Category: Uncategorized

EU Gender Directive – important update

The Court of Justice of the European Union decided today that insurance companies are no longer allowed to use gender as a factor for assessing risk. This change is effective as of 21st December 2012.

This means that from that date the rates for all types of insurance eg life, motor, incapacity will be the same for men and women. It will also affect annuity rates. Mostly, women will be disadvantaged by this since they benefit from better current rates due to their greater longevity and the fact that contrary to popular rumour about women drivers they constitute a lower moral hazard to motor insurers.

The bizare aspect about this Euro nonsense is that age discrimination still appears to still be allowed when it is now banned in many countries such as the UK.

Changes to Early Retirement Rules

On 6th April 2010 the minimum age at which you can access your pension benefits will increase from 50 to 55.

Both your employer’s pension schemes (past or present) and any individual pension plan’s you hold will be subject to the new rules. From 6th April 2010 therefore, you will not be able to access pension benefits unless you are at least age 55.

There are some very limited circumstances where retirement prior to age 55 will still be allowed after this date which are detailed below:

1. Some sportspeople/those in hazardous occupations or those who had a ‘contractual right’ to an early retirement age as at December 2003.

2. Those individuals who are in ill health can still apply to take benefits early and the scheme trustees will determine, following a medical report, whether it will be granted.

In the majority of cases, it is more worthwhile to leave your pension benefits to grow for as long as possible. However, if you need to access some or all of your pension benefits early, between the ages of 50 and 55 you should contact your financial adviser as soon as possible for further guidance.

For the avoidance of doubt, this could affect you if your date of birth is between 7th April 1955 and 5th April 1960.

Top firms’ pension funds plummet

The BBC today reported that the top 100 UK firms have a combined shortfall on their Final Salary pension funds of £96Billion (yes Billion!). This represents a deterioration from a combined deficit of £41Billion at the same time last year. Most of the fall in value has been attributed to falls in share prices but changes in the assumptions, which are used to determine the level of funding needed to meet promised benefits, have also had a significant bearing. In some cases the value of the underfunding actually exceeds the value of the company.

The BBC article goes on to suggest that this will lead to more schemes being closed to new members. Of the top 100 companies, only three still offer Final Salary Pensions to new members. If you are interested, they are Cadbury, Diageo and Tesco.

What the article does not mention is that there are many more Final Salary pensions, mostly held on behalf of small to medium sized employers (and most people in Britain work for one of these rather than a top 100 firm). These will also be suffering from substantial deficits. The difference between a lot of the smaller firms and the top 100 firms is that they are often privately owned and therefore do not have the same access to additional capital as companies that are quoted on the Stock Exchange.

The issue with the smaller companies, who will be feeling the pinch every bit as badly at the moment is that, they are more likely to go bust and therefore be unable to make up the under-funding on their pension funds. Where this occurs the benefits will come under the auspices of the Pension Protection Fund, about which I have blogged before Protection for Final Salary Scheme Benefits could be under threat.

To cut a long story short, the PPF provides limited protection which, over time, can fall substantially short of what was originally promised. Furthermore, due to potential difficulties with funding the protection (based on levies charges to the remaining schemes which are already in financial difficulties) PPF benefits could need to be reduced in future.

So what should you do if you have final salary benefits either with your current or a previous employer? Well, for certain you should obtain details of the Transfer Value and the benefits to which you are entitled. These should be reviewed on your behalf by a pensions specialist (who will also take a whole range of other factors into account such as the state of funding of the scheme and the financial health of the sponsoring employer, amongst others). From this you will be able to form a realistic assessment of the safety of your benefits and whether you ought to move them to an arrangement that provides you with greater personal control.

If you are a financial adviser reading this article and you are not qualified to provide Pension Transfer Advice, consider referring your clients to an adviser who will work with you to ensure that your client’s needs are met in this regard.

Acts of Commission make you feel worse than Acts of Omission

Take a look at this 5 min video about Dollar Cost Averaging by Professor Kenneth French.

Dollar (UK investors should read Pound) Cost Averaging, in this case refers to lump sums available for  investment which, instead of  immediately being fully invested in the markets, are allocated over a series of months. The objective is to avoid being caught out by sudden market falls shortly after making the investment. In the UK we call this ‘Phased Investment’.

Interestingly, Prof French  reinforces the academically accepted view that Dollar Cost Averaging does not optimise returns, given the level of risk that an investor wishes to take. When considered purely from a finance perspective, if the right thing to do, in order to deliver a set of goals, is to invest in an equity portfolio, then it should be implemented in full, immediately. Market timing has been shown to contribute very little to returns and as a consequence there is no good reason to delay.

But, is this always right? Well ,Prof French observed that, from a behavioural finance point of view, it may be a good thing. People apparently feel worse about the negative outcomes from acts of comission (things they did) than they do about acts of ommission (things they didn’t do). Hence an investor feels a lot worse about the fact that his portfolio plummeted shortly after investing the money that he does about the returns which he failed to make because he didn’t invest the money.

On balance, Prof French concludes that, even with his finance professor’s hat on, the damage to prospective returns caused by Dollar Cost Averaging is very little, so it makes little difference whether investors use it or not. However, he observed that it may give them an experience that they feel better about.

Ultimately as investment professionals and, especially as financial planners, we do need to step outside of the theoretical world of optimised portfolios and look at things more closely from our client’s point of view. If doing things that are theoretically sub-optimal but not actually damaging makes our clients feel better about what they are doing then there is no good reason not to facilitate this. After all we are not on some kind of Evangelical mission to convert the pagan unwashed. Oh, and it is their money…. not ours.

Interesting huh!

Inadequate Protection When Final Salary Schemes Close

Final Salary Scheme Closures

In a recent survey nearly a third of employers indicated that they intend to freeze their final salary schemes to existing members and over 80% had already closed the schemes to new members. In addition, the Pension Protection Fund (PPF) recently indicated that collectively the UK’s final salary schemes have a shortfall against the amount needed to provide members benefits of £179.3Billion.

What is this article about?

This piece looks at the reality of the protection provided by the Pension Protection Fund. If you want to be spared my verbiage and cut to the Conclusions

Final salary schemes have traditionally been described as guaranteed on the grounds that the benefits provided by them are ‘guaranteed’ by the employer. In any case, if the employer went bust, benefits would be protected by the PPF. Correct?

Well, not quite. Whilst those who had already retired and reached their scheme’s normal pension age when their employer went bust will receive 100%of their entitlement, others will receive 90% of a their entitlement subject to maximum pension of £28,742.68. This equates to the maximum pension an individual earning £43,115 would receive after 40 years service assuming that their entitlement builds up at 1/60th per year of service (which is commonly the case with this type of scheme). Individuals with a greater pension entitlement than this will have their benefits reduced to £28,742.68.

Many readers who are not lucky enough to be on high earnings or who don’t have a large pension entitlement may conclude that they are pretty well protected by the scheme since it provides 90% of their pension entitlement. Unfortunately, especially for those with some time to go, before they are due to retire, there are a couple of other catches with the ‘protection.’ One of these is that the option of early retirement is lost. PPF Benefits are only payable at the original scheme’s normal retirement age, typically 65. Forget heading to Spain at age 55!

The other catch, which is more subtle but, in the long run highly damaging to the level of benefits actually paid out, relates to the level at which the pension entitlement increases in the time before retirement. Since the Social Security Act 1990 came into effect all benefits must be increased between leaving service and retirement by RPI, subject to a 5% pa cap. This means that deferred pensions are substantially inflation proofed. However if the scheme comes under the auspices of the PPF the rate at which deferred pensions increase is capped at 2.5% per annum.

In common with many financial calculations, the effect of a 1-2% reduction to pension increases in deferment may be difficult to see. However, this is perhaps best illustrated by the rate of return (commonly called the ‘Critical Yield’) required to match final salary scheme benefits given up in the event of a transfer. Without going into the full details of final salary pension transfers, returns of 6-7%pa are usually required to match scheme benefits in the event of a transfer. However, in a number of cases I have recently looked at, returns of around 3-4% are required to match PPF benefits. This means that the PPF benefits, which need to be targetted, are substantially lower than the original entitlement. In addition, whilst it may be borderline to transfer for the purpose of beating original benefits, even for relatively risk averse individuals the chances are fairly good that PPF benefits would be exceeded.

It would be remiss of me not to point out there there is a great deal more to final salary pension scheme transfers than this and it is essential that professional advice from an appropriately qualified pension specialist be sought before making any changes to pension benefits.

Summary

The Pension Protection Fund provides limited protection at best in the event that an employer with a final salary pension scheme goes bust. Benefits are capped and higher earning employees could stand to lose a substantial amount. Early retirement is not available and benefit increases, before and after payment, are subject to a low cap. PPF benefits are funded by way of levies from other pension funds and if there is a shortfall benefits could be reduced.

Conclusion

Anyone with final salary benefits should arrange for these to be reviewed by a specialist pension consultant, especially if they are fearful of the financial strength of their ex-employer. Once an employer goes bust it is too late.