Pensions World

As the agenda for pension schemes lengthens, consultant services continue to be in demand reports Allison Plager, financial journalist

Was there ever a time when pensions were not in the news? Not everyone has had to get to grips with the extensive reforms to pensions made by the Finance Act 2004 which came into effect on 6 April 2006, but since then there has been the great higher rate tax relief debacle, auto-enrolment and the national employment savings trust (Nest).

Meanwhile, pension deficits are still a headache for businesses, with FTSE 100 companies paying £17.5bn into their defined benefit (DB) schemes in 2009 to try to reduce their deficits, according to research from LCP in mid-2010. While deficits may fluctuate in size according to how the markets perform, they are not about to disappear, and must be high on any DB scheme trustee’s agenda.

It is not an easy task running a pension schemes and trustees look to professional advisers, including pension consultants, for help over a range of issues.

All change

Pension consultants come in all sizes and offer a wide variety of services (shown in Table 2). Table 1 provides some principal facts and figures about the consultants, and readers who have followed this survey over the years will note the loss of some familiar names as well as new ones. There has been some impressive corporate activity since the last Pensions World consultants’ survey (October 2009). First, Aon Hewitt was created on 1 October 2010 following the merger of Aon with Hewitt Associates. Looking further down, the name HSBC Actuaries and Consulting no longer appears, as its business was acquired by the JLT Group in December 2009. Then towards the end of the table, Towers Perrin and Watson Wyatt are now combined as Towers Watson, having merged in January 2010.

Table 3 gives an indicator as to the size of client with which the consultant tends to do business and also clients’ intentions regarding DB schemes. As might be expected, the percentages of clients intending to retain their DB scheme is low, although there are exceptions: for example, 40% of BDO’s clients are staying with their DB schemes and Redington reports that 45% of its clients intend to keep their DB scheme. On the whole, however, DB schemes are on the wane and the move away from them “has continued as companies seek to limit costs and to close off their exposure to pension risks”, according to LCP. Its research shows that “nearly a quarter of FTSE 100 companies have announced changes to their DB pension schemes, in many cases reducing or freezing benefits, since the beginning of 2009”.

As Towers Watson’s Mark Duke says “a lot would have to change for DB schemes to experience a renaissance”.

Business survival

Despite all the changes and tinkering, the consultants agree that their clients consider a company pension scheme an important benefit. Redington’s Robert Gardner says that “clients tell us that providing pension benefits remains a core part of a holistic benefits package, an incentive and reward for the employee’s service to the company”. He adds that employees value DB schemes, but “perhaps do not realise the true cost being borne by the company and many companies are looking for ways to demonstrate the value of pensions to them”. This might be done with flexible benefits or cost sharing.

The burden on the employer of running the pension scheme is undoubtedly considerable, particularly when coupled with the difficult economic conditions and the challenges that a lot of companies are facing to keep afloat. As Xafinity Consulting’s Lyndon Jones says, “the economic conditions are forcing companies to focus on costs and business survival: in this environment, increasing costs is largely off the agenda”.

Tomorrow is coming

Yet increasing costs is just what many companies are going to have to deal with as auto-enrolment draws ever closer. Therefore, “2011 is going to be the year employers take decisions”, says Towers Watson’s Mark Duke. Auto-enrolment has “felt like a tomorrow issue for some time, but tomorrow is coming soon”, he adds. The degree of preparedness varies, but as John Cooper of Alexander Forbes Financial Services says, some clients are prepared, but “all are thinking ahead and planning for it”.

Key issues are cost and Nest and these will lead to most employers reviewing their pension arrangements, perhaps even levelling down. Mr Cooper adds that auto-enrolment “presents financial and administrative challenges for clients who have low take-up rates”, as well as those with large numbers of low paid, part-time and casual employees or with a high staff turnover. Given the cost entailed, he sees some clients thinking about “defaulting to Nest”.

The problems associated with auto-enrolment will vary from company to company, but Mr Jones agrees that those “most affected are companies with low percentage take up of their existing arrangements” and once they have met the auto-enrolment requirements will “probably find around 90% of eligible employees moving to an occupational arrangement and hence incur the company additional pension costs”.

“It would be wrong to say that clients are fully prepared”, says Mercer’s Steve Charlton, but he adds that “following outcomes of the Coalition government’s review, most medium and large employers now understand the steps they need to take to become prepared”. This includes “introducing new, relatively burdensome, processes to ensure that the right information is provided to, and actions taken in respect of, the appropriate employee groups”.

Table 1 About the consultants

Table 2 Services provided and firms’ charges

Table 3 Client profiles

Also suggesting that some employers with existing arrangements may be tempted to choose Nest as their auto-enrolment vehicle for certain groups of employees, eg temporary or short term employees, Mr Charlton feels that this may not be ideal as “at the outset Nest is likely to be inflexible and, as an unknown and untested vehicle, we still expect most employers with existing schemes to continue to make their own provision, albeit with a revised benefit/contribution structure”. He adds that many employers are reviewing their current pension arrangements “to ensure that it will remain cost-effective for all potential new joiners, and continue to meet the companies’ aims”.

Ways to manage

Investment was a major issue for 2010 according to most consultants, with managing risk and volatility at the top of the agenda. Lyndon Jones says “clients have been searching for higher rates of returns especially given the low yields on government bonds and cash, thus the focus has been on diversification of asset portfolios to try and deliver the desired level of return in a more risk averse way”. As Mr Gardner succinctly puts it “clients want to get fully funded with the least degree of risk”.

Mercer’s Dan Melley says “there is significant interest in strategies that mitigate some of the downside risks imposed by continued investment in traditional equity-type investments”. Such strategies include using swaps and derivatives, but also “consideration of partial buyins or buyouts”. He goes on to say that “trustees and employers are conscious that uncertain investment market behaviour, including historically low interest rates and volatile equity markets experienced over the past 36 months, could result in shortfalls being crystallised by certain changes in investment strategy. Rather than taking precipitous action, many companies and trustees have embraced the need for closer monitoring of funding, investments and the company covenant to help identify appropriate events that could trigger a change in investment strategy.”

Given that de-risking is an important issue for pension scheme trustees, developing ways to manage liabilities and increased contributions is a major area where consultants can help trustees.

A necessary evil

The Pension Protection Fund (PPF) continues to worry companies in varying degrees from “mildly irritated”, according to Smith & Williamson’s Peter Maher to “increasingly concerned” from Mark Riches of First Actuarial. He says that while clients accept that pension scheme members consider the PPF to offer valuable protection, they are worried about increasing costs. For a number of clients “the PPF levy represents a sizeable part of their total contribution to the scheme”. He suggests that financially secure employers may “see a significant increase in their PPF levy this year despite the fact that their D&B rating is unchanged and their PPF funding level has improved”. He explains that this is because of the changes in scaling factor, risk of default for stronger employers, and the sum considered to be at risk”. This is likely, he says, to create “a severe reputational risk for the PPF”.

A necessary evil is how some companies view the PPF, according to Mercer’s Deborah Cooper, largely because “most clients believe their members are unlikely ever to receive any compensation from the fund”. The volatility of the levy from year to year and particularly the assessment of corporate insolvency risk, which can vary significantly from month to month, are particularly worrisome. She adds that the system, although providing an increased level of security to members, needs to become more robust and durable and ensure that well run schemes with strong company support and rigorous risk management controls are fairly rewarded. She also describes the administrative burden as “complex and inflexible”. She adds that another perceived unfairness of the fund is that it does not encourage “clients to correct mistakes in scheme returns, consequently sometimes charging a higher levy than the payment that properly reflects the risk it is exposed to”.

While consultants seem to agree that on the whole clients are resigned to the levy, they are aware that, as the number of DB schemes declines, the costs associated with the PPF will increase. For some consultants, this is likely to provide a growth area.

Given everything that is on the agenda for pension schemes, consultants are unlikely to  have much spare time on their hands.

Allison Plager is a financial journalist; allison.plager@lexisnexis.co.uk