Final salary schemes in transition

1
Final salary schemes in transition

• Presentation to the Insurance Institute of
  London
• 9 March 2004
• Andrew Cheseldine

2
The shift from Final Salary provision

• Putting it in context
• Reasons for the switch from Final Salary
• Is DC always inferior?
• The shape of things to come

3
UK companies - by employee numbers
500
3,540
250-499
3,245
1,625
200-249
7,895
100-199
18,145
50-99
54,845
20-49
112,690
10-19
200,315
5-9
747,655
1-4
Source Small Business Service 2001
4
Employees by industry
Source Small Business Service 2001 Total
employees 22.6m
5
Long term trends in occupational scheme coverage
1953-95
Decline in occupational pension scheme coverage
is a long-term phenomenon, over around 30 years,
rather than a recent change. Growth in female
membership, decline in male membership and drop
in public sector reflect shifts in the labour
market.
Source GAD, as reported in ACA Survey 2001
6
Alternatives to Final Salary

• Hybrid
• Career Average
• Cash balance
• DC
• Occupational
• Retail
• Cash/Flexed benefits

7
The current situation

• Survey evidence (Emphasis on larger schemes,
  Watson Wyatt Pension Design Survey 2003)
• 219 organisations surveyed, of which 56 still
  offer open DB (down from 65 in 2002)
• 59 of final salary schemes were reviewed in the
  past year, following the review 55 of these were
  left unchanged and open to new members
• Of those that changed, 27 transitioned to career
  average or cash balance the balanced moved to DC
• Of the balance, 43 chose occupational DC, 27
  Stakeholder 3 GPP

8
Status of final salary plans mid-2002
Evidence from the Association of Consulting
Actuaries points to continued decline among final
salary schemes, with only 37 still open to new
members (and 47 of those contemplating closure).
The findings should be treated with caution, as
the survey was not a thorough research piece and
focussed on smaller schemes, but the message is
consistent with anecdotal information.
47
53
Source Association of Consulting Actuaries June
2002
9
Reasons for the switch from Final Salary

• Cost volatility
• Cost
• Fashion
• Accounting standards
• Equity market meltdown
• Transparency and fairness
• Empowerment

10
DB Cost the Glace cherry syndrome

• Pre 1986 cost bog standard 60ths assume 100
• LPI post retirement - 40
• Indexation of preserved benefits - 10
• Compulsory SDIR benefits - 5
• ACT dividend credit withdrawal - 5
• Governance costs (Pens Act ) - 2
• Mortality improvements - 40
• Long-term interest rates - 25
• Cumulative compound effect - 200

Rounded estimates for comparison purposes
11
Annuity rate volatility (as proxy for mortality
rate/long-term interest rate changes)
12
Increasing role for insurers and for personal
pensions
Alongside decline in occupational pension
coverage over the long term, there has been
medium term growth in insured pension
arrangements and in the importance of pension
business to insurers. These factors are linked
to growth in personal pensions (both individual
and group).
Life insurer assets medium term trend
Pension assets medium term trend
Source ABI (Values in 1999 money)
13
Is DC always inferior?

• It depends..
• Whose viewpoint - Member, Trustee, Employer,
  Shareholder, Government, Society?
• Garbage in garbage out low contributions give
  low benefits
• Complicating factors
• Cross-subsidies in traditional DB
• Contracting out rebates
• Workforce demographics
• Assumptions
• Propaganda and mis-information

14
Value of Leaving Service Benefit (as percentage
of gross earnings at leaving), Male 25 earning
20,000)
15
The shape of things to come

• Market size
• Will Final Salary disappear completely?
• Will Final Salary, or at least Defined Benefit,
  make a comeback?
• Will it still be Final Salary as we know it (LPI,
  SDIS pension, priority for pensioners)?
• Provider product changes driven by
  Simplification

16
Why might things change

• UK Legislation with the intention of making DB
  more viable (note the Law of unintended
  consequences)
• European legislation
• Increase in long-term interest rates
• Changes to international financial reporting
  rules
• Changes to long-term mortality expectations
• Offering DB pension may become commercially
  advantageous a differentiator for recruitment
  and/or retention

17
Current prevalence of DC plans in Europe
18
Four key areas for debate

• Impact of demographics on capital markets
• Functioning of annuities markets
• Role of employers post Simplification
• Impact of incentives (to the extreme of
  compulsion) on savings behaviour

Pensions Policy 9.xii.03