoring of the funding level becomes more important, as the performance compared to the liabilities should be the main measure. Depending on the degree of discretion in the portfolio, the manager may also be given some degree of asset performance measure.
   The other main implication of LDI is that if LDI is used to reduce the risk, trustees may be interested in investing in more high-performing assets to spend the saved risk. These high-performing assets will generally be unfamiliar to trustees, and a huge degree of education will berequired. Remember page one of the investment textbook – “if you don’t understand,don’t invest.”
3. Yes. A lot of the unrewarded risk is further out. A swap portfolio (inflation or interest) in particular is good for matching these longer term cash flows.
4. Yes, although the requirement to understand remains the same.

1. The first step in liability-driven investment (LDI) structure is to separate the overall portfolio. The first part normally relates to the pensioner liabilities, which looks at gilts, corporate bonds and maybe portable alpha and currency techniques to create a match. The remainder of the portfolio, which is focused on the active members, concentrates on non-bond elements to generate excess returns, where equities will typically make up a large part. However, this should also contain a significant proportion of other assets, which may include private equity, hedge funds, and the other alternative asset classes, in order to provide diversification from equities and focus on minimising risk.
2. The key aspect of LDI, from a governance perspective, is the focus on the scheme’s own liabilities, not those of a peer group. Close monitoring is important, as modelling is not an exact science, being based on long-term assumptions. Ensuring good monitoring allows for even marginal shifts in the liability profile to be dealt with quickly and relatively inexpensively.
3. For the very point made above, anything set on a framework of longer than 20 years requires a more pragmatic view. It is not unusual for this to cover up to 80% of the liability. Model projections must accommodate flexibility in the assumptions used and it should also be made clear, in discussions with clients, of the potential impact of even small changes to these assumptions.
4. There is definitely demand for pooled products and their introduction will make LDI solutions available to a much wider range of schemes. They may not be able to provide totally bespoke solutions but represent a significant advance for small schemes. In this regard, the lack of requirement to complete seemingly complicated ISDA agreements will also be seen as an advantage.

The questions

The first international conference on longevity risk and capital market solutions raised critical issues for corporate sponsors and trustees of DB schemes. Alistair Byrne and Debbie Harrison report

PFI offers an investment opportunity for pension funds with an attractive risk/return profile as one of its many selling points, says David Toplas

John Lawson, marketing technical manager at Standard Life, answers this month’s G60 questions on tax-free lump sums, posed by the following case study

Pensions simplification may seem like an oxymoron, but in only 12 months from now it will be a reality for pension schemes, advisers and individuals alike. The final details of simplification have still to be revealed, but we do have a good idea of what it will look like. As such, work has already started for many in preparing for simplification, even if not all final decisions can be made.

1. Pensions simplification, if it truly is simplification, will enable consumers to plan for their retirement using products they actually understand. The vast majority of our clients come to us with a very negative view of ‘pensions’ as a whole – mainly due to the very bad press certain pension schemes have had over recent years. If simplification can help to de-mystify the whole subject of retirement planning, as well as offering new ways of saving for retirement such as property purchase etc, this can only be a good thing for the industry and for consumers in general.
2. Providers have a major role to play by devising new products which will offer consumers the flexibility they require, along with simplicity so clients can understand exactly what it is they are investing in, and what they can or cannot do within the bounds of the new legislation. Advisers must use this opportunity to meet with as many new and existing clients as possible to re-educate the public regarding the importance of retirement planning. Together, advisers and providers have the opportunity to re-envigorate the whole area of retirement planning and avoid a potential future pensions crisis due to underfunding and ignorance.
3. The outline changes are a step in the right direction, however already the Inland Revenue and others are already recommending changes to the legislation which detract from the whole ethos of simplification – even before the legislation has passed through parliament.
   For the changes to work, there must be one set of rules which the consumer can easily understand and can plan their retirement savings around. Too many clauses and amendments will reduce the impact simplification can have, and consumers will not be attracted back into the pensions arena. Simplification must mean simplification.
4. This depends entirely upon the final rules and changes. Total simplification, with freedom of choice to invest in a wide range of asset classes, will certainly boost the popularity of the pension as the best way to save for retirement. A key part of this will be whether government, and providers in general, support the changes adequately by way of publicity and advertising – public awareness is key. If the public is made aware of the changes, and understand the benefits of simplification, pension savings will be boosted as a result. Whether this will stimulate enough additional savings to reduce the impact of the pensions timebomb remains to be seen.

1. Hopefully it will live up to its name and be simpler. However, for a non-flippant answer I think that the range of investments broadening out and this is likely to encourage a competitive self-invested pension plan (Sipp) market, which will be good news. Investors feel disengaged from their pensions and the more interesting they become for consumers, the better. Residential property has already sparked interest and even if it does not result in purchases it does interest investors.
2. For advisers it will be understanding all the finer points and how they impact so differently for each client. It is like de-junking your brain of all past pension stuff in order to let in a totally different set of rules. For providers dealing with legacy systems will be a nightmare. Also being up to date in terms of revised products.
3. Yes. I don’t like advising on maybes.
4. Could do. I would like to be optimistic as people need to save more for their pensions. More will be written about pensions and with the broadening of investment scope I am hopeful.

1. One of the greatest benefits will be the clarity offered to a consumer when contributing to pension schemes.
   For example, there will no longer be any contribution restrictions based on age or concurrency issues if an individual wishes to be a member of both their employers scheme and a personal pension scheme.
   The wider choice of investments will also greatly benefit consumers.
2. The two we are most concerned with are the complexity of the transitional provisions and the difficulty of interpreting and applying these correctly. Also the difficulty of dealing with some of the proposed permitted investments where widespread abuse can be expected with the pension provider presumably expected to police this.
3. Yes – time is getting short for systems development in particular and as yet there is not a lot of detail known. Hopefully, this will be produced, along with the Revenue guidelines in the near future.
4. Yes – the wider range of investments, higher contribution levels and concurrency make pensions much more attractive and will help counter the decline in the traditional company scheme.

1. Flexibility is the biggest attraction for clients, they are no longer stuck with the strict rules we have been used to such as; contribution limits, Inland Revenue maximum pension, complicated tax-free cash calculations, investment restrictions and concurrency issues.
   Consumers will now be able to plan for their retirement under a much more flexible pension regime, which includes continuing to work after retiring from their scheme, having the ability to invest in various asset classes such as residential property, funding pensions at a much higher rate than they are currently used to.
   This, with the removal of compulsory annuity purchase at age 75, means that retirement/ pension planning for consumers should become much more attractive.
2. Time; we are fast approaching April 2006, and there is still an awful lot of work to do. Along with getting to grips with all of the new rules, advisers need to ensure they contact all of their pension clients and review their current pension plans to ensure that they are best placed to take advantages of the new rules.
   Along with training all of their pension staff, providers will need to ensure that their systems and product ranges are equipped to cope with the new rules. If providers lag behind in the development of new products such as alternative secured pension (ASP), they could find themselves out in the cold from April 2006 when investors and advisers will be looking to the providers to offer the flexible products that will be required in order to benefit from the changes.
3. I do believe we have the basic structure in place and little will change from this, however, there still seems to be a lot of discussions taking place concerning the finer detail of the changes.
   These discussions are likely to continue for some time as we all become more familiar with the changes and the likely implications for our own clients. One that is of particular interest at present is the treatment of benefits when they are passed on to dependants who are not a spouse following the death of a member in ASP.
   Due to the time constraints we are under, I believe there is little time to make big changes and what we see now is likely to be what we will end up with.
4. Not really, I believe many people will still find pensions extremely confusing and although some of the investment opportunities such as residential property may seem attractive, until there is a better understanding of how pensions work we will still struggle to encourage the majority of people to invest in pensions.
   Many of the changes that have been introduced will appear extremely attractive to the high net worth experienced pension investor, and with the new contribution limits, removal of the earnings cap and the introduction of ASP we could see a greater inflow of money from the high net worth clients.

The questions

Complication or clarification? Pamela Atherton gauges industry reaction to the Inland Revenue’s extensive technical guidance on pension simplification and finds it mixed

The proposed framework for self-invested pensions has widened permitted investments to include residential property but the parameters are far too wide, argues David Baker

Poor administration was the cause of 30% of complaints in the pensions industry last year. The quality of both administration and complaints handling must be addressed, says Hannah Palmer

As businesses await draft legislation on age discrimination, Esther White looks at the challenges these new laws will bring for pension provision

1. The recent high-profile cases – Philip Green/M&S, Permira/WH Smith, Duke Street/Uniq – highlight the fact that acquirers now realise that if they acquire the company, they acquire the pensions debt, and that the method by which that debt is discharged is not something which is under their control. The wild card comes in the form of the trustees, whose legal duties won’t be wholly aligned with the interests of the acquiring company. That is precisely as it should be, but where interests conflict, you can’t always expect to get agreement.
2. The deficit in itself is really a pricing issue. It’s the strategy which must be developed to manage the deficit which can lead to the collapse of a deal. And in a sense, the deficit doesn’t exist at all until the scheme is actually in wind-up. Until then, the deficit is the outcome of actuarial prognostication, and it has been known for different actuaries to reach different views on the future.
3. Trustees should know what powers they have. They should receive professional advice to help them evaluate how or if they should seek to exercise those powers. They should not exercise them just because the names of the shareholders in the sponsoring employer might change. It should be an ongoing duty. Nor should they afraid of challenging the advice if it produces a palpably absurd outcome. Companies need new investment. Trustees need to consider how the new money is going to be generated to pay off the deficit. Most companies are taken over because the new owners think that they can make them more, not less, financially secure.
4. Ongoing dialogue with the employer is always the best way forward. The provision of good pension schemes should be a collaborative, not a combative, exercise. Sadly, the new pension laws look likely to drive further wedge between trustees and employers.

1. WH Smith is the most high profile example and generally pensions have jumped up the list of priorities for buyers and sellers.
2. There is commonly a tension between trustees’ duties to members and the seller. The assessment of pension deficit is especially becoming problematic.
3. For trustees, the key issue is how to ensure members’ interests are protected in: how deficits are assessed; maximising the deficit for members benefit; being seen to address the appropriate issues including the employers interests if the deficit is not maximised. Moral hazard is on companies’ radars, in particular where they can still have pension deficits assessed on an MFR rather than full buy-out basis. We will be able to stop gazing into our crystal balls on this when the full regulatory framework is put in place.
4. Fundamentally, this is about trustees keeping up an ongoing dialogue with the employer to ensure there is enough money in the scheme to pay members’ benefits.

1. It is difficult to determine, however, it is safe to say that pension arrangements have become one of the significant issues that need to be reviewed before proceeding with an acquisition. Pension issues have acted to reduce the number of potential bidders at an early stage, particularly where the size of the deficit is large relative to the expected purchase price of the target company.
2. An actuary valuing the pension scheme might give you three very different answers – the wind-up deficit, the accounting deficit and the on-going deficit. The acquirer needs to work out which is relevant in terms of the overall deal. Key clauses in the scheme’s trust deed and rules also need to be considered, to check the balance of scheme powers, such as who sets contributions, who can wind-up the scheme, change benefits and grant early retirements etc. A deficit should not lead to a withdrawal, as long as it is well understood and factored into the purchase price.
3. Trustees will often hear of the deal quite late, and they won’t be thanked if they frustrate the business aspects. They should seek to understand their powers from their trust deed and legislation. This will involve actuarial and legal advice. They should be prepared to investigate the credit-worthiness of the deal and consider whether it represents an opportunity to improve member security. The complexities of corporate structures make moral hazard a real issue but the message is difficult for trustees to relay to scheme members.
4. Trustees should consider negotiating before the deal closes, as it may be too late once the deal has been struck. They should also consider: the strength of the employer, requesting cash injections, obtaining charges over company assets, changing investment strategy, and even winding-up. They should monitor the position carefully post-deal, as the new owner may have changes planned. They should aim to build up a partnership with the new owner to ensure concerns are understood. This will become increasingly important as the number of active members in final salary schemes falls in relation to numbers of ex-employees covered.

1. Pension scheme deficits have been very much at fore of deal-making and deal-breaking for the past couple of years. Permira’s bid for WH Smith failed because the trustees of the WH Smith pension scheme were reported as demanding that any bidder plug a £200m deficit in their scheme. Philip Green also abandoned his offer for Marks & Spencer when the trustees of the M&S scheme refused to assist him in pricing his bid by giving him up-to-date funding levels.
2. Deficits should not necessarily lead to withdrawal. Larger companies will often have some sort of final salary scheme which has a deficit. Buyers will aim for the best possible funding information and negotiate on price. There is usually debate over the valuation of scheme liabilities, with parties often settling on the relatively tightly drawn FRS 17/IAS 19 accounting bases but even this still leaves room for argument.
3. Trustees of schemes have a duty to act in the best financial interests of members. The major issues for trustees include the ability of employers to fund scheme liabilities and the risk that those employers might fail. The climate in which a scheme operates can change dramatically following a transaction. The new owner may wish to pay the minimum contributions rather than fund past service deficits. Trustees will also be concerned if financially sound companies cease to participate in schemes leaving behind less secure employers behind to meet a burgeoning deficit.
4. Possible trustee strategies include: demanding a large one-off contribution to meet the deficit; switching investment strategy from equities and into bonds to reduce risk but increase employers’ costs; requesting parent company guarantees on funding; involving a PR company to publicise a scheme’s “plight”. The new moral hazard powers already inform debate. Employers are wary of taking steps to reduce liabilities on winding-up or cessation of participation or transferring schemes into the sponsorship of insufficiently resourced companies. Steps which might lead to the imposition of liability on group companies and anyone connected or associated with employers.

1. In the WH Smith case, the trustees were unprepared to maintain the current funding plan when they perceived deterioration in the strength of the employer’s financial covenant. We understand the scheme had the (unusual) power to allow the trustees to set the funding rate. M&S trustees appeared unprepared to reveal any of the scheme’s financial information to Philip Green. This is understandable, as they apparently had no authority to reveal confidential data to an as yet unconnected third party.
2. Clearly the existence of a substantial deficit and the need to finance this forces all parties to assess the raison d’etre of the commercial proposition. The tension comes from the trustees perhaps resisting the proposal as they will view the matter on a ‘prudent’ basis while the company’s decision-making is made on a commercial basis. One is risk adverse, the other accepts inherent risk. As to the second question – no it does not, as the ‘deal’ may make the deficit financing easier and/or the trustees may have no power to resist the merger.
3. To consider their duties, powers and overall role in the matter. Trustees must understand what they can do, what they should consider and what they should disregard. They are not there to protect jobs or allow their lack of enthusiasm or otherwise to colour or taint their decision-making. Clearly, they need to understand the commercial thinking behind the merger, the impact this could have on current agreements with the company, changes to the company’s financial strength, etc. Most importantly, this must be reviewed in terms of their powers conferred on them by the deed.
4. This is still uncharted territory. Much depends on the nature of the transaction being proposed. In the face of apparent increased risks to the scheme, they could consider taking charges on specific company assets or accepting banking guarantees or higher contributions. We would not include in this accepting better benefits for members. Trustees are probably not in the best position to make judgements about the commercial viability of a merger, but they are in a good position to judge current solvency and be alert to any deterioration in the schemes solvency and/or a failure of the sponsor to achieve its financial goals post merger.

The questions

Pension liabilities represent a major obstacle to successfully completing M&A deals, and the scale of scheme deficits is also putting advisers in the firing line when valuation figures change. Ceri Jones reports

Before 2000, pensions were not a major consideration in M&A deals. But the hidden costs to employers and pension scheme members has now come to the fore, says Paul Jagger

Alasdair Reid looks at the evolution of custody services and the trends which seem to be driving the market in one direction today

With-profits annuities have not performed well in the past few years but there are signs of a comeback as bonuses improve. Advisers should not ignore them, says William Burrows

Index-linked, real-return bonds yields look unsustainably low and investors should be wary, especially because such bonds only protect against official inflation rather than real inflation, warns Dr Jerry Toner

Law firm Cobbetts has indicated a desire to expand its pension team with the appointment of pensions specialist Helen Davies-Williams as a partner.

Winterthur Life UK has appointed two new business development managers to offer support to financial adviser clients.

Penny Shepherd MBE is to become the next chief executive of the UK Social Investment Forum (UKSIF).