Pensions agenda 2002

SUMMARY OF KEY POINTS

According to the six leading pension figures we approached, the coming year will see:

This is the 10th year in which Occupational Pensions has asked leading figures from the pensions industry to outline the main issues that will need to be addressed in the year ahead. The six short items taken together provide a pensions agenda for 2002.

Below we reproduce their views, which, unlike all the other items we publish during the year, are unedited except for our house style and where the specified length has been exceeded.

CREDIT WHERE CREDIT IS DUE

By Ian McCartney MP, Minister of State for Pensions

"I predict that pension credit, state second pension and stakeholders will continue to hit the headlines over the coming 12 months. The credit is a revolutionary concept because for the first time ever, it will make sure that it pays people to save for their retirement.

Around 5.3 million people will benefit from the credit to the tune of around £400 a year, so it will make a big difference to thrifty pensioners in the here and now.

It will work by giving pensioners a cash addition of 60p for every pound of income they have above the level of the basic state pension, up to a maximum of £13.80 a week for single pensioners, £18.60 for couples.

But, as nothing in the world of pensions happens in a vacuum, the introduction of the credit in 2003 will also have knock-on effects elsewhere. By enshrining the principle that it pays to save, the credit will help to create and sustain an environment where everyone can make a real difference to their financial security in their third age.

The sale of stakeholders will also continue apace. Four hundred thousand people already have a stakeholder pension, and as more people get to hear about them and see the benefits of having one for themselves, they will continue to grow in popularity.

April will see the introduction of the state second pension, which will radically improve the pensionable prospects of 18 million people, including low earners, carers and disabled people.

And over the next 12 months we should also see the blossoming of the new, dedicated pension service, which I'm hopeful will revolutionise the whole way the government deals with pensions and pensioners.

Overall, it's going to be a busy year with lots of opportunities to ring the changes that will be shaping pension provision in this country for some years to come."

GETTING TO THE BOTTOM OF EQUITABLE LIFE

By Lord Penrose, conducting the inquiry into Equitable Life

"I was very pleased when Ruth Kelly, Economic Secretary to the Treasury, invited me to lead the inquiry into Equitable Life following the Hyman ruling by the House of Lords (OP, September 2000), and its aftermath. I am relishing the challenges.

The Economic Secretary has given me a fairly open remit, which I hope will enable me to get to the bottom of what happened and why. But the main focus of the inquiry is to identify meaningful lessons that will lead to life assurance business being better run and better regulated, thus protecting policyholders. It is not for me to investigate or determine issues of legal liability. I shall deal with matters of fact, and form views on what has happened, and what might be done to improve the system. Inferences of breach of duty are matters for the courts, and involve issues which are beyond the scope of the inquiry.

I intend to conduct the inquiry in a non-adversarial manner. My first task is gathering mainly paper-based information to assist me in forming a picture of the events leading up to the position of Equitable, and to identify issues that require further information. Naturally, I welcome representations from all interested parties, though because the inquiry is non-statutory, those providing me with information, such as policyholders, will have to waive their rights to confidentiality (but only for the internal purposes of the inquiry and for questioning third parties). Interviews will come later, along the lines of the Bingham inquiry, to fill in gaps and to pursue lines of enquiry that have developed.

I hope to report on the sort of timescale ministers expect. At this stage I can only say that I expect to make a report later this year. I do not intend to make interim reports; rather I should come to a final view informed by all the information."

INNOVATIONS

By Jane Samsworth, President, Society of Pension Consultants, and partner, Lovells

"Like most people professionally involved with pensions, I have been aware of the move away from final-salary schemes. The trend is accelerating and for compelling reasons: longer life expectancy, low interest rates and investment returns, over-regulation and a growing awareness of risk have either increased the cost of final-salary provision or highlighted the volatility of that cost.

Many final-salary schemes are being replaced with defined-contribution arrangements, shifting investment risk to employees. There are alternatives and I believe this is the time to give creative consideration to pension cost and risk sharing between employers and employees.

Career average revalued earnings schemes are worth consideration. Tesco launched one last April (OP, August 2001). This design is excellent for employees with stable career earnings and those whose pay tails off as they get older. It is not so beneficial for high-flyers.

The Pension Trust offers an innovative mixture of core career average revalued earnings benefits, with a defined-contribution top-up funded from surplus. The employers' contribution rate is only 10% and this is expected to remain very stable.

Cash-balance schemes look like defined-contribution arrangements but provide defined benefits. Employers therefore retain the investment risk, but may find such schemes cheaper than final-salary.

Of course, lower overall contributions to any scheme must mean lower benefits. So what about asking members to pay more? In one final-salary scheme, members happily pay 10% of salary, reducing the balance to be found by the employer.

There are different ways of mixing defined benefits and defined contributions to keep pensions affordable. This territory is worth exploring."

A SIMPLER WAY TO A HAPPY RETIREMENT

By Alan Pickering, leading the pensions simplification review, and partner, Watson Wyatt

"Provided that an improvement in the quality of life goes hand in hand with the increase in life expectancy, greater longevity is something to be excited about rather than feared. While good health is important, financial security is an essential ingredient in a happy retirement.

A pension system based on the four cornerstones of diversity, inclusiveness, stability and simplicity can facilitate that seamless transition from a world of work to a world of retirement. Our present system is anything but simple. Our complex regulatory structure and pension terminology, far from being an incentive to save, is a real disincentive for product provider, plan sponsor and consumer alike.

As a result of the simplification initiatives launched by both the Treasury and DWP [Department for Work and Pensions], we have a once-in-a-generation opportunity to make things simpler. We should grasp this opportunity with both hands. In doing so, we should not indulge in blame culture. We are where we are because layer upon layer of well-intentioned regulation has been introduced as a series of piecemeal reactions to cataclysmic occurrences such as hyper-inflation, the Maxwell debacle and the mis-selling scandal. While tidying up the present landscape, we must endeavour to create a policy-making mindset that will prevent future well-intentioned knee-jerk and counterproductive reactions to subsequent one-off occurrences.

A simple pension system should be an accessible pension system. An accessible pension system should be an inclusive pension system bringing financial security across a broad spectrum. The stakes are high, but because they are so high, the game is worth playing. Let's make 2002 the year of pension simplification. Thereafter individual and corporate choice will be based on fitness for purpose rather than narrowed horizons flowing from an over-burdensome and unduly prescriptive legislative framework."

COSTING GUARANTEED BENEFITS

By Mike Arnold, chair of the Association of Consulting Actuaries, senior partner of Hymans Robertson, and currently acting as the independent actuary in relation to the compromise scheme proposed by Equitable Life

"Equitable Life is not alone in facing the high cost of fixed guaranteed benefits in a low inflation/low investment yield environment. The days of high inflation and high nominal investment returns, where the value of members' benefits was eroded by inflation while the assets kept pace, are long past. This, together with the creeping increase in guaranteed benefits through legislative changes, mean that many schemes no longer have the cushion to withstand a market downturn.

Many schemes have recognised this and are funding for the increased cost of pensions (or switching to defined-contribution schemes). Many have not yet recognised this truth. With the introduction of [the accounting standard] FRS 17, the high cost of pensions will become apparent.

The increasing costs of pensions ought to have been clear from the pressure being placed on MFR [minimum funding requirement] funding levels. While the MFR is flawed, it does at least serve as a useful benchmark for funding. Schemes that fail to meet the MFR are poorly funded.

With the abolition of the MFR comes an increased financial burden on employers. Most schemes were established at a time when the employer could simply walk away if it was unable or unwilling to continue funding its scheme. Employers will now be expected to stand behind the benefits that they, and successive governments, have promised. This is a material change for shareholders, particularly at a time when many schemes are unable to meet the full cost of their benefits on wind-up. We can expect some company failures triggered by historic pension commitments.

Defined-benefit schemes do have a future. However, for these schemes to continue, benefits may need to be cut or contributions will need to be increased or, more likely, both. It will be another busy year with trustees and employers being well advised to take a long, hard look at the funding of their schemes."

CURSED TO LIVE IN INTERESTING TIMES

By Lindsay Tomlinson, chair, Fund Managers' Association, and chief executive, Barclays Global Investors Europe

"The next year promises to be an interesting and testing one for pension fund investors.

Within the next 12 months we will know whether the fiscal and monetary stimuli applied in the US and elsewhere have done the trick. Crucially, we will know whether the US recession is shaped as a "V", a "U", or an "L", ie whether there is a quick recovery - or a Japanese-style continuing recession. In turn this will show whether bond markets can make further progress and whether equity markets will continue to recover. These are very important questions, both for future investment strategy and for forthcoming pension fund actuarial valuations. By 31 December 2002 the answers will be apparent.

At the same, time pension fund trustees will be getting to grips with the recommendations arising from Paul Myners' review of institutional investment in the UK. The government will revisit the issue in 2003, so 2002 is the year in which the pension fund movement addresses the recommendations. Pension fund trustees will need to take steps to comply with the 'Myners' principles'. They will have to review their decision-making framework, their long-term investment objectives and benchmarks and the structure which they use in engaging external advisers. They will also need to wrap their heads in cold towels whilst delving into the complex and important issue of transaction costs.

If this isn't enough, 2002 is the year in which the new accounting standard, Financial Reporting Standard (FRS) 17, starts to bite. By June 2003 sponsoring companies will have to put unfunded pension liabilities on their balance sheets. Pension assets will be valued at market value and pension liabilities will be discounted at AA-rated corporate bond yields. Expect pension funds to continue to switch from equities to bonds, and companies to continue to switch from defined-benefit to defined-contribution pension provision.

Interesting times indeed!"