2013 will be another challenging year for pensions
Everyone thought 2012 was a difficult year to negotiate defined benefit funding agreements but this year will be worse. It will be hard for the regulator to repeat its argument that most deficits can be accommodated by making modest tweaks to existing recovery plans.
What the numbers will look like precisely and how they are dealt with may depend on whether the Government changes the rules before negotiations kick off.
End of contracting out signalled
The Government is expected to publish a White Paper on State Pension reform that will propose ending the option for defined benefit schemes to contract out of the State Pension, forcing employers to review the pensions they offer.
The change should be signalled this year but is unlikely to come in until 2016 or thereabouts. When it does, employers who still have staff in their DB schemes will have to choose between cutting back benefits and swallowing more of the cost themselves – something to which most have not yet given much thought.
Offsetting the lost National Insurance rebates with higher employee contributions could be tricky because members will have to pay more National Insurance too.
Bulk buy-ins at highest level for five years
This year will see the bulk buy-in market exceeding £5bn and be at the highest level since 2008. Last year has been a year where pricing opportunities have been available to schemes that were data-ready and asset-ready for transaction.
Not all schemes crossed the line before the year-end and we expect to see a number of completed deals in the first quarter of 2013.
More generally, pension schemes that have tested the market in the last year are now much better placed to enter into transactions when the time arises and many schemes have good monitoring tools in place to quickly highlight market opportunities relative to their own assets.
Once again there are likely to be a number of completed deals in the last few weeks of the year but, as opposed to 2012, we should see a steadier stream of completed deals throughout the year now that schemes are more comfortable in setting objectives and making key decisions in a low interest-rate environment.
Auto-enrolment – limited opt-outs, limited provider capacity
Just as in 2012, auto-enrolment will continue to dominate the UK pensions agenda. The auto-enrolment opt out rates will dramatically undershoot the 30% estimates that have been predicted as inertia proves to be a strong force.
The main concern for 2013 is around capacity. Employers selecting pension providers in the second half of 2013 will find that it is no longer a buyers' market, as capacity dries up and providers begin to price accordingly.
In addition, the effect of the Retail Distribution Review will see further consolidation in the adviser market and, longer term, possibly in the provider market too.
There will also be an ever increasing focus on pension charges, from regulators, legislators, employers and employees.
Greater transparency in transaction charges and consultancy charging will increase pressure for charges to be split into their component parts, so that members can see how much they are paying for administration, investment management, investment transactions, communication and adviser-related costs respectively.
Arrangements set up on an 'active member discount' basis, where former employees pay more than current employees, will find that model no longer works if 'pot follows member' takes off as seems likely.
More flexibility for people retiring from DB schemes
More DB scheme members approaching retirement will find that they can enjoy much of the flexibility available to those with defined contribution (DC) benefits – either by exploring options they already have or where employers expand these options.
For employers and trustees it is critical that they help members understand all their retirement options, and that taking the DB pension from the scheme is not the only option. Strong communications and impartial advice is crucial so that people make choices which are right for them.
Choices include reshaping pension to have different levels of spouses' benefits or higher initial pensions with lower annual increases. The outcome may lead to lower cost and risk for the employer and for some members the value of taking more income now may have a big benefit.
2013 is likely to see a significant increase in the number of DC pension scheme members considering an alternative to traditional annuity purchase. The combination of low gilt yields and the impact of the European Gender Directive mean that annuity rates are pretty much at an all-time low, with male members particularly badly hit.
Contrast this with the recent announcement by the Chancellor in the Autumn Statement that the maximum permitted income under capped drawdown will increase from 100% to 120%of GAD rates, together with the fact that members can use flexible drawdown provided they meet the Minimum Income Requirement of £20,000 pa and it is easy to see why they are likely to want to explore the alternatives.
John Ball is head of UK pensions at Towers Watson
This article was written for our sister website Money Observer
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.