All money-purchase plans must issue pension forecasts

All money-purchase pension plans must now automatically provide members with an annual illustration of their likely pension benefits. These benefit forecasts have to be in today's money terms and are also required for money-purchase AVC arrangements. Here we examine what the rules are and how they will work.


Summary of key points

  • In future, all money-purchase pension arrangements, including AVC plans offered by final-salary schemes, must produce a single-figure illustration of the possible pension a member might receive, expressed in today's money terms, based on contributions paid and likely to be paid by retirement.

  • The first illustration must be issued within 12 months of the year end for the first scheme year ending on or after 6 April 2003. All schemes must therefore have issued an illustration by April 2005. The reference date for the benefit statement can be any date during the scheme year.

  • The assumptions to be used in producing the illustration are specified principally in a technical memorandum issued by the actuarial profession, which has been given statutory backing, and to a limited extent in Regulations. Some actuarial assumptions are automatically updated and others are to be reviewed annually.

  • Not all AVC providers plan to produce these illustrations on client schemes' behalf.

  • Different rules apply to the illustrations given to the purchasers of personal pensions, stakeholder pensions and freestanding AVC policies at the time of purchase.

    Until now occupational money-purchase schemes have had to produce an annual benefit statement for members automatically, but they have not been required to include an illustration of the likely benefits at retirement. Now the statement must include a single-figure forecast of the pension they may receive based on stipulated actuarial assumptions in today's money terms.

    The requirement applies to all money-purchase benefits, including money-purchase additional voluntary contribution (AVC) arrangements attached to defined-benefit (DB) schemes and, in broadly the same terms, to personal pensions, stakeholder plans and freestanding AVCs. It will also apply, for example, to any transferred-in rights that are used to buy money-purchase benefits, but not to added years AVCs. In addition, schemes providing a money-purchase underpin are not caught by the requirement when the trustees believe the DB benefits will be greater than the underpin (though this could mean that members receive illustrations in some years and not others), and forecasts are also not needed for members with no new contributions and a fund valued at under £5,000.

    Here we examine the new requirement, concentrating on its impact on occupational schemes. Much of the technical detail, which is set out in Regulations and in Technical Memorandum 1 (TM1) issued by the actuarial profession, is summarised in the box 1. An example of what a statement might look like is set out in the box 2.

    Intentions and outcomes

    The aim of the new statutory money-purchase illustrations (SMPIs) is to enable members to plan for their retirement. Under the previous requirements money-purchase schemes could simply state the total value of the member's fund at the date of the statement. Members could not easily work out what their pension was likely to be. Now a forecast has to be produced in today's money on the basis of assumed investment returns and annuity rates.

    It is widely expected to be a wake-up call for members as to the likely (low) value of their pensions. This may have three outcomes: (a) more members paying AVCs, and those paying AVCs increasing the amounts contributed; (b) increasing dissatisfaction with the pensions provided by some employers; or (c) a realisation on the part of those with poor prospective pensions that contributing may be pointless if their total pension would be below the level of the new pension guarantee credit (formerly the minimum income guarantee). There may also be a fourth outcome: more DB schemes may begin providing annual benefit statements to all members, covering not just their money-purchase AVCs but their DB pensions as well.

    Implementation

    When do the requirements come in? Schemes are required to produce statements relating to a date of their choosing, but must provide the statement within 12 months of the end of each scheme year. If the date of their choosing is on or after 6 April 2003, then an SMPI has to be provided. So if a scheme has a year-end of 5 April, the first SMPI must be produced in relation to a date no later than 5 April 2004 and be issued by 5 April 2005. Illustrations for stakeholder schemes have to be issued within three months of the year-end, but could be despatched during the scheme year - they do not have to go out after the scheme year-end.

    Subsequent statements for occupational schemes have to be issued within 12 months of the scheme year-end. Solicitors Linklaters confirms that there is no requirement to provide SMPIs at specified intervals, so if one statement was issued at the first possible opportunity and the next at the last minute there could be almost two years between the receipt of statements by members. However, as Linklaters points out, in practice providers will be likely to establish a routine for providing these statements at the same time each year. (TM1 suggests that the reference date will normally be the end of the scheme year.) No statements are required for those within two years of retirement at the illustration date.

    Some occupational schemes will be able to rely on their AVC providers to produce the illustrations. However, in most cases these will be on the providers' stationery, so members may not immediately associate the benefits with their employer's scheme. In addition, most schemes now offer AVCs with more than one provider and although the basis for the statements from all providers must be consistent, they will inevitably be presented in different ways. For these reasons some schemes may want to produce their own integrated statement covering AVCs with all providers or a series of consistently styled statements, one for each provider.

    Responsibility for producing and disseminating illustrations lies with the trustees of occupational schemes, not with providers. According to Watson Wyatt's latest AVC survey, most insurance companies and investment houses actively participating in the AVC market intend to supply trustees with illustrations or sufficient information to meet the requirement. However, of the bank and building society AVC providers, only Abbey, it says, intends to provide illustrations. In fact, the survey notes that Yorkshire Building Society decided to pull out of the AVC market partly because of the expense of the administrative developments required to provide illustrations.

    Legislative and regulatory provisions

    The new requirements are set out in the Occupational and Personal Pension Schemes (Disclosure of Information) Amendment Regulations 2002, which make changes to three other sets of Regulations dealing with the disclosure rules for occupational, stakeholder and personal pension schemes. The Regulations give statutory force to TM1, prepared by the Faculty and Institute of Actuaries. TM1 details how the forecasts must be calculated. Unlike the actuarial profession's Guidance Notes, TM1 is binding on anyone producing SMPIs, and not just actuaries.

    The Regulations set out what information must be included in the SMPI statement (see box 1 for a summary). They also specify that the provision of a spouse's pension of half the member's pension must normally be assumed (even if that is not actually an option under the scheme, but see box 1 for detail). TM1 requires illustrations to be rounded to three significant figures where over £1,000, to avoid the appearance of "spurious precision".

    Much of the detail about the underlying assumptions to be used is in TM1. The main assumptions are that:

  • retail prices increase by 2.5% per annum;

  • earnings increase by 2.5% per annum;

  • investments grow at 7% per annum less contract expenses (but appropriate reductions can be made where the fund is not mainly invested in equity-type investments); and

  • funds are converted to pensions on the basis of annuity conversion rates based on index-linked gilt yields as at 15 February in the financial year prior to the date the illustration relates to, mortality tables appropriate to the member's year of birth (PMA(92) and PFA(92)) and annuity expenses of 4% of the fund - the mortality tables used take account of expected improvements in life expectancy.

    While the index-linked gilt yields used will automatically be adjusted from year to year, the actuarial profession also plans to review (but not necessarily always change) TM1 on an annual basis. Such amendments require ministerial approval. A committee of the profession's Pensions Board reported in February 2003 that the TM1 formula had produced annuity conversion rates close to market rates at the start of 2002, but by the end of that year the rates being used were 15% below the market. It recommended that the mortality basis be changed with effect from 6 April 2004. The committee meets again in January and no change prior to April is likely.

    Both the Regulations and TM1 require trustees to base the illustration on contributions already paid and to assume that contributions continue to be paid in future. TM1 requires the SMPI to assume that the current contribution arrangements continue. Future "one-off" contributions are excluded unless in practice they form part of a regular series of such payments, which are expected to continue until a member's retirement date. TM1 also says that where contributions are linked to a member's earnings, the illustration should allow for earnings (and therefore contributions) to increase in future.

    The Regulations do allow members to select a retirement date other than their normal retirement date, though the trustees are not obliged to produce an SMPI on that basis.

    Flexibility for schemes

    Although the government has been encouraging the issuing of combined pension forecasts (combining state and scheme benefits in one statement; see our case study on Emap 's introduction of combined pension forecasts), it seems that forecasts of benefits from money-purchase AVCs must be shown as a separate figure though they could possibly, in addition, be aggregated with DB benefits. They could certainly appear on the same statement. According to TM1, the likely benefits from two different money-purchase funds, eg two AVC funds, can be combined if the same retirement date applies to each, or they can be illustrated separately.

    A key decision in developing the legislation for SMPIs was whether to use a single figure or a range of perhaps three figures based on more or less optimistic assumptions about investment returns. It was decided that having just one figure aided comprehension and contained costs. According to the actuarial profession it was also anticipated that the volatility of the forecasts would emerge when members compared one year's illustration with the next.

    TM1 makes clear that schemes can provide a range of illustrations if they wish, for example based on alternative investment returns. However, Linklaters points out that schemes would have to be careful to highlight which figure is the statutory illustration and what differences there were in the assumptions employed. The law firm says that schemes may still need to provide a written statement even if they have a website allowing members to produce projections on different bases, including on the statutory basis.

    Actuaries Watson Wyatt says that while the SMPI basis is reasonable as a standard basis, its "one size fits all" nature does mean it may be inadequate or inappropriate for some schemes. It suggests that schemes might want to provide additional illustrations showing:

  • benefits as a percentage of projected pay (which generally rises faster than prices);

  • the effect of different retirement ages;

  • a cash option at retirement;

  • the effect of different annuity choices (for example, flat-rate or single life);

  • sensitivity to higher or lower investment growth or higher or lower annuities; or

  • a split between the pension deriving from past contributions and future contributions.

    FSA rules

    Broadly the same rules about annual benefit illustrations applicable to occupational schemes also apply to personal pensions, stakeholder plans and freestanding AVCs. However, the Financial Services Authority (FSA) has different rules for the illustrations provided to purchasers of these types of policies at the point of sale, in other words before they start contributing. It consulted on these rules, announcing its conclusions1 in October 2002.

    The FSA decided not to require a single real projection in the key features document given to purchasers of policies, thus allowing providers to continue to issue illustrations that contain three figures, which tend to be significantly higher than the forecasts produced on the basis required for SMPIs. However, providers can provide a real value (ie in today's money) projection if they wish.

    Members of stakeholder schemes operated by employers or group personal pensions may be mystified by the lower illustrations they receive in their first SMPI by comparison with the figures quoted in the point of sale material. Such members may be prompted to query the SMPI figures, probably with their employers.

    And if trustees fail?

    The Occupational Pensions Regulatory Authority would be able to impose fines on trustees if they fail to provide SMPIs. These would be up to £1,000 for an individual trustee and £10,000 for a corporate trustee. However, trustees may be able to rely on a defence that there was a "reasonable excuse" for the failure. Linklaters says that this may apply where an AVC provider does not provide the necessary information in time to allow the trustees to produce forecasts (or provides incorrect information), particularly if the trustees could not have got the information from another source.


    Money-purchase illustrations

    Legislation and regulatory material: The provisions are set out in the Occupational and Personal Pension Schemes (Disclosure of Information) Amendment Regulations 2002 (SI 2002/1383), which amend the Personal Pension Schemes (Disclosure of Information) Regulations 1987 (SI 1987/1110), the Occupational Pension Schemes (Disclosure of Information) Regulations 1996 (SI 1996/1655) and the Stakeholder Pension Schemes Regulations 2000 (SI 2000/1403). Authority for the Regulations was provided by s.113 of the Pension Schemes Act 1993 as amended by s.52 of the Child Support, Pensions and Social Security Act 2000. Guidance that must be followed is set out in the Faculty and Institute of Actuaries' Technical Memorandum 1 (TM1): Statutory money-purchase illustrations.

    Availability: the new Regulations (SI 2002/1383) are available from The Stationery Office, PO Box 29, St Crispins, Duke Street, Norwich NR3 1GN, tel: 0870 600 5522, price £2.50 inc. p&p, and from the internet (at www.legislation.hmso.gov.uk/stat.htm); and TM1 is available from the Institute of Actuaries, Staple Inn Hall, High Holborn, London WC1V 7QJ, and from the profession's website (www.actuaries.org.uk and search on "SMPI").

    Effective: phased in from 6 April 2003 (see below).

    Summary of the provisions governing occupational schemes

    Note: broadly similar provisions apply to stakeholder pensions, personal pension schemes and freestanding AVC arrangements.

  • Pension schemes must provide most members with an annual statement that includes an illustration of the pension they would be likely to receive at their retirement date in respect of money-purchase benefits.

  • Forecasts must be prepared in line with the Regulations and with relevant guidance approved by the Secretary of State, which is exclusively TM1.

  • The reference date to which a benefit illustration relates is to be specified by the trustees. The first statement must be issued within 12 months of the end of the first scheme year ending on or after 6 April 2003.

    Calculation of illustrations

  • The figure to be provided is an illustration of the pension that the member would be likely to have accrued at retirement date. The retirement date may be any date specified by the member consistent with the scheme rules, but in the absence of any specification must be stipulated by the trustees.

  • It is assumed no further contributions will be made to a scheme by or on behalf of a deferred member.

  • It is assumed that (i) contributions will continue to be made to a scheme by or on behalf of a member in pensionable service on the same basis as currently until retirement, (ii) the tax treatment of the scheme will remain unchanged, and (iii) contracted-out rebates will continue to be paid and in line with TM1 assumptions (which are complex on this point given that the actual rebates to be paid in the long term are not known).

  • It is assumed that annuities will increase annually in line with prices (as set out in TM1).

    Exclusions

  • The requirement to provide an illustration does not apply to:

    -unapproved schemes, buy-out policies, retirement annuity policies and schemes with only one member;

    -pensioners;

    -members whose specified retirement date is within two years of the date to which the benefit statement is applicable;

    -members whose accrued money-purchase rights are valued at less than £5,000 as at the first illustration statement date after 5 April 2003, who have received no new contributions of any sort for money-purchase benefits and who, in the trustees' opinion, are unlikely to do so;

    -members whose accrued money-purchase rights are valued at less than £5,000 on the last illustration statement, who have received no new contributions of any sort for money-purchase benefits since then and who have been given notice that no further illustrations will be provided unless new contributions are made; or

    -members whose pension under a defined-benefit scheme enjoys a money-purchase underpin and in the trustees' opinion the underpin is not likely to affect the pension payable.

  • Additional voluntary contribution arrangements providing money-purchase benefits are treated as separate schemes for the purposes of the requirement to provide illustrations.

  • Illustrations must assume a 50% spouse's pension will be payable on the member's death, irrespective of whether the member is married, unless the trustees decide otherwise, either because the member is not married or on agreement with the member.

  • Illustrations of benefits must be accompanied by statements:

    -that it does not represent a guarantee;

    -that it is required by law;

    -about how more information can be obtained from the trustees;

    -that the illustration is based on specified guidance;

    -that assumptions have been made about the investments, which may not be appropriate;

    -that the illustration is in today's money terms;

    -that the pension eventually payable will depend on the actual investment performance and annuity rates when the pension becomes payable;

    -specifying what future contributions have been assumed;

    -about assumptions used on contracting-out rebates, that a spouse's pension is payable, and that the pension is assumed to increase in line with prices;

    -specifying the retirement date used; and

    -specifying the applicable date of the illustration.

  • Where trustees choose to provide an illustration even though not required to do so, it must be accompanied by all the statements specified above other than that the statement is required by law.


    • Example of statutory money-purchase illustration

    Your pension fund statement

    This statement is a guide to the amount of pension that you might get when you retire. In this statement, we refer to this as an "illustration". It is shown in today's prices and is not a promise or guarantee that your pension will be paid at this rate. This is because it is based on a number of assumptions.

    Please read the notes on the back of this statement [not included in this example]. They explain more about the way your illustration has been calculated, the assumptions that we have made and what will decide how much your final pension will be.

    Your name: Example

    Your date of birth: 1 May 1962

    Your national insurance number: XX123465A

    The name of your pension scheme is:

    ABC Stakeholder Pension Plan

    The date you joined the scheme was:

    1 May 2001

    The effective date of this illustration is:

    1 May 2002

    Contributions paid into your pension in the year up to 1/5/02

    You have paid into your pension:

    £1,560

    The government has paid in tax relief:

    £440

    The government has paid in national insurance rebate:

    £—

    Your employer has paid into your pension:

    £—

    The value of your pension fund so far

    The value of your fund at 1/5/02 is:

    £2,060

    Your future pension

    To illustrate your possible future pension we have assumed that:

  • your retirement date is: 1/5/2027;

  • you will continue to pay contributions until your retirement date at the rate of 10% of earnings including tax relief from the government - the earnings on which contributions are based was £20,000 at 1/5/02.

    The estimated pension when you retire is: £4,230 a year.

    If you have any questions about your illustration you can phone us on: xxxxxxxxx or email us on: xxxxxxxxx or write to us at: xxxxxxxxx.

    Source: Briefing statement on the Institute of Actuaries' website (www.actuaries.org.uk and search on "SMPI"), which also has other examples.

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    Our research

    This feature is based on the Regulations and TM1, on assistance provided by Isabel France of solicitors Linklaters and Georgina Ivers of the Institute of Actuaries and on client newsletters produced by actuaries Watson Wyatt, solicitors Freshfields Bruckhaus Deringer and Linklaters. We have also benefited from comments on a draft of this article provided by our technical advisers Aon Consulting.

    1See the FSA's website (at www.fsa.gov.uk/pubs/policy/ps134/index.html )  for details.