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What are the risks
associated with a DB
pension scheme?

Demographic assumptions:

DB benefits are
guaranteed, and
might still be in
payment 50 years
from now.
If there is any risk
that the future does
not turn out to hold
what we thought,
that risk falls on the
employer.


Life expectancy determines how
long a pension will be paid.
Financial assumptions:

Inflation determines the cost of
increasing benefits which are
inflation-linked.

Salary inflation determines the
cost of final salary benefits.
Investment returns ...
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Investment returns:
the discount rate
To value a pension
scheme’s liabilities,
the cost of paying
future instalments of
pension to a present
value must be
assessed.
If I have to pay you
£100 in 10 years
time, how much do I
need to hold now?



The discount rate is
determined by taking a view
on the investment return that
the scheme’s assets will
achieve.
Investing cautiously
minimises the risk of volatile
returns, at the cost of
achieving better returns.
The Northern Bank scheme is
very cautiously invested.
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The Bank’s
accounting issues

The Bank has to present
its accounts on the basis
of an international
accounting standard.
It seems to be committed
to delivering a return on
equity of 12.5%.
It has to meet capital
adequacy requirements
which are also driven by
the accounting basis.


The accounting standard
discount rate is determined by
“investment grade” corporate
bonds – linked to gilt yields
which are at an all-time low.
The Bank’s presentations of the
scheme’s surplus/deficit have
been measured by reference to
the accounting standard.
What is actually driving the
Bank’s proposal?
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Reducing or
eliminating risk

Risk does not go
away.
It’s a question of
who bears it.

In the world of DC, all of the
risk is borne by members:

Investment returns: what is your
individual “pot” invested in?

When you retire – how long will
you live for?

What will inflation do during
your retirement?
If you don’t purchase an
annuity you are effectively selfinsuring.
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Is there another
option?

The Bank’s position is
not unique.
Other organisations,
including banks, are
retaining open DB
schemes.
The Bank has not
made a convincing
case that its only
choice is closure.

We have asked for detailed
information regarding the
scheme’s investment strategy,
funding position and
actuarial and investment
advice.
Once we have that we will
present alternatives to closing
the scheme.
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Naimh’s
illustration
Naimh will be
45 by 30
September
2018
She will have
completed 25
years’
pensionable
service
Her current
salary is
£22,500 p.a.
Scheme continues
DC for the future –
Naimh takes cash
DC for the future –
Naimh buys an
annuity
DB pension
12,600
6,800
6,800
DC pension
0
0
4,300
Total pension
12,600
6,800
11,100
DB cash
83,900
45,100
45,100
DC cash – tax
free
0
32,200
32,200
DC cash taxed
0
96,600
0
83,900
173,900
77,300
Total cash
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Clarification
required
“No change” scenario:
It would be helpful to show DB
pension before and after 1 October
2018 separately.
DB pension for service after that
date will be bigger if the scheme is
not closed because it increases in
line with the RPI (CARE benefits)
or salary – not CPI.
DB cash is provided by converting
(“commuting”) pension into cash.
The illustration uses a
commutation factor of £20 for each
£1 of pension surrendered, but
commutation factors are agerelated. What are the actual factors
used?
Scheme continues
DC for the future –
Naimh buys an
annuity
Pension from
past service
DB
7,800
DB
Pension from
future service
DB
6,700
6,800
?
Total pension
14,500
Cash from
past service
52,000
45,500
Cash from
future service
44,000
?
Total cash
96,000
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Scheme
continues
Clarification
required
New scenario, and Naimh buys an
annuity:
The illustrated annuity does not
increase, and there is no attached
partner’s pension.
DC for the
future –
Naimh takes
cash
DC for the
future –
Naimh buys
an annuity
DB
6,800
DB
6,800
DC
3,000
Pension from
past service
DB
7,800
Pension from
future service
DB
6,700
0
14,500
6,800
Total pension
9,800
For clarity, the illustrative DC
annuity should include both.
Cash from past
service
DB
52,000
45,100
DB
45,100
New scenario, and Naimh takes her
DC benefits as cash:
Cash from
future service –
tax-free
DB
44,000
32,200
DC
32,200
The illustration points out that
some of the cash will be taxed but
the effect of taxation is not spelled
out. Is Naimh a basic rate
taxpayer?
Cash from
future service –
taxed
0
96,600
0
96,000
173,900
77,300
Total cash
Is a 6% investment return realistic?
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A health warning

These figures have
not been precisely
calculated. They are
intended to give an
early warning.
Once we have all of
the information we
need, our actuaries
will provide more
accurate illustrations



The illustration assumes that salary and RPI
increases are 1% higher than CPI increases.
The DC annuity is approximate and uses
current annuity rates.
But the illustration makes the loss of value of
DB pension visible, if the scheme closes.
It also makes the poor comparison of a DC
annuity with an unchanged DB pension for
future service visible.
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Is consent
required?
The proposals will require
an alteration to the rules.
The Trustee’s consent is
required. We need to see
the legal, actuarial, and
investment basis on
which it proposes to make
any decision.
Benefits from past service
cannot be reduced, but
the link to RPI increases
(CARE benefits) and final
salary can be terminated.


Generally contracts of employment will
not prevent proposals such as these going
ahead.
The members’ guide to the scheme:

“Nothing in this booklet may be taken to
override the provisions of the trust deed and
rules.”

“The Bank intends to continue the Scheme
indefinitely, but has the right to modify its
terms, with the consent of the Trustee, or to
terminate it.”
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Consultation
The Bank is under a legal
obligation to consult you and the
Union.
Information must be given
“in such fashion and with such
content as are appropriate to enable,
in particular, representatives
of affected members to consider,
conduct a study of, and give their
views to the employer on, the impact
of the change on such members.”
The Trustee must makes its
decision after considering what
is in the best interests of scheme
members. It is important that
they fully understand your point
of view.
“In any context, the essence of consultation is the
communication of a genuine invitation to give
advice and a genuine consideration of that advice.
In my view to achieve consultation sufficient
information must be supplied by the consulting to
the consulted party to enable it to tender helpful
advice.”
(R v Secretary of State for Social Services, ex parte
Association of Metropolitan Authorities [1986] )
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Ivan Walker
Walkers Solicitors
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