PwC Pensions. Pensions remain a huge challenge for UK employers June 2010

Transcription

1 PwC Pensions Pensions remain a huge challenge for UK employers June 2010

2 Pensions remain a huge challenge for UK employers The economic turmoil of the last few years has meant employers with defined benefit pension schemes are facing significant deficits they need to repair, a range of pension risks that could materially impact the sponsoring business and trustees demanding more cash than ever before. This potent cocktail of issues is further complicated by upcoming legislation that will affect the tax position of higher earners who participate in pension schemes, the requirement to ensure all employees in the workforce are enrolled into a pension scheme, and pension accounting changes that could substantially reduce disclosed profits. Employers are recognising that short-term piecemeal approaches simply will not create a solution to all of these problems. PwC has worked successfully with a significant number of clients to not only fix the issues created by the past, but to find a solution that is future proofed and will ensure employers can continue to help their employees save effectively for their retirement. Eight pension challenges and opportunities for UK employers Key contacts (page 13) Changes to future pension provision 1. New penal pensions tax for higher earners 2. Pensions enrolment costs to bite from Mass closure of defined benefit pension schemes Managing legacy defined benefits liabilities 4. Managing pension scheme cash demands 5. Using non-cash (or contingent) assets for more efficient pension funding 6. Tackling significant risks that pension schemes pose to sponsoring employers 7. Reducing pension liabilities by offering trades to former employees 8. Changing pension financing strategy to reflect accounting changes, which mean higher P&L expense and volatility From April 2011, your higher earners will face a punitive pension tax. How is your organisation preparing for this? How are you preparing and budgeting for additional pension costs and administration to ensure you are complying with new rules to enrol all employees into a pension scheme? How can you manage a closure (or reduction) of your DB pension scheme in a way that preserves employee relations and delivers acceptable financial outcomes? How can you control the amount of cash diverted for pension funding while satisfying trustee and regulatory needs? What have you done to use non-cash (or contingent) assets to save money and reduce trustee cash demands, while enhancing pension scheme security? What is your end game" for managing out pension risk, and what optimal actions could you take to reduce liabilities, deficit and volatility? What steps have you taken to reduce pension liabilities on your balance sheet in respect of former employees? What changes will you make to your pension scheme risk and investment strategies, given the new pension accounting standards? Marc Hommel Peter Woods Peter McDonald Raj Mody Brian Peters Chris Massey Sean Bottomley Vani Thavarajah 1

3 Why employers choose PwC for pensions advice Successful track record addressing the UK s major pension challenges as adviser to many major employers of all sizes in both the private and public sectors, including 38 FTSE100 companies over the last two years. Pensions Adviser of the Year 2007, 2008, 2009, Full breadth of expertise required to tackle today s pension challenges: commercial, regulatory and legal, financial, actuarial, tax, accounting, reward and HR. Named by Kennedy Research as one of only four global Vanguard benefits advisers. Unparalleled knowledge of the UK Pensions Regulator s latest thinking and of the new compulsory pension enrolment rules, through our work with both the Pension Regulator and the Personal Accounts Delivery Authority. Pensions adviser to policymakers and regulators including The Pensions Regulator, Pension Protection Fund, Personal Accounts Delivery Authority, Department for Work and Pensions, National Audit Office. Acted as lead adviser on five out of nine most significant UK pension risk transfer transactions. 2

4 Section A: Changes Section A: to future pension provision Changes to future pension provision 1. Penal pension tax from April 2011 for everyone earning more than 130,000 a year. 1. Penal pension tax from April 2011 for everyone earning more than 130,000 a year. 2. Compulsory pension enrolment from 2012 means increased employment costs and administration. 2. Compulsory pension enrolment from 2012 means increased employment costs and administration % of employers expect to close or change their future defined benefit pension provision for existing employees, to reduce future costs and risks % of employers expect to close or change their future defined benefit pension provision. 3

5 1. Penal pension tax from April 2011 for everyone earning more than 130,000 a year From April 2011, higher-earners (people with income over 130,000 a year) will face income tax of up to 30% on their pension savings, whether made by them or their employer. For example, an executive on 200,000 a year who has a defined benefit pension scheme and gets a 10% salary increase could face an extra tax charge of 46,000. Most-higher earners will no longer want to be in a pension scheme and will expect their employer to provide an alternative instead. The cost for employers of administrative compliance is estimated to be between 800 and 5,000 each year per affected individual. Identify people who are affected, or potentially affected. This cannot be done via payroll alone as the legislation takes into account all income of the individual. Decide whether to offer affected employees an alternative to pensions, such as a cash allowance or an employer payment into other types of (tax-effective) savings vehicles. Determine level of alternative employer payments, eligibility, choice, delivery vehicles and providers. Determine communication strategy to affected employees, including whether to provide access to individual financial advice. Obtain relevant governance sign-offs, including from remuneration committee. Collaborate with trustees and HR on setting up processes to ensure compliance with information requirements to employees. Senior people facing a large and unanticipated tax bill (in addition to recent 50% income tax and National Insurance increases). Talent prised away by competitors who are assertively engaging their senior people on the issue. Employer and employee waste money on continued pension saving that is tax-ineffective. Last minute panic to ensure compliance with new regulations, resulting in sub-optimal solutions. PwC has market leading insight into higher-earner tax regulations and their operation by HM Revenue & Customs and HM Treasury, and has implemented a range of customised solutions relevant to each particular set of circumstances. 4

6 2. Compulsory pension enrolment requirements from 2012 mean employers face increased pension costs and administration UK employers face millions of pounds additional costs from 2012 when they must automatically enrol all employees into a pension scheme and ensure minimum contributions are paid equal to 8% of total earnings. Employers most affected are those with sizeable portions of their workforce currently uncovered by any workplace pension provision or where there are considerable earnings (such as overtime, bonuses, commissions) in addition to basic pay. Retail, leisure and construction will be particularly hard hit, where currently up to 80% of employees are not covered. The cost of compliance is estimated to be 1,000 a year per affected individual, covering the costs of employer payments plus administration. The costs could be substantially higher (up to 3,000 a year) in respect of some employees. Identify cost and administration implications, and type of pension scheme to use to best manage costs. Identify extent to which your current pension arrangements comply or whether additional changes are also needed. Determine what pension vehicle to use to most cost-effectively comply; for example, whether to use one of your existing arrangements or the Government s new National Employment Savings Trust (NEST) arrangement. Determine policy for covering employees who do not currently participate, including level of contributions to be made by employer. Develop a project plan to implement pension scheme and operational changes where needed, to meet timescales set out in the regulations. Unanticipated increases in pension costs that have not been budgeted. Higher costs than necessary. Last minute panic, resulting in sub-optimal solutions. Failure to comply with regulations could lead to financial penalties and reputation issues. PwC has deep insight into auto-enrolment compliance requirements due to close working with both the Personal Accounts Development Authority (PADA) and National Employment Savings Trust (NEST). 5

7 3. 94% of employers expect to close or change their future defined benefit pension provision for existing employees PwC s 2010 survey of 179 employers (including 38 from the FTSE) shows that 94% of employers do not expect to retain their UK defined benefit (DB) pension scheme in its current form for existing and new employees. Many employers are now freezing DB pension accruals for existing employees, having closed DB schemes to new employees some years ago. Defined contribution is becoming the prevalent workplace pension provision but employers will need to ensure employees are saving sufficiently for their retirement to avoid there being an issue in the future of employees being unable to retire. Employers are accelerating their decision-making to accommodate changes in pension tax treatment for higher earners and the requirement to automatically enrol all employees from Determine your policy for the role of workplace retirement provision as part of overall reward. Make a decision regarding closing or amending existing DB pension provision, taking into account impact on employee relations, wider reward goals, pension scheme cash demands and accounting. Recognise that changing DB pensions can be complex and fraught with problems that need appropriate planning and experience to tackle successfully. Plan carefully for stakeholder engagement (including with management, trustees, unions and other employee representatives). Implement new arrangements, likely to be DC, that are durable to changes in legislation and workforce. Recognise that freezing accruals for existing employees only reduces risk and cost for the future. It doesn t address the majority of most pension deficits and risks, which relate to obligations for previous employees. Adding to risks already posed by your legacy DB arrangements Increasing the gaps in the workforce between those with generous and less-generous pension provision. Greater costs and risks than competitors who are taking action. Piecemeal approach to dealing with regulatory changes for higher-earners and auto-enrolment, and for difference in pension treatment for new employees versus legacy employees. Further complexity and management time in future. PwC has advised numerous major employers (including several from the FTSE) on ceasing or restricting DB accrual for active employees, helping employers keep their reputation and employee relations intact. 6

8 Section B: Managing Section 2: legacy Managing defined legacy benefit defined liabilities benefit liabilities 4. Manage increased cash demands of pension scheme trustees needed to plug large deficits. 4. Manage increasing cash demands of pension scheme trustees needed to plug large deficits. 5. Consider use of non-cash and contingent assets to more efficiently fund pension deficits. 5. Consider use of non-cash and contingent assets to more efficiently 6. Take action to reduce the legacy risks that huge pension liabilities pose to the wider business. fund pension deficits. 7. Reduce pension liabilities by offering trades to former employees. 8. Consider changes in pension financing strategy due to accounting changes, which will lead to higher P&L 6. Take action to reduce the risks that legacy pension liabilities pose to expense and volatility the wider business. 7. Reduce pension liabilities by offering trades to former employees. 8. Consider changes in pension financing strategy due to accounting changes, which will lead to higher P&L expense and volatility. 7

9 4. Manage increased cash demands of pension trustees needed to plug large deficits Defined benefit pension costs and deficits have increased due to adverse economic conditions and increasing life expectancy. Additionally, funding deficits have increased as the UK Pensions Regulator is encouraging pension trustees to be more prudent in the calculation of pension liabilities, and at a time when asset values are relatively depressed. Trustees are demanding more company cash to plug deficits, in competition with payments to other creditors, bonuses to the workforce and dividends to shareholders. Companies face a choice between diverting cash from other business priorities, or taking decisive and upfront action to control pension scheme cash commitments. Take an assertive and integrated approach to scheme funding negotiations with trustees taking account of desired benefit changes, risk and investment strategy and cash availability. Ensure you are asserting to your trustees the strength of the covenant offered by sponsoring employer in order to avoid undue prudence in the calculation of pension liabilities. Help your trustees understand what cash is available for pension funding, and the justification for limits. Assertively manage trustee negotiations to ensure the timeframe for reducing the deficit is realistic. Cash contributions can be supplemented by using value from property, receivables, brands, guarantees, licences and trademarks. Use different advisers than those used by the trustees to avoid conflicts and ensure independent perspectives allow your interests to be best represented. Paying more money than necessary into the pension scheme, negatively impacting other business priorities, dividends, credit rating and bonuses. Companies will face limitations to strategic business activity, including acquisitions and capex. Wasted management time in finding superficial short-term fixes for symptoms rather than robust long-term solutions for the cause. PwC s insight into The Pensions Regulator has been cited by several clients as instrumental in assisting them achieve their desired outcomes following difficult and complex negotiations. 8

10 5. Consider use of non-cash and contingent assets to more efficiently fund pension deficits Pension scheme trustees are demanding more cash to plug increased deficits at a time that cash is in short supply and expensive to borrow. Employers can make savings of up to 30% in long-term costs by using tax-efficient structures for non-cash pension funding, while also enhancing the security of the pension scheme in the event of employer default or insolvency Solutions have used a variety of non-cash assets including real estate, in-specie investments, receivables, brand and stakes in subsidiaries. Identify whether the use of non-cash and/or contingent assets for pension scheme funding purposes will result in more optimal use of finance. Identify whether such assets are available and under what circumstances. Ensure the structures are considered as part of the overall pension scheme funding negotiations with pension scheme trustees. Design a solution that, while being acceptable to the trustees and Pensions Regulator, meets the company s commercial objectives including impact on other creditors, tax, accounting, credit rating and attitude of investors. More cash than necessary is paid into the pension scheme, reducing availability of cash for other purposes. Missed opportunity for significant savings arising from better use of cash elsewhere in the organisation and acceleration of tax deductions. Negative impact on ability to pay dividends, bonuses and refinancing. Missed opportunity to make better use of assets on balance sheet; e.g. FSA regulated entities such as banks and insurers can use capital inefficient assets to fund pension deficit improving regulatory capital position. PwC has advised 33 organisations on non-cash funding, implementing nine different arrangements customised to the particular circumstances of the employer and pension scheme, comprising 5 billion of transactions. 9

11 6. Take action to reduce the risks that legacy pension liabilities pose to the wider business Most CFOs are grappling with the pain of unpredictable and volatile pension deficits, which have been growing due to adverse investment conditions and people living longer. These growing and volatile deficits pose huge risks to sponsoring employers. In addition to creating additional cash demands, they can negatively impact dividends, credit rating, accounts, ability and cost of refinancing, and the ability to carry out desired corporate transactions. Many companies have closed existing defined benefit schemes to new recruits and, in some cases, to existing employees. But these actions are insufficient to reign in the considerable risks posed to the wider business by legacy pension liabilities. There is increasing desire to remove pension risk completely by taking action to reduce liabilities, deficit and volatility. However, employers need a strategy and methodology for determining optimal actions, and the best time to transact as otherwise this can be expensive and not economically justifiable. Determine key objectives and constraints for financing legacy pension obligations: What contributions are affordable in future years? What is the maximum P&L pension expense that can be sustained? What pension deficit on the balance sheet can be tolerated? What is the realistic end game? Put a plan in place with the trustees to implement the actions required when market conditions are such that they become affordable. Increasingly volatile pension deficits, which will impact balance sheets, profits, cash availability, credit rating, dividends and shareholder returns. Severe restrictions on re-financing, M&A and business restructuring. Disproportionate absorption of management time. More difficult relationships with trustees. In extreme cases, business failure. PwC has acted as lead adviser on five out of the nine most significant UK risk transference transactions, and has a strong reputation for negotiating innovative pricing and security deals for sponsoring employers and their trustees. 10

12 7. Reduce pension liabilities and risks by offering trades to former employees The bulk of defined benefits liabilities sitting on employers balance sheets relates to former employees, called deferred and current pensioners. Pension liabilities relating to these former employees have grown due to increasing expectations of longevity. In 2010, a man age 65 is expected to live 22 years relative to 15 years in 1990, resulting in an estimated 25% increase in pension liabilities. The performance of assets earmarked to pay for these benefits has been erratic and volatile. It is possible to offer deferred pensioners (people who have left employment but not yet retired) the option of transferring all or part of their pension liability elsewhere. Current pensioners can be offered the option to take a higher pension now in exchange for giving up future pension increases. Assess feasibility of offering enhanced transfer values to deferred pensioners and pension increase trades to current pensioners. Identify the possible savings on cashflows, P&L expense, balance sheet provisions, funding deficits and insurance buy-out costs. Identify the market conditions that must be met to make a liability reduction offer economically beneficial for both the employer and the members being asked to make a decision. Timing is key, so employers need to plan in advance to be able to move quickly when market conditions are favourable. Ensure data relating to deferred and current pensioners is as complete and up-to-date as possible. Engage trustees in advance so that any approvals they need to give have been dealt with. Ensure sufficient budget and attention is paid to quality of communications and advice to individual members who are being made the offer so that they can make well informed decisions. Retaining huge liabilities and their risks on your balance sheet. Risking the consequences of continuing increases in life expectancy and volatility in liabilities and assets. More expensive costs of eventually transferring liabilities to an insurance company as your defined benefit pension scheme approaches its eventual exist goals. PwC has acted as lead adviser on the first ever FTSE100 pension increase trade programme for current pensioners and the first ever FTSE100 enhanced transfer value programme for deferred pensioners. 11

13 8. Consider changes in pension financing strategy due to accounting changes, which will increase P&L expense and volatility From 2013, companies will no longer be able to take credit in the P&L for expected pension fund equity investment out-performance thus creating higher pension expense in financial statements. For example, a company with 1 billion of pension scheme assets invested in equities will see P&L expense rise by about 25m a year. In addition, gains and losses will have to be fully reflected in the balance sheet leading to increased volatility. For the first time, companies will need to make disclosures in the accounts about risks posed by the pension scheme to the sponsoring business. Estimate impact on the balance sheet and P&L. Consider whether the accounting changes impact your desire for addressing pension scheme risk and changing pension investment strategy and whether such actions should be accelerated. Consider whether there are any consequences for incentive plans, dividends and debt covenants, and regulatory capital for insurers and banks. Difficult conversations with investors about unexpected impact of higher P&L pension expense and greater balance sheet volatility. Increased pressure from investors to address risks posed by the pension scheme to the sponsor s business. Missed opportunities for better management of the pension scheme. Unexpected consequences such as incentive plans not paying out, breach of covenants and inability to pay dividends. PwC audits the financial reporting and disclosures of 40% of the FTSE 100, including those with the largest UK pension funds, and provides advice on pension, financial and risk management strategies to these and a large number of other organisations. 12

14 PwC contacts London & South East Rosie Blackham +44 (0) Richard Cousins +44 (0) Marc Hommel +44 (0) Jonathon Land +44 (0) Chris Massey +44 (0) Raj Mody +44 (0) Brian Peters +44 (0) Jeffrey Rowney +44 (0) Vani Thavarajah +44 (0) Alex Wilson +44 (0) Midlands Jeremy May +44 (0) North-East Sean Bottomley +44 (0) Chris Ringrose +44 (0) Peter Woods +44 (0) North-West Peter McDonald +44 (0) Northern Ireland Mark McClintock +44 (0) Scotland Richard Slater +44 (0) Wales & West Mark Packham +44 (0) Uxbridge Mark Harris +44 (0) This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtain ing specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. PricewaterhouseCoopers provides industry-focused assurance, tax, and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 155,000 people in 153 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.