After a busy year in the world of pensions with new pension stories hitting the industry almost every week, 2014 won’t be any different according to Towers Watson. The firm believes there will be some key trends during 2014.
Risk transfer transactions – You ain’t seen nothin’ yet
Off the back of the biggest year ever for bulk annuity and longevity swap transactions in 2013, we expect that volumes will grow further in 2014. This will be driven by both the steady increases in the number of schemes exploring these markets and by a number of large schemes which are contemplating ‘mega deals’.
The glass ceiling of around £1bn for bulk annuity deals (which existed since the Cable & Wireless transaction in 2008) was chipped by recent transactions including the 1.5bn buyout of the EMI scheme, but will be smashed by significantly larger deals in 2014. Longevity hedges are also set to get supersized, made possible by the innovative structures being used to facilitate risk transfer to the reinsurance market.
Sadie Hayes, transaction specialist at Towers Watson, said: “Many of the UK’s largest pension schemes have been watching the bulk annuity market and longevity swap markets develop in recent years and 2014 will be the year that many of these schemes choose to get involved. While for some it will be a toe in the water, others are looking to dive in.”
DC charge cap – it’s coming
It looks inevitable that charges in DC schemes will be capped. The Government’s consultation is about how to cap them, not whether to cap them, while the Prime Minister has already tweeted that ‘we’re capping pension charges’.
Will Aitken, senior DC consultant at Towers Watson said: “The Regulatory Policy Committee said the DWP’s impact assessment was not ‘fit for purpose’ because of the assumption that charging people less would not cost providers anything. Putting a proper number on the cost to providers may make it harder for DWP to hit its deregulatory targets but we don’t expect it to derail the policy.
“What’s not clear is how worried the Government is about making providers revisit existing schemes during the automatic enrolment capacity crunch. Steve Webb’s recent suggestion of a cap that falls over time might be designed to ease that tension.”
Automatic enrolment – different employers, same story on opt-out rates
Automatic enrolment will enter a new phase. At the end of 2013, only firms with 500 or more staff were implementing automatic enrolment; by May 2014, firms with as few as 90 staff will start to comply.
Will Aitken said: “Although smaller employers are more likely to limit contributions to the minimum levels required by law and might put less effort into communications, we expect opt-out rates to remain very low. More of the employees being enrolled this year will be people who never previously had access to an employer contribution but would have signed up to join a scheme if one was available.”
DB scheme reviews to trigger more closures
With the clock ticking before National Insurance rebates disappear in April 2016, employers who still have staff building up new entitlements to defined benefit pensions will start deciding what to do. They have three options: swallow the cost, pass it to employees by reshaping benefits or raising contributions, or just shut the scheme down.
John Ball, UK head of pensions at Towers Watson said: “The defined ambition agenda might give employers more flexibility over how they reshape benefits but scheme closure will start as the favourite in many boardrooms.”
Pension Protection Fund levy changes to create winners and losers
The levy invoices that some employers receive from the PPF this year will be affected by changes to how their risk of insolvency is assessed.
Joanne Shepard, senior consultant at Towers Watson said: “The PPF’s decision to use Experian instead of D&B to grade employers will not affect levy bills until 2015/16. However, two changes are being made this year that will also create winners and losers. D&B is changing how it produces ‘failure scores’ in time to affect the last two or three of the 12 monthly scores that will feed into the 2014/15 levy and the PPF has changed the way in which parental overrides impact the PPF failure score. Where either of these changes push an employer from one levy band to another, it could have a significant effect on how much they have to pay. ”
Shoring up pension benefits promised in the past remains a major challenge for employers, with recent analysis suggesting that this helps explain the slow wage growth seen in recent years.
John Ball said: “The rules of the game will change in 2014, with the Regulator being given a new objective to ‘minimise any adverse impact on the sustainable growth of an employer’. The Regulator has also outlined a new approach to regulating scheme funding that puts more focus on the cash going into schemes. Some employers may be disappointed that the Regulator has not tilted its public statements further in their favour but how it polices funding agreements in practice will be more important than what it has said.
“We expect more use of asset-backed funding, which can be a ‘win-win’ solution where the asset provides real security in the event of employer insolvency. Some employers and trustees who decided not to be trailblazers for this approach at their last valuation will be more comfortable with it now. When approaches start to become mainstream, they can get a momentum of their own.”
State Pension reform: younger workers can expect to get less, later
Parliament is expected to sign off the single-tier pension and a system of regular reviews of the State Pension Age, meaning that younger workers will build up smaller State Pensions that kick in at older ages.
John Ball said: “How quickly the State Pension Age rises under these reviews depends on future government policy and life expectancy projections, both of which will change. Under current policy and assumptions, it would reach 68 by 2036, 689 by 2049 and 70 by 2063.
“The State Pension system was made more expensive just before the financial crisis, so it was inevitable that the next set of reforms would take things in the other direction. Younger workers can console themselves that smaller State Pension promises are more likely to be delivered, though it would be naïve to imagine that there will be no further changes. They may find it harder to understand why, while their State Pensions are being cut on affordability grounds, older colleagues who spent a lot of time contracted out into final salary schemes or personal pensions will get generous top-ups in return for the NICs they pay after 2016.”
Tax relief: decision time for high earners
The Annual Allowance and Lifetime Allowance are being reduced (to £40k and £1.25 million respectively), so some people who did not previously have to worry about these restrictions will now have to.
Jackie Holmes, senior consultant at Towers Watson said: “Although the tax rates are punitive, some people could still be better off exceeding these limits and paying the tax, especially where the offer from the employer is ‘pension or nothing.
“Even where an employer does provide an alternative to pension for members who wish to avoid breaching the AA/LTA there could still be unfortunate tax consequences if the member dies. Where death-in-service lump sums exceed the Lifetime Allowance a charge is payable on the excess, and greater use may need to be made of alternative life assurance policies.”