Actuarial and Benefits Consulting

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Actuarial and Benefits Consulting
Jonathan Mowbray CARES
1 December 2003
Aon Consulting Limited is regulated by the
Personal Investment Authority for investment
business
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Why Money Purchase fails

• Members take all the risk
• Transience
• No pooling of investment risk
• Members cannot afford the risk
• Safer investments
• Lower benefits for same cost

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Ancient History

• Preservation / 5 year vesting 1975
• GMP / Requisite Benefits 1978
• GMP revaluation 1978
• Anti-franking 1985
• Pension revaluation 1986

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Modern History

• 2 year vesting 1988
• GMP increases 1988
• Debt on employer 1991
• Pension revaluation again 1991
• LPI / wind-up / surplus 1992
• LPI 1997
• MFR / debt on employer 1997
• Wind-up / debt on employer again 2003

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Whats gone wrong?

• Targeted, minimum ongoing and guaranteed
  discontinuance benefits
• Only difference is real salary growth
• To pay lower than target benefits must break
  final salary link

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Why Final Salary fails

• Company takes the whole of the risk
• Cost has progressively increased
• Increased contribution volatility risk
• FAS, FRS IAS liabilities
• Loss of investment freedom

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What do companies want?

• Value for money
• Stable contributions
• Guaranteed benefits for members
• Staff retention
• Low risk

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CARE Schemes

• Career
• Average
• Revalued
• Earnings
• Schemes

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CARE Schemes

• Example - Each year member earns
• Salary 60 as a pension
• Each year pension earned to date is increased by
  the Trustees
• Increase guaranteed to be at least RPI
• More if investment returns etc allow it

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CARE Schemes

• The vital issue is the reintroduction of
  discretionary benefits
• Guaranteed benefit increases in line with RPI
• Target benefit increases in line with national
  average earnings etc
• Difference between target and guaranteed allows
  funding flexibility

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Not just a cheaper option

• If switch from Final Salary to CARES to reduce
  cost, potentially increasing risk
• Targeted, minimum ongoing and guaranteed
  discontinuance benefits

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Risk - Advantages

• Risk is shared
• Members receive a guaranteed benefit, more if
  affordable
• Company cost is relatively stable
• Benefits relatively easily understood

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Funding Flexibility

• The vital issue is the reintroduction of
  discretionary benefits
• Guaranteed ongoing benefit increases in line with
  RPI
• Target benefit increases in line with national
  average earnings etc
• Difference between target and guaranteed allows
  funding flexibility

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What CARES offers members

• A benefit which is guaranteed to be adequate
• A possibility of a larger benefit if affordable
• Ability to plan retirement as benefit becomes
  more certain over time

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CARES - For the Company

• Predictable cost
• Removal / reduction of FRS deficit
• Flexibility in sharing risk with members
• Pooled investments
• DB - so more saleable to workforce
• Golden handcuff aids retention
• No reduction to benefits???

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Why CARES can work

• Discretionary benefits
• Target benefit is around 30 larger than
  guaranteed benefit at revaluation of 2 pa above
  RPI
• Similar effect to discretionary increases in
  payment

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Is now the right time?

• Many companies moving to DC alternative may be
  discontinuance
• Possibly no reduction to benefits?
• If remain with Final Salary
• Assets fall - problems worsen
• Assets rise - problems disappear

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Reasons given

• Reduction of accrued liabilities to minimum
  guaranteed
• Cost containment
• Risk management
• Middle way

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Some issues

• Past service conversion?
• Same or separate Trust?
• Contributions and bonus policy
• Valuations bases

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Contributions / bonus policy

• Company funds for target benefits bonus paid in
  line with target unless unaffordable
• Co pays flat rate unless outside limits - bonuses
  paid on funding level between target and
  guarantee
• Fluctuations shared equally

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Alternatives - Hybrids

• 5 main types
• Underpin schemes
• Split benefits
• Top up schemes
• DC feeder to DB
• Cash balance plans