UK PENSION TRENDS FOR WORKPLACE PENSIONS

Due to the historically low interest rate, increased longevity and additional legislation demands from the UK and EU, the guaranteed Defined Benefit (DB) plans have become too expensive for many UK companies. Likewise for many Hybrid plans which have DB/DC aspects.*

Thus they switched to Defined Contribution (DC) plans. Which have experienced substantial growth, both in terms of membership and assets under management.

A DC pension claim means that the employee is not entitled to a guaranteed amount of pension at pension age. Instead he is only entitled to annually receive a guaranteed amount of pension premium which he has to invest himself until retirement age.

For the employer, the positive aspects of a DC plan are:

• No very high additional costs due to the low interest rate or increased longevity;
• The costs are very predictable which makes budgetting less difficult.

For the employee, the negative aspects of a DC plan are:

• At retirement age he will have to see how much capital he has for his retirement;
• In case he would like to buy an annuity, at pension age he will have to see see if the market interest rate is high/moderate/low which effects the amount of his annuity.

There are a wide range of DC pension schemes in the UK. They can be organised as:

• Occupational Schemes, typically run by a Board of Trustees;
• Contract Based, usually provided by an Insurance Company;
• They can be sponsored by the employer, where the employer contributes into the scheme or runs the scheme on behalf of a group of employees (such as Group Personal Pensions and Group Stakeholder Pensions);
• Or they can be taken out by individuals as Individual Personal Pensions.

*Defined Benefits Aspects

The funding position of a DB scheme: It is measured as the ratio of the assets held in the scheme compared to the liabilities owed to current and future pensioners for service completed to the date of the valuation. The funding position provides a snapshot of the situation at a given point in time.

In recent years, trustees and sponsors of DB schemes have adopted a wide range of strategies to help mitigate the increased costs and risks associated with DB pension provision:

1) Improving the scheme funding position

By increasing contributions to the scheme or by assigning contingent assets to increase the security of members’ benefits.

2) Changing benefit structures

Changes in the structure of private pension provision have been significant in recent years. Only 16% of DB schemes were still open to new members in 2011, compared to 36% in 2007.

3) Changing investment strategy

DB schemes may change their asset allocation as a way to achieve diversification in their portfolios and reduce some of their investment risk. Schemes may also change their asset allocation to reduce risk by better matching their liabilities. DB schemes have been moving away from equities towards investing in bonds, which better match their liabilities. Another strategy to better match liabilities is to use derivatives-based techniques such as Liability Driven Investment (LDI).

4) Reducing liability risks

Two of the most common strategies to reduce liability risks are the use of incentive exercises such as Enhanced Transfer Values (ETV) and Pension Increase Exchanges (PIE). An ETV allows deferred members to transfer out of the scheme in exchange for a statutory amount plus an enhancement in respect of the pension given up. A PIE involves exchanging some of the member’s right to a pension that increases in line with changes in prices for a higher but non-increasing or fixed-increasing pension.

5) Transferring risks to insurers

Active Membership of Defined Benefit schemes is currently concentrated in a small number of large schemes.

Life Cycle Funds are Investment Mix Funds that automatically reduce the risk as the owner ages. The central approach is the longer the investment horizon, the higher the acceptable risk. The positive aspect of these funds is that thus you have no risk problem if you forget to pay attention to your portfolio.

Life Cycle Funds are not suitable for ‘investors’ who like to prevent any kind of risk. For them there is only the savings account with its current rounded 0% interest rate and 1,4% annual inflation.

Investment Categories

The type of investment categories that can be used in the Life Cycle Funds, depend on the risk profile of the owner. In theory there are 6 investment categories:

1] Derivatives
• Extremely high risk which only aims at change in value and not to buy a certain object itself.
• For example Options/Warrants/Futures.
• Thus only for those with a Very Offensive risk profile and a high level of knowledge.

2] Equity/Stock
• High risk even though the exact amount of risk can be different due to the kind of sector and global location.
• Equity requires in general an investment horizon of at least 7 years.
• For those with a (very) offensive risk profile, a slightly shorter period might be acceptable.

3] Real Estate
• Depending on the type of Real Estate, similar or slightly less risk than Equity.
• Thus requires an investment horizon of in general at least 5-7 year.
• For those with a (very) offensive risk profile, a slightly shorter period might be acceptable.

4] High Yield Bonds
• As these kind of Bonds go for the higher return on investment and risk, they require in general an investment horizon of at least 5 years.
• For those with a (very) offensive risk profile, a shorter period might be acceptable

5] Solid Bonds
• As these kind of Bonds aim for a regular return on investment and risk, they require in general an investment horizon of at least 3 years.
• For those with a (very) offensive risk profile, a shorter period might be acceptable.

6] Savings

• No real investment risk as long as not at a fixed term

Risk Reduction

One of the most relevant aspects of Life Cycle Funds is if they indeed reduce in the most optimal manner risk as age increases.

A standard example is the following fund:

First Phase: 2017-2037 A fixed spread of:
• Equity 90%
• Bonds 10%

Second Phase: 2037-2062 Increasingly a shift towards lower risk and at the end:
• Equity 50%
• Bonds 40%
• Cash 10%

Third Phase: 2062-2069 Increasingly a shift towards lower risk and at the end:
• Equity 30%
• Bonds 50%
• Cash 20%

Difference in Risk Reduction

While comparing Life Cycle Funds risk reduction, we have seen that regarding a neutral risk profile, funds had the following different implementation:

                    Start Risk Reduction                           Equity Age 60                                     Equity Age 65  

Fund A                 Age 50                                                  23%                                                         5%

Fund B                 Age 53                                                  33%                                                       12%

Fund C                 Age 55                                                  50%                                                       35%

Conclusion

The fact that a Life Cycle Fund promises to provide optimal risk reduction fitting to your risk profile, does not automatically result in the best implementation. Sometimes we see funds that according to our client protective stance, keep the risk level too high for too long and too near retirement age.

As of 2018, all employers must provide a workplace pension scheme. This is called ‘automatic enrolment’.

When Auto Enrolment?

Your employer has to automatically enrol you into a workplace pension scheme if:
• You’re classed as a ‘worker’;
• You’re aged between 22 and your State Pension Age;
• You earn at least £ 10,000 per year;
• You ‘ordinarily’ work in the UK.

No Auto Enrolment

Your employer usually does not have to automatically enrol you if any of the following do apply:
• You’ve given notice to your employer that you’re leaving or they’ve given you notice;
• You have evidence of your lifetime allowance protection ( a certificate from HMRC);
• You’ve already taken a pension that meets the automatic enrolment rules and your employer arranged it;
• You get a one-off payment from a workplace pension scheme that’s closed (a ‘winding up lump sum’), and then leave and rejoin the same job within 12 months of receiving the payment;
• More than 12 months before your staging date, you ‘opted out’ of a pension arranged by your employer;
• You’re from another EU member state and are in a EU cross-border pension scheme;
• You’re in a limited liability partnership;
• You’re a director without an employment contract and employ at least one other person in your company.

FInally you can usually still join their workplace pension plan if you would like to. Your employer cannot refuse.

Auto Enrolment In Practice

Your employer must write to you when you’ve been automatically enrolled into their workplace pension scheme.

They must provide the following information:
• The date they have added you to their pension scheme;
• The type of pension scheme and who runs it;
• How much they’ll contribute and how much you’ll have to pay in;
• How to leave the scheme, if you would want to;
• How tax relief applies to you.

Delaying Auto Enrolment Date

Your employer can delay the date they must enrol you into a pension scheme by up to 3 months.

In some cases they may be able to delay longer if they’ve chosen either:
• a ‘Defined Benefit’ pension plan;
• a ‘Hybrid’ pension plan (a mixture of guaranteed Defined Benefit and Defined Contribution pensions) that allows you to take a Defined Benefit pension.

In case of delay, your employer has to:
• Inform you about the delay in writing;
• Let you join in the meantime if you would ask to.

No Option For Your Employer:

• To unfairly dismiss or discriminate against you for being in a workplace pension scheme;
• To encourage or force you to opt out.