RAILWAYS PENSION SCHEME VALUATION UPDATE

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1 TSSA Rep s Bulletin Ref: PEN/008/JAN2003 RAILWAYS PENSION SCHEME VALUATION UPDATE INTRODUCTION In the last RPS Reps' Bulletin (PEN/007/MAY2002) we highlighted the fact that following the latest triennial of the RPS that contribution rates, for both employers and members could increase for the majority of Sections. Currently, the pension committees in the ninty odd Sections (Because of the different rules of the 1994 Pensioners Section, much of this Bulletin does not apply to the 1994 Pensioners Section) of the RPS will be considering the results of the latest valuation of December This Bulletin, using the Actuary's January 2003 Valuation Report, seeks to explain the purpose and thinking behind the valuation and advises how members can participate in consultative opportunities about their pension. PURPOSE OF THE ACTUARIAL VALUATION Clause 6B of the Pension Trust requires the Trustee to obtain actuarial valuations from the Actuary at intervals of not more than three and a half years. This was the third valuation of the RPS, the previous valuation having been carried out as at 31 December The actuarial valuation must be presented to allow each section to be considered separately. Before preparing the valuation, the Actuary must consult with the Trustee, the Designated Employers and the Pension Committees, including consulting on the basis, methodology and assumptions. This consultation took place between October 2001 and May For the Shared Cost Arrangement, Rule 20 (Surplus Assets) and Rule 21 (Shortfall) describe the main purposes of the valuation. The valuation must show, for each section, whether "the assets together ith future income and future contributions are likely to be sufficient to provide the benefits for and in respect of members". If this is the case, then rule 20 states that the Designated Employer and the Trustee and the Pension Committee may agree to use some or all of the surplus assets in some way consistent with Inland Revenue approval, unless the Actuary determines the surplus is trivial or that it would be prudent to retain that surplus within the section. If the valuation reveals a shortfall the Designated Employer and the Trustee (including the Pension Committees) will seek to agree a way of making good the shortfall, subject to actuarial approval. If there is a failure to agree be a certain date then Rule 21 is triggered, which specifies mandatory actions for contribution increases for employers and employees (with employers' contributions reverting to 1.5 times those of members') and ultimately, for reducing benefits for future service. OTHER PURPOSES OF THE VALUATION These largely relate to additional legal requirements, including certifying to the

2 pension and revenue authorities that the valuation does not mean that assets exceed tax relief levels and meets the statutory minimum funding requirement (MFR). HOW THE VALUATION IS CALCULATED Use of market values As the primary purpose of the valuation is to assess the ongoing financial status of each section, this requires an assessment of the future investment income from both the existing assets and future new investments. The market value of the existing assets at the valuation date is known, together with the market-related yields available at that time. These can be used to assess the likely level of future income from the investments including the profits if assets are sold. This is what the Actuary calls the 'assumed rate of return'. A similar process is used to assess the likely level of return, from future new investments, although here the Actuary will emphasise more the likely future market yields, instead of those applying on the valuation date. This assumed rate of return on the existing assets is used to calculate the capital value of the accrued liabilities and contribution reserves, and the assumed rate on new investments is used to calculate the normal contribution rate. The value of accrued liabilities (the benefits arising from service before 31 December 2001). These are: Pensions already in payment deferred pensions for former members who have left service Benefit rights earned in respect of membership up to the valuation date by members in service. The valuation involves the projection, for each future year involved, of the anticipated benefit pay outs for the past service benefit entitlements described above as at the valuation date. The projected amounts are then discounted to a capital value at the valuation date using the assumed rate of return on the existing assets. This is then compared to the market value of the assets at that date. This differs presentationally from the approach used in 1998 because of subsequent changes in accounting rules. The 1998 valuation used the assumed rate of return on new investments to calculate the discounted capital value of both the accrued liabilities and the existing assets. The change in method for this valuation has no effect on the calculated funding level. The normal contribution rate needed to meet the cost of the future accrual of benefits arising from members' service after the valuation date. The Actuary, for a stable membership (whose age, sex and pay profile is unlikely to change materially) normally uses the 'projected unit' method of calculating the contribution rates require for future service benefits. This calculates the capital cost of the projected future benefits arising from the single year of service following the valuation date, and expresses this cost as a percentage of current Section Pay. However, if say the age profile of a Section was expected to rise over time (perhaps because the Section had been closed to new members), then the Actuary normally uses the 'attained age' method to calculate a stable contribution rate. This projects benefits arising from all future service (not just one year's service) and therefore anticipates the increasing costs which would be expected to emerge over time. 2

3 The normal contribution rate represents the year on year cost of providing the Scheme's standard benefits. No allowance is made for employers' BRASS contributions for members commencing BRASS contributions at a future date - any such employers' BRASS contributions would be an additional cost to the normal contribution rate. Contribution reserves. Having calculated the normal contribution rate required to meet the future service benefits, an assessment is made of the impact of existing contributions being paid. For about half the sections this is the reduced rate of 12.5% (joint) until September This is the period over which reduced contributions were projected to be payable following the 1990 valuation of the BR Pension Scheme, and was reflected in the 1993, 1996 and 1998 valuations. For the remaining Sections, other contribution arrangements have been implemented, arising from the distribution of surpluses following the 1996 and/or 1998 valuations. These arrangements generally comprise reduced contribution rates for the employer and/or members until a specified date. The capital value of the shortfall in contributions over the period to 30 September 2003, or other period agreed following the 1996 or 1998 valuation, is calculated using the methods described above) and counts as an additional liability of the section. The Actuary has used the attained age method for closed sections to calculate a stable contribution rate. In the initial years following closure this will normally result in part of the contributions being used to build up a "stabilisation reserve". This will be released in later years to allow a stable contribution rate to be maintained despite the increasing average age of the membership. STOCK MARKET VOLATILITY Since the valuation date equity markets have fallen significantly, resulting in corresponding falls in the market values of sections assets. This in itself is not a reason to panic. The effect on the ongoing financial position of each section will depend on the extent to which the fall in markets produces a reduction in the long-term income (and ultimately sale proceeds) from equity investments. In other words this fall in asset value may be offset, when assessing the affect on the ongoing funding level, by an increase in the assumed future rate of return on those assets used for valuing the corresponding liabilities. It must also be remembered that the Actuary has included a "significant margin of prudence in the assumed rate of return on the existing assets at the valuation date". Nonetheless, the Actuary concludes there is "undoubtedly pressure on sections' ongoing financial position" because of stock market decreases post-valuation. The Actuary has advised the Trustee, that for those sections in surplus overall, after allowing for contribution reserves, "should consider carrying forward some of the surplus unutilised, subject to specific advice based on each section's specific circumstances". For sections with a shortfall relative to accrued liabilities (ie. before allowing for contribution reserves), "a substantial part of the shortfall should be met by additional contributions over a period not longer than five years, again subject to specific advice based on each section's specific circumstances". ACTUARIAL ASSUMPTIONS For the valuation the Actuary will make assumptions regarding the following 3

4 factors which affect long-term expenditure and income for each section. Demographic factors Mortality rates, withdrawal and retirement of serving members. Rates of retirement of deferred pensioners. Mortality rates of pensioners and other beneficiaries. Allowance for promotional salarly scales reflecting increasing age and responsibility (additional to the general increases below). Proportions of members who have dependants at death or retirement, the relative ages of husbands and wives, and the numbers and ages of children eligible for benefit. Financial factors Rate of escalation of general levels of pay. Rate of increase in the State Basic Pension. Rate of increase in price-indexed pensions. Rate of return on existing assets. Rate of return on new assets. WHAT HAPPENS NEXT? Under the Pensions Act, each shared cost section must prepare a Schedule of Contributions. It must cover the next 5 years and be agreed by the Trustee (& Pension Committees) and the employers on or before 25 February This schedule must specify the contribution rates payable by the Employers and members, and these rates must be certified by the Actuary as being appropriate to meet the statutory Minimum Funding Requirement. This certification must be given by 25 March IF A SECTION HAS AN OVERALL SHORTFALL For these sections, the Schedule will include the adjustments to the contribution rates to meet this shortfall if these have been agreed. If they have yet been agreed, an interim Schedule will be implemented which comprises the contribution rates currently payable. A revised Schedule will then be prepared (and re-certified) when agreement has been reached on funding the shortfall, or Rule 21 is triggered, no later than 30 June IF A SECTION HAS AN OVERALL SURPLUS The Schedule will comprise the contribution rates currently payable (reverting to the normal joint rate, as reassessed at this valuation, at the dates currently specified) plus any additional contributions required to satisfy the MFR, and will be amended (and re-certified) if necessary as and when agreement is reached on any utilisation of the valuation surplus. WHAT TSSA RPS MEMBERS SHOULD DO Though the RPS rules do not explicitly oblige employers to consult employees the Trustee expects all members to be consulted to ensure that the interests of all involved have been taken sufficiently into account. If the TSSA has collective bargaining rights with your company, then pension arrangements are included in TSSA s negotiations. But if you are unclear what the Valuation means for you and your Section the most important thing to do is to get involved - ask your employer for a copy of the valuation report for your Section - they are legally obliged to do so. Contact us, through a workplace rep, your Negotiations Officer or by phoning the Helpdesk and ask what is the appropriate way to initiate discussion with your employer. If a collective agreement between TSSA and your company does not yet exist, 4

5 write to your employer to inform them of your concerns and request they discuss this matter with your union. WHAT ARE SOME OF THE ISSUES? Your main objective should be to seek a phased increase in contributions if your Section is in shortfall, rather than a step increase. This will mean contributions are fairly shared and your employer is not enjoying a contributions holiday at members expense. Remember that increases should maintain the 40/60 ratio and as you share the funding costs it is only right that your company should meaningfully consult you on how a shortfall or surplus is handled. Though rectifying a shortfall is an important matter it should not be agreed hurriedly or under pressure - under Scheme regulations, Rule 21, which stipulates what must happen if agreement is not reached, only kicks in on 30 June Clearly your Employer has sufficient time to consult you and your union meaningfully on what is one of your most important terms and conditions. Two thirds of the Sections are over 100% funded. For those schemes that are currently funded at less than 100% there is no genuine cause for alarm. It is quite natural for pension contribution rates to vary over the considerable time period that characterises pension provision. The contribution rates now needed are very similar to the contribution rates paid up to the late 1980's before very strong equity returns on RPS investments allowed reduced contributions because of consistent surpluses. 5