Occupational Pensioner s Alliance Louise Inward Key areas

Occupational Pensioner's Alliance Louise Inward

Key areas 1. Awareness of risks 2. Potential solutions 3. Costs vs risks Copyright © 2010 Pension Corporation. All rights reserved. 2

1. Awareness of risks 3

Perception of pension risks Investment returns Longevity Copyright © 2010 Pension Corporation. All rights reserved. 4

Under-appreciation of risks Individuals Base Mortality Concentration Scheme Improvements Longevity Risks Transferred Early/late retirement Selection effects Proportions Married GMP Equalisation Copyright © 2010 Pension Corporation. All rights reserved. Retirement ages Legislative Changes Funding Levels Concentration Risk Investment and ALM Overheads Solvency Levels Regulation Administration Expenses Operational Risks Valuation Errors Bad Data Commutation Factors Systems/Controls 5 Investment Risks Investment and ALM Sponsor Covenant Demographics and member options Other dependants Inflation Global Accuracy of data Socio-economic profile National Macro Investment Rates

Do you know your threats? EST TER IN TES RA SPONS OR CO VENAN INFLATION ONGEVITY L MARRIED PROPOR TION Copyright © 2010 Pension Corporation. All rights reserved. 6 T

Interest rates & volatility A scheme has liabilities of £ 1 bn when the markets closed on election night. What were they at 11 am the next morning? A: Down by £ 20 m B: Up by £ 40 m C: Remained unchanged Copyright © 2010 Pension Corporation. All rights reserved. 7

Interest rates – “The day after” 1% change in long-term interest rates increases liabilities by 15 -25% Copyright © 2010 Pension Corporation. All rights reserved. 8

Interest rates – long term interest rates since 1900 Based on yields on 2. 5% Consols since 1900 Source DMO / Investors Chronicle Need to manage assets / liability position through volatile periods Copyright © 2010 Pension Corporation. All rights reserved. 9

Sponsor covenant According to the market, which is most likely to default on its debt obligations over the next five years A: Spain B: IBM C: BP Copyright © 2010 Pension Corporation. All rights reserved. 10

Sponsor covenant Starting Rating Investment Grade 44. 43% AA 52. 53% A 59. 74% BBB 66. 50% BB 77. 68% 87. 22% CCC High rated companies AAA B G 7 Government Probability of Default within 100 years 93. 29% Pension Corporation estimates based on S&P data 1970 -2000 Copyright © 2010 Pension Corporation. All rights reserved. 11

Inflation An average car costs about £ 8, 000 now. How much did it cost in 1914? A: £ 330 B: £ 152 C: £ 968 Copyright © 2010 Pension Corporation. All rights reserved. 12

Inflation £ 330 ¢ 1% change in long-term £ 4250 inflation rates increases liabilities by 15 -25% 50 year span £ 8000 ¢Are you protected against deflation? £ 152 Source : Bo. E report Feb 2009 – CPI inflation charts Copyright © 2010 Pension Corporation. All rights reserved. 13

Longevity To what did the longest-lived British man, Henry Allingham, credit his longevity? A: Cod liver oil B: A glass of burgundy every day C: Cigarettes, whisky and wild women Copyright © 2010 Pension Corporation. All rights reserved. 14

Longevity Henry Allingham, who died in July 2009, was the last surviving founder-member of the RAF Copyright © 2010 Pension Corporation. All rights reserved. 15

Marital statistics The American Civil War ended 145 years ago in 1865. When did the Civil War veterans’ pension scheme pay the last pension? A: 1907 B: 1965 C: 2004 Copyright © 2010 Pension Corporation. All rights reserved. 16

Marital statistics ¢ Difference between spouse and no spouse – 20% ¢ Much younger spouse – up to 40%! Alberta Martin, the last surviving widow of a US Civil War veteran who died nearly 140 years after the conflict ended Copyright © 2010 Pension Corporation. All rights reserved. 17

2. Potential Insurance Solutions 18

The pension insurance market has developed rapidly Pension insurance transactions completed - market Transaction volumes in the pension insurance market Longevity insurance Buyout / buy-in Total of £ 16. 5 billion of buy-ins and buyouts written between 2007 and Q 2 2010 Copyright © 2010 Pension Corporation. All rights reserved. 19

What is a buy-in? Insurance Policy Premium Pension Plan Benefit payments Member Copyright © 2010 Pension Corporation. All rights reserved. 20

What is a buyout? Individual Insurance Policy Buy-in policy converted to individual policy Pension Plan Assets Usually preceded by the purchase of a buy-in insurance policy Member Copyright © 2010 Pension Corporation. All rights reserved. 21 Liabilities Insured

3. Costs vs Risks 22

Costs Vs risks Solution type Typical Costs Full Buyout 110 – 150% of Technical Provisions All Pensioner Buy-in 100 – 110% of Technical Provisions Higher price Lower price High pension amounts Low pension amounts Uncapped pension increases Limited pension increases Unrealistic mortality assumptions Realistic mortality assumptions Younger ages Copyright © 2010 Pension Corporation. All rights reserved. Older ages 23

CPI v RPI 24

What’s happening? ¢Government have announced they propose to use CPI rather than RPI to revalue pensions ¢CPI has been on average 0. 5% lower ¢Why? ►They are changing public sector schemes to CPI ►More appropriate measure ►Believe that they must be consistent ¢All about the money!! Copyright © 2010 Pension Corporation. All rights reserved. 25

RPI vs CPI Year-on-Year since 1989 ¢ 12. 0% ¢ 10. 0% ¢ 8. 0% ¢ 6. 0% ¢ 4. 0% ¢ 2. 0% ¢ 0. 0% ¢ Yo. Y % increase RPI 2. 0% -4. 0% ¢ 09 09 20 08 09 09 20 07 ¢ ¢ 20 06 09 09 ¢ 20 05 09 20 04 ¢ ¢ 20 03 09 09 ¢ 20 02 09 ¢ 20 01 09 ¢ 26 20 00 09 ¢ 20 99 09 ¢ 19 98 09 ¢ 19 97 09 ¢ 19 96 09 ¢ Copyright © 2010 Pension Corporation. All rights reserved. 19 95 09 ¢ 19 94 09 ¢ 19 93 09 ¢ 19 92 09 19 91 ¢ 90 ¢ 19 89 19 ¢ ¢ 09 ¢ ¢ Yo. Y % increase CPI 19 - 09 ¢

Why the difference? ¢ the “formula effect” – the RPI combines the individual prices together using the arithmetic mean, whereas the CPI uses the geometric mean; This has added between +0. 4 and +0. 8%, although it has been fairly stable around the mean of +0. 5% ¢ mortgage interest payments, included in the RPI but not in the CPI; ►This has contributed between +1. 1% and -2. 9% to the differences, Average 0% ¢ other housing components, such as house prices as a measure of housing depreciation, and council taxes; This has contributed between +1. 2% and -1% to the differences. The average since 1997 has been +0. 4% ¢ other factors, such as weights, the inclusion or exclusion of other components, different price indicators for some components, and a different population base. average around zero. “The GM formula implicitly assumes that consumers will switch purchases of particular brands or varieties of products to cheaper alternatives when relative prices change. By contrast, the use of arithmetic means in the RPI is consistent with no substitution between products within an elementary aggregate. For this reason, in practice GM always shows a lower price rise than AR for given price data. " Copyright © 2010 Pension Corporation. All rights reserved. 27

But. . . “ In a letter to the Bank of England Governor today, Osborne said: 'As we have discussed, over the longer term I would welcome your views on how we might accelerate the process of including housing costs in the CPI inflation target. ' ¢ 18 May 2010 http: //www. thisismoney. co. uk/news/article. html? in_article_id=504743& in_page_id=2 Copyright © 2010 Pension Corporation. All rights reserved. 28

Will it effect me? ¢Probably if you are a pensioner ¢Definitely if you are a deferred or active member ¢Most likely change is that going forward, pensions will be revalued on a CPI basis ►Past revaluations will remain as they were ¢But for deferred members revaluation does not take place until the year before NRA – so if that is after 2011 it is likely to be CPI ¢Not clear – scheme rules often have RPI “hard-coded” for pensioners ¢Legislation could override this or allow Trustees to change ¢Trustees may find it difficult to agree to changes Copyright © 2010 Pension Corporation. All rights reserved. 29

Some Numbers using CPI ¢If you left the scheme at 50 in 1989 with a pension of £ 1000 ¢Have 10 years of deferment increases till 60 ¢And then 10 years of payment increases till 70 Copyright © 2010 Pension Corporation. All rights reserved. 30

You would be worse off in most circumstances Copyright © 2010 Pension Corporation. All rights reserved. 31

Retrospective? ¢ Accrued benefits cannot be detrimentally affected – s 67 of the Pensions Act 1995 ¢ How is this possible then? ¢ Government logic seems to be ►The right to receive indexation on accrued revaluing benefits is not changed ►Historical ►Only revaluation orders are also not changed future revlautions that will be linked to CPI. ►The change is not retrospective as it is plainly contemplated by the Pension Schemes Act 1993. ►Crucially, indexation for an indexed benefit is not actually accrued until the revaluation percentage is determined and applied according to the order made at the time. ¢ Is this a good argument? ? ? ? Copyright © 2010 Pension Corporation. All rights reserved. 32

Questions? 33

Contact Louise Inward, Pension Corporation – inward@pensioncorporation. com Louise was previously at Pricewaterhouse. Coopers Legal as Head of Pensions. An expert in pension regulation, including the clearance and scheme funding regimes, Louise was heavily involved in the development of the Pensions Act 2004 and in particular the moral hazard and clearance provisions. She then established and led the Corporate Risk Management Team at the Pensions Regulator. Views expressed are authors own!! This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, Pension Corporation, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 'Pension Corporation' refers to the Pension Corporation LLP, Pension Insurance Corporation Limited and their affiliated entities Copyright © 2010 Pension Corporation. All rights reserved. 34