Under the heading of public interest, what do pension scheme actuaries think of the statutory funding disclosure requirements for defined benefit (DB) schemes? We think they could do better
Under the heading of 'public interest', what do pension scheme actuaries think of the statutory funding disclosure requirements for defined benefit (DB) schemes? We think they could do better.
In the annual Summary Funding Statement, members firstly have to be told about the ongoing funding position and any recovery plan in place. It is right for the disclosure to highlight the employer's commitment to contribute so that the scheme can meet its obligations. But we also need to say what happens if the scheme is actually wound up.
Disclosure should answer the question uppermost in a member's mind: "What will happen to me, personally. To my benefits?". Remember the conclusion of the sessional paper of Cowling et al (2011): for disclosing funding information to members, we should focus on the (current and expected future) solvency position, which should use a "matching framework". For example, this may involve a discount rate based on gilts or swaps or could use the wind-up basis as being similar to matching.
The statutory wind-up/solvency disclosure normally takes the form: "In the event of the scheme having to be wound up, as at the valuation date it is estimated that the assets would provide X% of the benefits accrued to date" - the range of coverage is typically between 50% and 80%. Any member, particularly a current pensioner, reading such a statement is entitled to be worried: "What? I could lose 20%-50% of my pension?"
But this statutory disclosure pre-dates a number of major developments: principally, the Pensions Act 1995 now overrides scheme-specific wind-up rules, and the Pension Protection Fund (PPF) usually underpins DB benefits. So, we appeal to scheme actuaries to give their trustee or sponsor clients some more useful information to pass on to members. It is the actuary after all who writes the annual funding statements.
How this should best be done depends on whether or not the scheme is fully funded on a PPF basis. If it is not, then the disclosure statements can be accompanied by a reminder to members of their entitlements under the PPF - not individual calculations, just a summary to the effect that: "Pensions in payment (if you're over age 65) would not be reduced, while for all members below that age (pensioners, deferreds and actives) benefits would be reduced to 90% and there would be a maximum pension of about £26,000; revaluation would still apply up to state pension age and only the pension earned after April 1997 would be increased; your spouse would receive 50% of your pension on death." (Yes, we know that's a simple version - you can work out your own wording).
But if a scheme is funded above the PPF level - which should become increasingly true for the majority of schemes now closed to new members and future accrual and with journey plans in place - then extra information can be added, along the lines of: "You will receive the Pension Protection Fund benefits already described as a minimum and the trustees would be able to secure increases of about y% on pre-1997 benefits".
Here the actuary would have to do a few more sums, but only on a scheme-wide basis, we're not advocating disclosing individual member amounts.
The important thing about adding some sentences about the PPF, and funding above that level, is that it reminds members, particularly older pensioners, not to panic. The bald statement about 60%ish "solvency" is really quite frightening.
Ideally we would like to see changes to the statutory disclosure rules but, failing that, we urge scheme actuaries to consider how they can communicate scheme financing using a matching framework and set out the wind-up position in a way that takes account of the PPF. So, what's not to like?
Chris O'Brien is a senior associate at Nottingham University Business School's Centre of Risk, Banking and Financial Services.
Bob Chadwick is mostly retired after a career in insurance and consulting but is now a trustee of two pension schemes.