CorporateBulletin
Quarterly update January 2016
In brief
}} We give an update
on accounting
assumptions as at
31 December 2015
}} In particular we consider
the potential benefits
of updating mortality
assumptions annually
}} Investment returns
over the year may
have been limited,
but an increase in
corporate bond
yields means that
accounting deficits
may have improved
}} With the release of
recent guidance on
employer covenant and
risk management, it is
critical for sponsoring
employers to engage
with their pension
scheme trustees
to align long-term
objectives and achieve
positive outcomes for
the valuation process
Hot topics for companies
in January 2016
An increase in the level of corporate bond yields is
positive news for pension scheme accounting deficits
and company balance sheets. We take a look at
market conditions and accounting assumptions at the
31 December 2015 year end in more detail.
We also update sponsoring employers on a variety of
topical issues including taxation and contracting-out
changes from April 2016.
Accounting disclosures Quarter 4 2015
Discount rate
Relative to this time last year, the yields across all terms at 31 December 2015
have increased by around 0.3% pa.
Bond yields
}} We also provide an
update on PPF levies
and an overview of the
trends in the buy-out
and de-risking market
this last quarter
Source: Bank of England and Merrill Lynch Bank of America
Visit www.puntersouthall.com for all the latest pensions news, information and events
Corporate Bulletin
January 2016
Less mature schemes will be able to adopt a discount
rate at the higher end of the range as a result of putting
a heavier weighting on the upper end of the yield curve
based on scheme cashflows extending longer into the
future. This results in a range of discount rates being
adopted by companies at the year end.
31 December 2014 were mainly in the range 3.0% to
3.2% pa). We expect that use of a downward adjustment to
the market-implied RPI will still be prevalent but continue
to vary significantly between companies.
Discount rates adopted by the majority of the FTSE 350
companies reporting at 31 December 2014 were in the range
of 3.5% to 3.7% pa. This year, we are expecting an increase in
the discount rates adopted relative to last year, to an average
rate of around 3.9% pa as shown in the graph below.
In recent periods, the median gap between RPI and CPI has
been around 1% pa, with companies tending to adopt a gap
centred around this figure. The OBR report released in March
2015 lowered its long-term estimate to a range of 0.9%1.1% pa. Although 1% pa may remain a commonly adopted
assumption, we expect the number of companies adopting a
difference greater than this to reduce this year.
Discount rates
Asset returns and scheme deficits
Investment returns over the year to 31 December 2015
have been unimpressive with many asset classes having
returned close to zero.
As corporate bond yields have increased over the year,
balance sheet positions may have improved.
The corresponding increase in gilt yields has been slightly
lower so the spread between the yield on government
and corporate bonds has increased slightly over the year.
Any improvement seen in the accounting position may
therefore not translate into an improvement in other
measures such as scheme funding.
In the above graph showing assumptions adopted by FTSE 350 companies, the box shows
the interquartile range (the middle 50%) and the whisker shows the full range.
Price inflation
The Bank of England implied RPI curve is steeper as at
31 December 2015 than last year. This means that, for
most schemes, it is likely that the RPI assumption may
increase slightly over the year whilst the opposite might
be true for very mature schemes.
Inflation (RPI)
Life expectancy
Gilt-implied inflation
(31/12/15)
Gilt-implied inflation
(31/12/14)
Source: Bank of England
In practice, the RPI inflation assumptions adopted by
companies sit slightly below the implied level (those
adopted by FTSE 350 companies reporting as at
Quarterly update
... the spread between the
yield on government and
corporate bonds has increased
slightly over the year.
Historically, many companies only considered the
mortality assumption in any detail every three years
following the completion of the triennial actuarial
valuation. Regular research by the CMI now means
that it is reasonable (and straightforward) to update
this assumption annually to allow for the latest known
improvements in the CMI model.
Long-term improvement projections are updated
annually by the CMI using population data from
England and Wales since 1975. Company accounting
assumptions, if agreed triennially, can sometimes lag a
couple of years behind the CMI model, waiting for the
next funding valuation to be agreed.
The CMI_2015 model is the latest model available. An
unusually high number of deaths was observed in early
2015 (predominantly due to the flu virus). The model
Corporate Bulletin
... updating to the latest
CMI model is consistent,
justifiable and will likely
reduce pension liabilities in
the accounts.
takes account of the 2015 data, which, together with
relatively high death rates in 2012 and 2013, means that
the predicted improvements in mortality rates using this
model are lower than would have been estimated using
earlier versions of the model (mortality rates are still
continuing to improve, just more slowly). Who knows
whether this trend will continue?
When CMI_2015 is used to value pension scheme
liabilities, it will give lower results than when using
previous versions of the model (all else being equal).
There is a strong case to be made that updating to the
latest CMI model is consistent, justifiable and will likely
reduce pension liabilities in the accounts.
Setting the discount rate assumption
under US accounting standard SFAS87
In recent months the Security and Exchange
Commission (SEC) and the big four auditors
have been discussing a change in the method
for measuring the components of the net
periodic pension cost (the interest cost and
the service cost). In particular there appears to
be some merit in adopting a different discount
rate assumption for these components than is
adopted for measuring the benefit obligation at
the year end.
These discussions have concluded that, rather
than using the single equivalent rate (appropriate
to the term of the liabilities as a whole),
companies could look at how a discount rate
might be derived from spot rates specifically
for the purpose of measuring interest cost and
service cost components. A change would affect
the calculation of the net periodic pension cost
for future financial statements.
This is likely to be an area that auditors will want to
discuss in particular with companies this year. We
recommend that directors consider the alternatives
in more detail when agreeing the discount rate for
SFAS87 purposes.
Quarterly update
January 2016
Buy-out and
de-risking market
After a modest first quarter, the final three
quarters of 2015 saw a number of sizeable
transactions, which led to total deals in the
buy-in and buy-out market of approximately
£10 billion for the year. Whilst transactions were
down relative to deals made in 2014 (£13 billion),
consultants are optimistic of a strong bulk
annuity market in 2016.
The increase in transactions towards the end
of 2015 may have been influenced by the
Solvency II transitional arrangements that
allowed exemptions from the rules coming into
force on 1 January 2016. Whilst the full impact
of Solvency II will become clearer as we move
through 2016, it is expected that the impact on
pensioner premiums will be minimal but costs
could increase slightly for deferred annuities.
The following are the headlining buy-in and buy-out
cases for quarter 4 2015:
• Philips UK Pension Fund completed a £2.4 billion
buy-in with Pension Insurance Corporation;
• Scottish Widows completed their first bulk
annuity deal with a £400 million buy-in with The
Wiggins Teape Pension Scheme; and
• In December, Inchcape plc secured a £300 million
buyout for the TKM Group scheme with Aviva.
The medically-underwritten buy-in market has
been growing significantly since its introduction
in 2013, with approximately £2 billion of
liabilities now insured. Three notable medically
underwritten buy-ins over quarter 4 include:
• A £230 million deal between Legal and General and
an unnamed scheme, completed in late December;
• The Institute of Engineering and Technology
Superannuation and Assurance Scheme which
insured £32 million of its £150 million liabilities; and
• The Institute of Chartered Accountants Staff
Pensions Fund which insured £30 million of
liabilities with Partnership.
The final quarter of 2015 also saw another
significant longevity swap in the £600 million
deal between the RAC (2003) Pension Scheme
and reinsurer SCOR SE.
Corporate Bulletin
January 2016
Pension Protection Fund Levy – confirmed
details for the 2016/17 levy year
On 17 December 2015, the PPF published its final
determination confirming the details of how levies
will be calculated for the 2016/17 levy year. The PPF
has confirmed the levy scaling factors and calculation
parameters will remain unchanged from those used for
2015/16 and the total levy estimate is £615m.
Changes include some minor procedural changes
designed to simplify the recertification of voluntary
mortgage certificates. Certificates relating to investment
grade credit ratings, pension scheme mortgages
and rental deposit deeds will be carried forward and
count for future Experian scores, without the need for
recertification. Immaterial mortgages will still need to
be recertified each year and charges over bank accounts
have been added to the charges that can be certified as
immaterial. The scores for non-corporate entities could
improve if evidence can be provided confirming that
they are prohibited from borrowing.
Interim accounts may now be submitted for new
companies. The majority of deadlines for submitting
information to the PPF are 31 March 2016.
The PPF has reconfirmed its plans for re-invoicing
multi-employer schemes that have previously
incorrectly identified themselves as last-man-standing
schemes and has indicated that it will be in touch with
affected schemes.
The PPF is carrying out analysis to see whether
changes will be necessary for the 2017/18 levy to
reflect the introduction of FRS102, which could have
a significant impact on Experian scores and the levies
payable relating to multi-employer schemes.
Reclaiming VAT on scheme expenses
In October, HMRC published their long-awaited Brief on
the deduction of VAT on pension fund management costs,
announcing a 12-month extension to the transitional
period up to 31 December 2016. This means that, for this
year, sponsoring employers (with the trustees’ agreement)
may continue to use the 70:30 split for recovering VAT on
pension-related services to DB schemes.
The Brief also addresses a number of other points,
including concerns about whether employers are able
to deduct payments under tripartite agreements for
corporation tax purposes. HMRC now plan to publish
further guidance on alternative tripartite agreements that
could enable a corporation tax deduction.
Scheme changes
The National Trust will close its defined benefit (DB)
pension scheme to future accrual on 31 March 2016.
The changes will affect around 1,200 members of staff
(approximately 16% of the Trust’s permanent workforce)
and are as a result of the £116m deficit reported in the
April 2014 valuation. On closure, scheme members will be
eligible to join the existing DC scheme.
United Utilities are also planning to close their DB scheme
to future accrual from 31 March 2016. The company is
currently conducting a 60-day consultation process, but the
plan is for all existing DB scheme members to be offered
membership of a DC scheme for service from 1 April 2016.
In contrast, employees joining energy giant EDF Energy
will have access to a new DB Career Average Revalued
Earnings (CARE) scheme with a 1/60th accrual rate.
Quarterly update
A 1% pensionable salary cap will be introduced on basic
pay above £65,000. As part of the negotiated agreement,
there will be no further changes to EDF pensions for at
least the next five years. It is suggested that the deal will
save EDF around £270m from the current deficit and
around £20m each year in ongoing funding costs.
Heathrow, the busiest airport in the UK, implemented a
number of changes to the BAA pension scheme for active
members with effect from 1 October 2015. These included
a change to the annual benefit accrual rate from 1/54th
to 1/60th of pensionable pay, and the introduction of an
annual cap of 2% on future increases to pensionable pay
and a 2.5% cap on annual increases to pension payments
in retirement. The overall impact was to reduce funding
liabilities by £236m.
Corporate Bulletin
January 2016
Employer covenant assessments
The covenant assessment sets the tone for the valuation
process – so it is important for sponsoring employers to
engage with the covenant assessment from the outset.
In August 2015, the Pensions Regulator published new
guidance entitled “Assessing and monitoring the employer
covenant”. The aim of the new guidance is to provide
“good practice guidance” to trustees, but what is the
impact on sponsoring employers?
The guidance is pragmatic: steering trustees towards
the relevant areas of analysis and explaining how
proportionality can be applied. Covenant reviews may
now become more tailored and focused. Employers may
wish to be involved in agreeing the scope of covenant
reviews to ensure that the time and costs involved are
not excessive.
The guidance should make more trustees comfortable
with how they are assessing the covenant, particularly
those undertaking the analysis themselves. Employers
should understand the objectives of their assessment and
be forthcoming with relevant information. There is a key
message for trustees to consider the employer’s sustainable
growth plans and so there is real value to the employer
engaging with trustees up front about their business aims.
Without the employer outlining how cash will be invested
and utilised for business growth, trustees will inevitably ask
for available cash for funding the deficit.
Internal investment, safety buffers and dividends are all
valid options for employers as well as paying cash towards
the deficit. There are also non-cash alternatives such as
providing the pension scheme with alternative security and
so reducing the cash requirement to the scheme. Employers
may need assistance to get the right balance between the
various uses for their cash and help frame the relevant
arguments to the trustees.
We run a series of seminars aimed at helping sponsors
understand the valuation framework and obtaining desirable
outcomes in terms of covenant assessment, funding
objectives, valuation assumptions and contributions.
Getting ready for your next
pension valuation:
Masterclass
To book, please contact us:
0845 815 9879
[email protected]
www.puntersouthall.com/events
Thursday, 03 March 2016 | Central London
Risk assessment
The Pensions Regulator published its guidance on
“Integrated risk management” on 8 December 2015 to
help trustees and employers implement a proportionate
and integrated approach to risk management.
Before launching into potentially expensive risk modelling,
projections and testing that are not focused on the
scheme’s specific risks, it is vital for trustees and employers
to take a step back and look at the sponsor covenant,
funding and investment strategies in a holistic manner.
“…it is best to start with the employer covenant
assessment including appraisal of the reliable level of
cash flow generation by the employer to determine the
extent to which it can underwrite the risks to which the
scheme is exposed.”
The Pensions Regulator
The sponsor covenant really does drive the process
and helps determine the areas of risk that need to be
Quarterly update
considered in greater detail (and the proportionality that
can be applied elsewhere).
For sponsors currently thinking that this is just another
tick box exercise for the scheme, we urge you to think
again: engagement between sponsor and trustees can
have real value. A set of trustees which has a better
understanding of risks and an open dialogue with the
employer can ultimately mean a long-term investment
and funding strategy that better (more quickly and
efficiently) delivers in line with your objectives.
In our experience, early engagement from employers has
meant more focus on the “right level of risk” over the
medium and longer term as opposed to the herd-like
push for asset de-risking taken by some trustees. Where
appropriate, input from the employer on how the covenant
is expected to develop relative to the scheme over the
medium and longer term can add real value to this process.
Corporate Bulletin
January 2016
State pensions – the end of contracting out
April 2016 signifies the end of contracting out. Affected
employers should have budgeted for the increase in their
NI contributions. Employers should make sure that the
increase in NI contributions faced by employees who are
currently contracted out is properly communicated.
changes are likely to be effective after April 2016,
with higher costs absorbed in the interim. If you have
a valuation process being undertaken in 2015/2016
then this is an ideal time to request costings of benefit
changes. We can help with this.
It is possible to increase member contributions or reduce
benefit accrual to offset the increased cost to the
employer, or indeed go even further to reduce costs. The
usual 60 day consultation with members is needed, so
unless an employer has already set the wheels in motion,
One further consideration for employers will be how to
certify ongoing DB schemes for the purpose of meeting
their employer duties for auto enrolment. This will no
longer be as simple as rubber stamping a contracted-out
scheme and actuarial certification may need to be sought.
Implications of the Budget Pensions Changes: Breakfast Seminar
Thursday, 04 February 2016 | Central London
To book, please contact us:
0845 815 9879
Wednesday, 10 February 2016 | Birmingham
[email protected]
www.puntersouthall.com/events
Coping with tax changes
The latest round of complex pension tax changes impact
from April 2016. High-earning employees are again most
likely to be affected by the reduction in Lifetime Allowance
and tapering of the Annual Allowance.
We will be on hand to support employers in this area. In
particular, we are running a series of seminars which have
been very well received by employers to date: “Implications
of Budget Changes.”
Aside from your highest-earning individuals, the
change in Pension Input Periods to align these with the
tax year may be tricky in terms of communications
and processes.
The Chancellor has deferred any announcement on major
changes to pensions taxation until the 2016 Budget;
however, it is clear that the Treasury continues to be
interested in the idea of significant reforms.
Find out more
For further information please speak to Helen Ross or Chris Parlour:
Helen Ross
Chris Parlour
0121 230 1900
020 3327 5293
[email protected]
[email protected]
Alternatively, please speak to your usual
Punter Southall contact.
company/punter-southall
@puntersouthall
For further information, visit our website at www.puntersouthall.com
© Punter Southall 2016. Punter Southall is a trading name of Punter Southall Limited. Registered in England and Wales No. 04807951. Registered office: 11 Strand, London WC2N 5HR.
Punter Southall Limited is registered in England and Wales No. 03842603.
This communication is based on our understanding of the position as at the date shown. It should not be relied upon for detailed advice or taken as an authoritative statement of the law.
If you would like any scheme specific advice, please speak to your usual Punter Southall contact or email [email protected].
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