LCP Radar Update - Pensions
29 November 2011

Funding Proposals- 16 December is a key date

The Pensions Board has confirmed that funding proposals submitted on or before 16 December 2011 will be assessed under the current regime. Funding proposals submitted after this date will be assessed on a revised basis and the guidelines are due to be published before the end of this year. Enabling legislation is likely to follow in early 2012 as part of the Social Welfare and Pensions Act.

There are two key elements of the proposed amendments that are likely to impact on the required assets to meet the funding standard;

• A requirement to hold an additional risk reserve (likely to add c. 10% to the liabilities of a typical scheme).
• An allowance in the liabilities for the amount and type of bonds or sovereign annuities held (this will reduce the assets required to satisfy the funding standard in some cases)

A key question for trustees of schemes in deficit will be whether to submit a funding proposal before the 16 December deadline or defer and submit under the revised regime in 2012.

Ultimately, the statutory funding standard will not in itself determine the amount of contributions required to meet the benefits under any pension scheme. The cost of the pension scheme will depend on actual experience over the lifetime of the pension scheme (e.g. investment returns achieved, salary increases granted, etc.)

However, as the statutory funding standard determines the minimum level of assets required to cover accrued benefits, it can have a significant impact on the timing of contributions and the cash calls on the sponsoring employer.

If the intention is to avoid significant increases in cash contributions in the short term (e.g. due to sponsor funding difficulties) and the trustees are satisfied that such an approach is in the members' best interests, then this may in some cases be achieved by a submission under the existing regime before the 16 December deadline.

Broadly, schemes that have a relatively low bond holding, and those that do not intend to make a Section 50 application (to amend benefits) should consider submitting a funding proposal before 16 December if the intention is to limit increases to cash contributions. The key benefit is that the requirement to hold risk reserves may be deferred and some certainty has been reached on the agreed contributions.

On the downside, schemes that submit their funding proposal before 16 December 2011 will not be able to avail of any reduction in the funding standard to reflect their sovereign bond holdings. Note however that this allowance should be relatively minor where holdings in bonds are low or where the bonds held are rated AAA. In addition, the pensions board have indicated that any relief on the funding standard from holdings in sovereign bonds would need to be accompanied by a statement of intention from Trustees that "sovereign annuities" would be used in a wind-up, We would urge caution and recommend analysis of the implications before such a statement be made.

For schemes that intend to submit a Section 50 application to reduce member benefits but have yet to formally start the process, there is insufficient time to hold the requisite member consultation period and such schemes may have no option but to submit under the new regime.

Sovereign Annuities/Bonds - A solution or added risk?

The new legislation will allow trustees to take credit for Sovereign Annuities and sovereign bonds when calculating their liabilities under the revised regime. The extent to which this will impact on liabilities is as yet unclear.

The question of whether to invest in sovereign annuities has been discussed at length and in the absence of pricing details, the general consensus is that they may be a useful tool for assisting schemes facing significant difficulties. However, we would recommend that Trustees await further development of this initiative and carry out detailed analysis of the implications before securing any members benefits using sovereign annuities.

For the majority of schemes, sovereign annuities may have limited use and the focus may move to sovereign bonds. Key questions that trustees face include not just the amount of bonds to hold, but also the nature of these bonds (i.e. should they include bonds from core European countries or should they be more diversified). This analysis is of more relevance given the continuing uncertainty in the Eurozone sovereign bond market.

The new standard - time to take a stiff drink?

After 16 December 2011, schemes will be subject to a new, stronger standard that may require additional reserves. It is likely that all schemes will have to meet this more onerous standard by 2022 at the latest. The solvency level, type of funding proposal and timing of the submission of the funding proposal will all impact on the level of additional reserves required.

Following the steps of the UK, the introduction of an enforceable employer guarantee is currently being considered as a method to eliminate/reduce the additional reserves required. Of course, if the employer guarantee is introduced, trustees will be tasked with identifying the probability that the employer can pay in the event that the guarantee is called in. One popular acronym which trustees might use to assess the strength of a covenant is CAMPARI ; Character, Ability, Means, Purpose, Amount, Repayment, Insurance. As this is new territory for companies and trustees, we expect to see further discussion in this area.

New rules likely to encourage investment re-think

In the absence of an enforceable employer guarantee, the risk reserve requirement can be mitigated if schemes move out of volatile assets such as equities and into more matched investments such as bonds. This has long been a hot topic in Ireland with the optimistic Irish pension scheme investing more significantly in equities when compared with other countries. LCP reported in its 2010 Accounting Briefing that the average equity asset allocation for defined benefit pensions schemes operated by the largest ISEQ companies was 59% compared to just 43% for FTSE100 companies during the same period.

While the Pensions Board are strongly encouraging schemes to consider bond investment, the question of what bonds to invest in, particularly given the rapidly rising yields in Italy and the possibility of a downgrade to French bonds in the near term, is of crucial importance. LCP believe that a significant transfer into the wrong type of bonds may only serve to ultimately increase the inherent risks and we are helping clients determine their options on this issue.

If you have any queries please contact Roma Burke at 01 614 4393 or the consultant who normally advises you.