Newsletter – July 2015


Pensions News Bulletin July 2015

1. Summer Budget – what to do about pensions?

There were several pension topics covered in July’s budget including salary sacrifice. I talked about salary sacrifice in June’s newsletter and the reasons it may be removed for pension contributions. The chancellor merely said he would be monitoring its use and impact. He won’t learn anything new but presumably it’s a holding pattern approach to coincide with the big initiative he announced – a wide consultation on how to improve pension saving while reviewing the pension taxation regime.

I’ve written before about the £50bn a year of tax lost to the exchequer from all the elements of the current pensions tax allowances, so it shouldn’t be surprising that with pension auto enrolment and people being pushed rather than pulled into pension schemes, that incentives through the tax system could be cut.

Many commentators on the subject have said for years that there should be a level playing field between investment mediums, and particularly that pension incentives are too generous compared to ISAs and other forms of investing. However levelling works both ways. Do we want ISAs to be out of reach until we are 55 or do we want to be able to spend our pension account as soon as we like? It remains a demonstrable fact of human nature that if you want people – and companies — to put their money and investment return out of reach for many years, you have to offer some benefit for that to happen.

I agree that for certain parts of society the tax incentive hasn’t been effective and with auto enrolment making pension enrolment mandatory, reducing the cost makes sense.

If we segment pension scheme investors into two distinct groups – 1) the Tax Effectives and 2) the Income Cravers – it is clear that taking advantage of whatever tax effective spend there is, is the natural habit of group 1. If they don’t do it of their own volition there are people who are commercially active to advise them to do so. This group will complain about the reduction or disappearance of the tax relief but if they need an income in retirement they will invest for it.

Group 2 don’t earn the income or have the commercial encouragement to chase the tax relief but they will have no income when they stop working. For example a survey by Barclays last year showed that 11% of workers have no savings and regularly spend more than they earn. Lloyds Bank in a survey in January this year found that half of all UK bank account holders have less than two months’ salary in savings that they could draw on in an emergency. These are the ‘Income Cravers’ who need an incentive to save for the long term and who will rely on building up a financial cushion for when they can no longer work.

A new pension taxation policy should reduce the cost of incentivising the ‘Tax Effectives’ and do something more effective than now – but cheaper – for the ‘Income Cravers’.

Over many years I have seen that the most effective incentive for pension saving is contribution matching. Like BOGOF, the buy one get one free mechanism is always successful. This is where for £1 contribution someone else pays £x – it could be equal matching or half matching limited to an affordable contribution and earnings threshold. If this was to become reality then you would have, for example, a member’s contribution of £50 increased by £50 from the employer and £50 by the government / tax payer. Or, say, £50, £50, £25 respectively. The numbers, costs and savings over the current regime would need to be tested and modelled.

It would be vital to keep it clear and simple and not diminish the incentive effect. So all contributions must be invested within the current time limits. You can’t have a situation where the government payment only happens at (say) year end. Distancing the incentive from the action that generates it negates the incentive effect.

What would be a poor incentive and a wasted incentive for the ‘Income Cravers’ would be the system currently being socialised, of pension contributions from taxed income followed in retirement by tax free pensions. This would be taken up by the ‘Tax Effectives’ but would not motivate the ‘Income Cravers.’ If introduced some of the cost would have to be on the contribution incentive, or the ‘Income Cravers’ will never pay more than the mandatory minimum.

The other area to refine is the opportunity of withdrawing  tax free – or taxed – cash when accessing the pension. Once the decision is made to start utilising the pension value, if it is in society’s interest at the time, a certain additional sum (the kicker) can be awarded for taking an income. This decision could be announced each year in the budget or by the (imagined) independent pension board.

2. Cyber Security – How secure are you, your business and your pension scheme?

We all have some consciousness of the cyber security issue and many of our companies will have processes in place to guard us. I hope as individuals we all use a proven anti-virus protection system on all our own IT kit. However I have a feeling that until we take the time to consider IT security properly with the advice of an expert, we treat the matter lightly.

A recent computer security presentation got me thinking – it was a real eye opener to spend time learning how vulnerable we all are. For 99% of us and our companies if we have not been hacked it’s only because we haven’t been targeted.

Okay, so not many people think they need to worry about an international IT onslaught like Sony suffered a few months ago. However even if you are right, if your business supplies or receives from a major company your system is probably an easy route in for a hacker to attack them. You would not notice when it happened. Your supplier or customer would notice first and their IT would track it back to you. How would that be for your future relationship?

All of us should worry about threats closer to home than the Far East. For example, disgruntled staff, innocent or negligent staff errors, including our own, and crooks who want to sell something on to your competitor, are the most common causes of IT security breaches.

What about free WiFi hot spots? For £100 you can buy an unobtrusive piece of kit to use in the corner of a coffee shop, train carriage or airport (keep it in your bag and just have your laptop on show) to set up a WiFi hotspot. This allows you to view everything being transacted in its range (except for those who use encryption – but who does?). I now realise how sensible it was when my own office internet service provider (ISP) turned off access to my email accounts and made me re-password. I was frustrated and annoyed at the time and thought it was an error on their part, but I now know that it had detected I linked to a WiFi hot spot in a shopping centre earlier that day.

Do you use the ‘Cloud’? Of course. What a fantastic piece of marketing speak. What is it? Someone else’s computer! Think about security when you use it.

The main weakness in our cyber security is the password. That is why cyber security people tend to be the main users of the automated password generation systems. They also use encryption on all their communications. Shouldn’t we all? Yes, but we don’t bother.

It strikes me that not many companies outside the FTSE have very strong IT security protocols for the non IT staff. Even where they exist they are not communicated simply and often enough. A ‘security point for the day’ may be a good idea to introduce as a company emailer.

The IT structure may be secure to an extent but that doesn’t guard against the disgruntled or lax staff member. Once someone has got into your still logged on desktop, or seen or guessed your password, they could do serious damage to you or your company. The risk is even greater if you use your personal computer for corporate business and copy data from one to the other.

Its not all gloomy though. You may be interested to know we have GCHQ and HM Government wanting to help and you can find some very worthwhile information, training, self-assessment certification and independent validation at the following links.

3. Is your company still at risk from the pension scheme? Have you stalled on your de-risking?

Have you sufficiently reduced the risk of your DB pension scheme disrupting your company? I could have called this ‘LDI and de-risking strategies’ but although neater the longer phrase makes more sense than the jargon.

As many readers will know – and most are HR and Finance personnel — your company’s defined benefit scheme is based on liabilities which constantly change – usually growing larger. This produces volatility in your company accounts and increases the probability that at some stage the company will have to contribute (further?) large sums of money into the pension fund. Thereby diverting investment away from the business.

I recently had the honour of moderating at a conference on reducing risks in DB (defined benefit) pension schemes, which prompted me to write this piece. The conference covered all the potential de-risking strategies, how they should be approached, what current investment and economic conditions imply for this issue, which providers are doing what, and noted the amount of pension schemes engaging with the process.

The issue that I wanted to share here is that although many pension schemes are in fact going down a sensible route of aligning their investments with their liabilities (called liability driven investment or LDI), thereby reducing the long-term risks to the company, the majority of pension schemes are still to start or may have stalled in the early part of the process. Particularly those schemes with under £50m of assets are not tackling the problem, or have not gone very far.

This is likely to be because it’s a complex issue and there is no-one in the company to take charge of it on a day to day basis. (If that is the case then Corpias can do this for you). However the main thing about reducing your pension scheme’s risks is that it’s a journey. Pension schemes should plan the process with the understanding that the alignment of the assets with the liabilities happens in a structured fashion over time and that certain trigger points are set in advance so actions can be taken effectively and efficiently when expected.

The project may be designed like a flight path with a goal of full pension scheme buy-out – meaning it’s no longer your company’s responsibility in x years’ time. (Buy-out is not the only goal, some companies may want to get the scheme into a manageable long term structure which is benign).

Below you have a list of the elements that should be considered.

De-risking project headings

  • Auditing all pension scheme data and ensuring genders, ages and addresses of all beneficiaries, in addition to the other pension calculation elements are present in a data file.
  • Educating the decision makers – trustees, board – about what de-risking entails.(ongoing)
  • Identifying the service providers – consultants, insurance companies, investment managers and which to use and how to use them – and how to get the most help from them.
  • Plan to reduce riskier assets (equities) for safer assets (bonds/gilts) over a period of time.
  • Decide how much risk seeking assets, if any, should remain as a diversifying booster.
  • Learn about and review potential derivative strategies which provide de-risking exposure while improving scheme’s liquidity.
  • Decide and arrange trigger points for de-risking actions such as by solvency level or by date.
  • Pensioner buy in – buy an insurance policy to cover the cost of current pensions (one off or in tranches).
  • Arrange a swap of income streams with a financial institution to compensate for (insure against) unexpected increases in member longevity and changes in interest rates.
  • Monitor how it’s all going regularly and ensure there was appropriate flexibility built in should a course change be necessary.
  • Buy-out scheme with an insurance company or other objective – as chosen.

Thank you for reading