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Guidance on the Calculation of Transfer Values

In May’s edition of Pensions Express, we commented on the amending regulations for transfer values provided by occupational pension schemes that will come into effect from 1 October 2008. In response to these regulations, and to provide guidance to trustees on their new statutory duties and their individual scheme responsibilities, the Pensions Regulator has issued a consultation on guidance for the calculation of transfer values.

The reason the Regulator has issued this guidance is due to the change in person ultimately responsible for determining the assumptions behind the calculation of a transfer value; that is the trustees (on advice from the scheme actuary). As a result of this, with effect from 1 October 2008, the technical guidance (GN11) from the Board for Actuarial Standards will be withdrawn.

The Regulator’s guidance applies to pension sharing requirements as well as the actual transfer of benefits, and covers:

The calculation of cash equivalent transfer values (CETVs) in respect of defined benefits;
The calculation of other transfer values in respect of defined benefits which are not CETVs as defined in legislation; and
The calculation of defined benefits granted in exchange for a transfer-in.

However, it does not cover money purchase transfer values as the calculation of these is relatively straightforward.

The fundamental approach set out in the guidance is that the basic cash equivalent should be at least the best estimate of the cash required to be invested in the scheme to reproduce the relevant member’s benefits.

In calculating the best estimate, the legislation establishes a framework that provides for the ‘initial cash equivalent’ (ICE), which is then adjusted if necessary to arrive at the final transfer value available to the member to transfer. The ICE must place a value on the member’s accrued benefits, together with any added value options and discretionary benefits that the trustees decide should be included.

Trustees should be aware that the best estimate is not a precise concept and they will often be required to make pragmatic decisions based on the information available to them at the time. Alternatively, trustees can use a method where the CETV is higher, but must have consideration to the scheme’s funding level.

When determining the assumptions on which to base the best estimate, trustees must seek advice from the scheme actuary. The guidance highlights issues to be considered.

The Regulator welcomes views on the guidance but has noted the following matters to be of particular interest:

Options

Only benefit options that increase the CETV should be included. An option can be exercised by the member without the consent of the trustees and/or employer. The Regulator has clarified that reduced value options should not be used to offset added value options.

Discretionary benefits

The legislation is silent on whether discretionary benefits should increase the CETV. The Regulator suggests that trustees should have regard to custom and consult the employer, where appropriate, if the employer has the discretion to award a benefit before deciding on the extent to which that discretionary benefit is included for CETV purposes.

Investment strategy

Trustees, having taken the advice of the scheme actuary, must consider the scheme’s funding strategy when determining the investment assumptions underlying a CETV. The Regulator is concerned that without actuarial guidance, trustees may assume an investment policy which does not appropriately reflect how they in fact intend to invest over the term of a deferred member’s lifetime.

Reductions for underfunding

Reductions to the ICE are permitted under legislation where the scheme is underfunded. Trustees may only reduce CETVs for this reason after obtaining an insufficiency report from the scheme actuary.

Trustees should not automatically reduce the CETV just because the law permits it, but before making any decision should consider the strength of the employer’s covenant and the length of any recovery plan.

Quotations in a PPF assessment period

Although transfer values may not be paid during an assessment period, there is no corresponding embargo on issuing statements of entitlement. Unless required under pension sharing legislation, the Regulator suggests that usual practice should be to decline to issue a statement of entitlement providing the member is told why. This will avoid any action by the Regulator.

Disclosure

Although not mandated under the legislation, it would be considered good practice to disclose the transfer basis on request and to tell members what options and discretionary benefits are included in the CETV.

The consultation is limited to a period of six weeks and the closing date for responses is 19 September 2008.

The consultation document can be found at:

www.thepensionsregulator.gov.uk/pdf/CETVGuidanceConsultationDocAug08.pdf

Note: It was hoped that the final guidance would be ready well in advance of 1 October, but this will not now be achieved, and this will hinder some trustees in amending their transfer basis by the effective date of the legislation.

Any statement of entitlement issued on or after 1 October 2008 will need to have been produced in line with the amending transfer regulations. Trustees of defined benefit arrangements should therefore have agreed the basis for the calculation of transfer values prior to this date. Any decisions should be made having considered the Regulator’s guidance and following advice from the scheme actuary and other relevant scheme advisers.

TPR consultation on record keeping

The Pensions Regulator (TPR) has launched a consultation on record keeping. It is aimed at those who are responsible for record keeping, i.e. trustees or pension providers, and those who administer pension schemes (such as third party administrators and insurance companies).

TPR asserts that the maintenance of accurate records is vital to good administrative practice. Records are used and examined by providers, administrators, trustees, actuaries, auditors, employers, and of course members. TPR’s aim for record-keeping is “to ensure that the records of every work-based scheme are such that the benefits due to each member at any point in time and in any circumstances can be calculated accurately”.

The consultation paper outlines the benefits of good record keeping; for example, if benefits are administered correctly, service level agreements can be met and member confidence in the pension scheme can be built and maintained. Holding good data is also a requirement to properly discharge fiduciary and statutory obligations in administering a scheme. Good record keeping will also enable the employer to accurately assess its liabilities in relation to the scheme, which will enable informed decisions to be made on valuations and funding. Member web access to scheme records is increasingly popular, and maintenance of accurate records is a pre-requisite in order to provide this. Web access is therefore seen as a driving force to establish and maintain scheme records.

Further technological advances in pensions administration, such as Straight Through Processing (STP) solutions between administrators and fund managers, aim to reduce manual investment transactions and improve risk control in the transfer of information between different parties. Capita Hartshead was one of five major players in the industry who collaborated on the original ViaNova project, creating a STP interface.

The consultation paper also outlines the negative effects and additional costs that poor record-keeping imposes, the costs of which will ultimately fall on members and the employer. Administration may be more expensive (due to a higher degree of checking and rework) and it is likely that complaints will be received from members, for which compensation may be payable. If an actuary has doubts about data on a scheme, they will make more prudent assumptions in the actuarial valuation to account for this – leading to potentially inaccurate valuations and higher costs for the employer. In addition, the employer will be unable to accurately assess their liabilities in relation to the scheme and their FRS17 liability will be inaccurate. Costs will be higher during buy out or wind up - poor data can add up to 5% to the liabilities of a scheme. The cost of data cleansing on a pension scheme will always arise at some point in time, and therefore deferring record keeping checks is only delaying the inevitable.

TPR highlights a number of key problem areas in the paper, the main one being poor quality legacy data – perhaps as a result of an administration process, a change in administrator, system or method of storage, or scheme rule or legislative changes that have been incorrectly recorded or interpreted. There is a relatively low level of professional skills and qualifications in a sector of considerable complexity. There is also a lack of appreciation of the importance of administration by both sponsors and trustees; figures show that many trustee boards do not monitor administration performance effectively, and is often low down on the agenda at many trustee meetings.

TPR proposes introducing a benchmark ‘core' data set for each scheme member - and that maintaining this core data is the foundation when calculating member benefits - each item must be present. The proposed definition of core data comprises a maximum of 19 data types, depending on the status of the member and the type of scheme. It includes name, sex, date of birth, date joined pension scheme, member status and salary, plus DC scheme transactions where applicable.

TPR also enquires whether it would be good practice for trustees and providers to identify and measure additional data required to administer their particular scheme, and to develop a plan to obtain/improve it. TPR recommends the methodology but the decision as to what additional information is required should be one made by the record keepers, who have first-hand knowledge of the scheme. This could include NI contribution history, salary history, part-time history, DC fund value at A-Day, etc. A timescale for resolution is likely to be recommended. TPR is due to collate information about the additional data which could be used to identify benchmarks for different types of schemes.

TPR is aware of the cost of ascertaining the presence of core and additional information, but maintains that the expense will result in meeting obligations to members and may result in significant cost savings in the future.

TPR’s proposals on record keeping are consistent with its statutory objectives. The proposed approach is to ‘educate and enable’ those responsible for record keeping, and if necessary, ‘enforce’ the requirements under its powers. This involves raising awareness of the importance of record keeping through TPR workshops and visits to providers and administrators, and extending their e-learning programme - the Trustee Toolkit. They will consider widening the trustee knowledge and understanding requirements to include administration as a subject in its own right. There will be no enforcement action against schemes which do not adopt the good practice recommendations, although a review is planned for 2009.

The deadline for responses to the consultation is 15 October 2008. The full consultation document can be found at:

www.thepensionsregulator.gov.uk/pdf/RecordKeepingConDoc.pdf

Note: The consultation emphasises the importance of good record keeping as part of the Regulator’s focus on pension scheme governance. The subject of data quality has the potential to be overlooked by trustees as they focus on higher level issues such as investment, funding and legal decisions.

However, poor data is a huge risk for the trustees in how they discharge their statutory duties. Data cleansing exercises are not just appropriate for those schemes commencing wind up or entering the PPF assessment period, but costs have to be justified for trustees of on-going schemes.

The lack of enforcement and legislation to back up the guidance may be significant factors in how this issue is addressed going forward.

New money laundering guidance gives registration exemption for trustees

HMRC has finally published its updated money laundering guidance. The latest guidance makes it clear that the vast majority of pension scheme trustees will not need to register with HMRC as a Trust or Company Service Provider (TCSP).

By way of background, the original money laundering guidance to complement the new legislation required those trustees who act "by way of business" to register with HMRC. However, there was some confusion as to whether independent trustees, and lay trustees who were remunerated or reimbursed for their expenses, would be required to register. This was covered in previous editions of Pensions Express.

The latest guidance from HMRC classifies occupational pension schemes as low risk trusts and provides an exemption to registration for trustees. It includes an exemption for sole practitioners and firms who only provide professional trustee services limited to a low risk trust, including occupational pension schemes. Such trustees are not considered to be TCSPs and will therefore not be required to register with HMRC.

Our interpretation is that the guidance will cover most occupational pension scheme trustees, including paid trustees and paid directors of trustee companies.

However, if there is any doubt, the new deadline for registration has been extended to 30 September 2008.

To view the updated guidance, visit:

www.hmrc.gov.uk/mlr/mlr9-reg-dates-announced.htm

Note: We welcome HMRC’s latest guidance as a common-sense solution to this issue. It finally puts the minds of occupational pension scheme trustees at rest.

Changes to Maternity Leave rights

The Maternity and Parental Leave etc and the Paternity and Adoption Leave (Amendment) Regulations 2008 came into force on 23 July 2008.

The regulations apply to employees whose expected week of childbirth is on or after 5 October 2008, or employees who adopt a child on or after that date. They remove some of the distinctions between the rights of employees on ordinary maternity leave (OML) and those of employees on additional maternity leave (AML).

For OML and AML, a woman will be entitled to the same terms and conditions of employment, other than terms and conditions relating to remuneration, as would have applied if she had not been absent. The regulations make changes to the entitlement to non-paid rights such as use of a company car, or private medical insurance.

The regulations do not require employers to do anything different in terms of pensions - there is still no requirement for employers to provide for continued pension accrual or for contributions to be maintained during periods of unpaid AML.

Women who return to employment following an AML period may be given the option to repay contributions for the period when they were unpaid, depending on the generosity of the employer and the scheme rules. If they do repay these contributions, the employer would need to make their contributions or to fund this additional accrual.

The Government has made it clear that, despite conflicts between UK employment legislation (which gives women the right to claim discrimination if they do not receive the same level of benefits (other than remuneration) during AML as during OML) and social security legislation, employers are not obliged to go beyond the requirements of the social security legislation and the intention is that there is no change to the treatment of pension provision during unpaid periods of maternity leave.

Note: There is some concern that UK Government approaches are incorrect in how they correspond with EU primary legislation. In the future it is likely that employers will be required to continue their contributions for the whole of the maternity period, whether paid or unpaid, when the Government extends the period during which statutory maternity pay is paid, which is likely to happen over the next couple of years.

Delay in the introduction of the mortality trigger by the Pensions Regulator

When defined benefit pension scheme trustees have had an actuarial valuation completed and send their Recovery Plan to the Pensions Regulator, it is assessed by reference to trigger points. The Regulator’s guidance makes it clear that the triggers are not targets, i.e. the Regulator will not reject a Recovery Plan merely because it triggers, but they will look closely at it to ensure it is reasonable.

Current triggers

The triggers relate to the Technical Provisions and the Recovery Plan. These are as follows:

Technical Provisions

There is one trigger point set at a point between the value of the liabilities in accordance with the employer’s accounting standard (either FRS 17 or IAS 19) and the value placed on the Pension Protection Fund level of compensation benefits for levy purposes (section 179 liability). The precise point in the range will vary between schemes, depending on the maturity of the scheme and the strength of the employer’s covenant

Recovery Plans

A Recovery Plan will trigger further review if:

The period of the Recovery Plan is greater than ten years and/or
The Recovery Plan is excessively back loaded and/or
The investment return assumption over the term of the Recovery Plan appears to be inappropriate.

Announcement of new mortality trigger

As reported in the April edition of Pension Express, the Pensions Regulator announced in February 2008 that it intends to introduce a further trigger point relating to pensioner mortality. This was because work by the Government Actuary’s Department, the Continuous Mortality Investigation of the actuarial profession and data produced by the Office of National Statistics has highlighted a rapid reduction in general mortality/increases in longevity, and the Regulator expects this fact to be taken into account in future Recovery Plans submitted.

In their communication, the Regulator advised that:

Mortality improvement assumptions that appear to be weaker than the long cohort assumption will attract further scrutiny and dialogue with the trustees where appropriate.
Assumptions which allow the rate of mortality improvement to tend towards zero and do not have some form of underpin will also attract further scrutiny - i.e. the trustees should assume that mortality will continue to improve indefinitely.

The Regulator originally advised that the new trigger point would be applied to valuations with effective dates from March 2007 onwards. This new amended approach and guidance was subject to industry-wide consultation which ended in May 2008.

Since pension schemes effectively have fifteen months from the date of the valuation to complete it, if the Regulator’s timescale had stood, then the result would have been that many schemes with valuation dates after March 2007 would have triggered. This is because few schemes in the period since then were using the long cohort projection with an underpin as their pensioner mortality assumption, when determining the Technical Provisions. Most schemes were using the medium cohort mortality improvement projection (which ceases to allow for additional mortality improvement from 2020 onwards), whereas the proposed long cohort projection assumes that these additional mortality improvements will continue until 2040.

Delay in introduction of mortality trigger to 1st September 2008

As a result of the feedback received from the consultation (which is almost certain to show that many schemes currently finishing their valuation will trigger), the Regulator has decided to eliminate the element of backdating. In an announcement in July 2008, the Regulator advised that the new mortality trigger is to be applied to actuarial valuations whose effective date is on or after 1 September 2008.

The effect of the change in the mortality basis will be to significantly increase a pension scheme’s Technical Provisions, assuming the trustees decide to introduce what is effectively the Regulator’s suggested basis, as most schemes will currently be using a weaker basis.

Effect on Technical Provisions of new mortality assumptions

The change in the mortality improvement assumption from the medium cohort to the long cohort assumption with an underpin, will have the effect of significantly increasing the Technical Provisions. The precise effect will vary from scheme to scheme as this will depend on the average ages of the active, deferred and pensioner members, as well as the relative weighing of these categories in the overall liability. However, an indication of the effect can be obtained from the table below.

Category of member	Increase in technical provisions
Pensioners	3% – 5%
Deferred pensioners and active members	5% – 10%

The table indicates the percentage increase in the liability for pensioners, deferred pensioners and active members on changing the pensioner improvement assumption rate from the medium cohort with no underpin to the long cohort with a 1% per annum underpin.

Note: It is emphasised that the above table is indicative only. If you wish to know the precise effect for your own particular scheme you should contact your Consultant or Scheme Actuary.