Publications

Bulletin 21 Autumn/Winter 2003

BESTrustees has been issuing bulletins on an irregular basis, when we have something to say, for eleven years now – this is issue twenty one.

We have tried to provide information that trustees, pensions managers and their advisers will find interesting and useful, without the immediate pressure of it being time critical. This is the first bulletin that runs to eight pages and, continuing the discussions that all trustees have had following the Myners review, our major articles discuss business plans and non investment risk assessment. We also look at the tax treatment of swaps as potential investments, an interesting defence against being forced to produce information under the Data Protection Act and Equitable Life AVCs’.

We have deliberately avoided commenting on the various simplification proposals as the broad thrust is well known, but detailed regulations are still awaited.

If any reader has ideas for future articles, please let us know.

Equitable Life AVCs

In a recent case the Ombudsman was sympathetic to the difficulties faced by trustees in deciding how to deal with AVCs held with Equitable Life. Despite taking 15 months to appoint a new AVC provider and transfer members across, the trustees in this case could not be criticised for the delay, particularly as they had followed professional advice.

The member had complained that although Equitable Life closed its doors to new business in December 2000, the trustees did not allow members to make individual transfers of their Equitable Life AVCs until November 2001. By this time exit penalties had increased and policy values reduced. The trustees considered the issue of individual transfers but, because of uncertainty over whether individual transfers would prejudice a later bulk transfer, they chose not to allow them.

The Ombudsman did not uphold the member's complaint. He decided that the trustees were not at fault, nor was there any maladministration in taking 15 months to transfer AVCs to a new provider. A key point was that the trustees had obtained advice on a regular basis which advised that it would not be prudent to take precipitate action. The advice was not obviously inappropriate and it was entirely reasonable for the trustees to act in reliance upon it.

‘Trustees should draw up a forward looking Business Plan’. Discuss

Sound like an examination question? No it’s part of one of the Myners’ Principles accepted by the Government in November 2001. The Treasury is now in the process of checking on how far this and the remainder of the principles have been adopted by trustees. With little written guidance on this subject a panel of experienced professionals met to come up with some thoughts on the subject. It is hoped that these might direct trustees to issues they should look at in the context of managing their pension schemes over the longer term.

A 'Business Plan' for trustees

Several terms were considered by the panel including ‘Management plan’, ‘Governance plan’ and ‘Business plan’ considered several terms. After considerable debate, it was decided that ‘Business plan’ was the most appropriate term to be used.

Why have a plan at all?

Whilst most trustee boards have considered the applicability of Myners’ recommendations to their schemes relatively few have formally set out a Business Plan in writing. Those that have done so have tended to focus on the investment aspects. However a good Business Plan should cover the whole of the trustee operation.

Clear advantages flow from the preparation of a plan, such as: -

Enabling trustees to be proactive in highlighting issues which need attention;
Identifying the trustees’ scope of responsibility by developing a schedule of activities and meetings not only for the year ahead but also for the longer term covering the normal pension cycle
Enabling the effective direction of and delegation of responsibilities to Pensions Managers and Scheme Administrators
Setting out aims and objectives covering such vital issues as
- Relationship with the Sponsoring Employer
- Funding strategies and basis for monitoring their effectiveness
- Determining and defining the different ‘risks’ involved and ensuring plans are in place so far as possible to control such risks
- Communicating with members, employers, administrators and advisers
- Administration
- Compliance Training

Relationship with the Sponsoring Employer

Establishing and maintaining a good relationship with the Sponsoring Employer is an important objective. Not only is it important that trustees understand the nature of its covenant, but also its longer-term aims. What would be the position of the scheme if its aims change? It was always the position that the health of the pension scheme had an effect on the employer’s fortune. In the past the employer’s position and its covenant were largely taken for granted. Conditions are now very different; deficits are more common than surpluses; accounting practices (FRS 17) have focussed on pension fund liabilities and shareholders are looking through to pension funds and worrying about the implications for companies in which they invest.

This relationship with employers will become much more high profile when it becomes necessary for trustees to enter into negotiations with them to agree the Scheme Specific Funding Plan that is shortly to replace the Minimum Funding Requirement (MFR). The perspectives of the employer may well turn out to be different to the objectives of the trustees but it is important to establish common ground to try to spell out the agreed objectives in the Business Plan so trustees and the employer agree, what they need to achieve.

Funding strategies

It is clear that these should be set out in some detail. We already have the Statement of Investment Principles, with the Funding Plan to come. These notwithstanding, trustees need to establish an appropriate funding strategy. This, in the context of contribution rates and asset allocation, will aim to achieve the principal goal of providing the benefits due under the scheme to the members when they are due.

Of course the actuarial valuation will give a guide to what is required long term taking account of current deficit or surplus. What asset classes will be used and in what combinations? What freedom to operate will any investment managers have? Will an investment sub-committee be appointed and on what terms? Will this sub-committee be the focus for providing recommendations to the trustee board or will it have some executive powers? These need careful consideration. The manner of monitoring this investment activity should be set out and agreed with the investment managers and advisors so there is absolute clarity on what is expected. Trustees do need to give investment managers enough time to perform to the agreed standards, possibly a minimum of three years. Thereafter the managers should be reviewed – this does not necessarily mean a full ‘beauty parade’ but consideration of the managers in all aspects not just “last quarter’s /year’s” performance. Remember to review investment consultants on the basis of strategic advice/benchmark allocation.

If carefully thought out and discussed with the employer it should be possible to meet the employer’s objectives as well as the scheme’s.

Risk

There are several aspects of risk about which trustees should be aware and for which they need to have plans and clear objectives. Risk itself is not the same as the “health risk” advertised on a cigarette packet, but it must be recognised and properly taken into account. A prime case is ‘Administration Risk’, dealt with in the next section.

Various headings to be considered are:-

Benchmark Risk – the risk of assets not performing in line with expectations. This issue must be regularly reviewed with investment consultants and investment managers.
Investment risk – this should be thought about when dealing with the asset allocation strategies above and beyond the appointment of the investment managers. Trustees should ask themselves “Does this asset class we’re considering have any special risks and are they acceptable?”
The corollary is “Does the investment manager cause us to think the appointment could provide a risk?”
Asset vs. Liability Risk – to what extent is it appropriate to attempt to immunize volatility of the funding position? Are Bonds more suitable than Equities? What would a change in strategic asset allocation cost, both to implement, and possibly by way of increasing funding rate? How should the thinking of the trustees be affected by the objectives of the Company, particularly in the matter of delivering long-term shareholder value, while at the same time pre-funding on a secure basis for pension promises to employees?
Custodial Risk – where are the documents of title kept? Are they kept with an external custodian? What cover do you have if there is a failure on the part of the custodian?
Reputational Risk – where the scheme’s, and trustees’, reputation is tarnished by actions, appointments, performance and benefit delivery which is sub-standard and not completely transparent. This leads to an important objective for trustees whereby they set out on a regular basis to monitor their own performance. Relationships with all advisors will need to be reviewed as a result.
Inertia Risk – a new term, refers to the reluctance for trustees to review advisors other than the investment managers. ALL advisors should be reviewed regularly and the process built into the Business Plan.

Administration

This is the one responsibility of trustees, which is often least thought about until there is an Internal Dispute Resolution (IDR) or other crisis. This can be particularly true where the employer performs the administration with his own employees – usually an internal Pensions Department.

We recommend the introduction of a Service Level Agreement with the administration provider, detailing performance standards, turnaround times and efficient dealing with the members. This should be agreed and in place whether the administration is performed by the employer’s staff, or by the trustees’ own staff or by third party administrators. (Note a Model Administrative Agreement is on the PMI website www.pensions-pmi.org.uk). Delegation of duties is involved in this particular area, so trustees must ensure that delegation is handled correctly. Not only that, but there must be well thought out reporting mechanisms so trustees are not taken by surprise by some problem with the administration. All these give rise to potential risk and need to be a high profile issue for trustees.

Communication

There are often misunderstandings, which can lead to disputes, quite inadvertently arising from defective communication by trustees and/or administrators with members of pension schemes. It is important for members to know how they should communicate with trustees. A part of the Business Plan must be to review regularly, not only the formal Announcements and Booklets, but also the correspondence about benefits with members. Often standard letters, ‘topped and tailed’, are used to tell individual members about their benefits but who wrote them? Did the trustees’ see and approve these? How long have they been in use? Are they really current, correct and comprehensible?

Unfortunately, the messages trustees need to pass to members are complex and are becoming more so despite the Government’s attempts to simplify. Trustees need to consider what they can do to tackle this situation.

Training

Neither a popular activity nor one easily dealt with by trustees, but training and keeping up to date is vital for trustees. Another Myners’ principle is that “trustees must be familiar with the issues”. Training is the way in which trustees can become “familiar”. The Business Plan should trigger the Training Plan. For example, where the Actuarial Valuation is due then some training in this area might be undertaken so that trustees can better handle discussing the forthcoming valuation with the actuary. The subject of training will be a part of the next Pensions Act, so start preparing now. Clearly all trustees need not be expert in all the areas covered in the Business Plan but should ensure all areas are covered by the trustee board as a whole.

It is not always necessary to attend external courses. Often there is in-house expertise to help trustees. Trustees’ advisors will also be able to assist with training sessions as part of trustee meetings, where these can be tailored to the particular scheme.

Compliance

Any good Business Plan will take account of the various compliance issues. There must be mechanisms established to highlight issues that would need to be reported to the Occupational Pensions Regulatory Authority (OPRA) by trustees. There should be a checklist of items, which need reporting to OPRA to a specific timescale – there is no excuse for overlooking an item. Trustees should also be monitoring the administrators’ compliance with Inland Revenue limits. Every three years re-registration with The Information Commission (Data Protection) is necessary – do the trustees review their registration to ensure its correctness at the time? Similarly are changes, relevant to the Pensions Registry, dealt with in a timely manner?

Delegation and review

Of course, many of the day-to-day operational functions are formally delegated, to a Pensions Manager or Administrator. Nevertheless, the responsibility remains that of the trustees.

Trustees should review regularly the effectiveness of such delegations, and the guidance that they give to those who actually run their schemes.

They should also review their own effectiveness, such as the decision making process, the preparation for and the running of formal meetings, interaction with advisers and administrators and the identification of both strengths to be built on and weaknesses, where action may be required.

In conclusion

We hope that these comments will provide a starting point for trustees to think about and prepare a Business Plan which covers the broad scope of trustees’ responsibilities, avoids short term thinking and puts everything into a context, for four or five years ahead. Clearly there will be urgent issues that cannot be forecast but with the confidence of a good Business Plan in place this should not prove too traumatic.

It is clear that not all of this is applicable to all schemes for example small schemes or insured schemes, but nonetheless trustees have responsibility for the scheme and from time to time should step back and, using these suggested guidelines, review their own scheme

From time to time this group will meet to consider other issues and provide suggestions to trustees.

Tony Ashmore - Chairman of PMI Trustee Group

Sarah Aitken - Merrill Lynch Investment Management

Bob Bridges - Capital Cranfield Trustees Ltd

Zahir Fazal - Horwath Clark Whitehill

Clive Gilchrist - BESTrustees PLC

Teresa Humphries - British Airways Pension Scheme

Chris Mullen - Pinsent Trustees Limited

Michael Pickard - MGN Pension Trustees Limited

Non Investment Risks

Some companies have operated in an environment sensitive to critical risks for many years. For most pension trustees, however, the concept of risk assessment is relatively new.

Under the Pensions Act, trustees are required to prepare a Statement of Investment Principles, which must include an assessment of the investment risks facing trustees. Typically these may be classified as manager risk, custody risk and investment or benchmark risk.

More recently the Myners Report highlighted the importance of an efficient strategic scheme specific asset allocation process. All trustees should, by now be considering their asset disposition in the light of their scheme’s liability profile. This generally implies scheme specific benchmarks – adapted by much larger schemes many years ago.

But what of non-investment risks – until now largely ignored?

With some of our clients we have been involved in a number of exercises to assess the overall risks faced by schemes. These have ranged from formal consultant led processes, to the production of a simple checklist of risk areas.

There are a number of ways of categorising non-investment risks, which include the following: -

· The sponsoring employer. The employer’s ability and willingness to continue funding the scheme will need to be assessed and monitored, particularly in the light of impending scheme specific funding regulations.

· The impact of FRS 17 and potentially volatile contribution rates

· The performance of advisers and conflicts that may arise from the use of the same advisers by the trustees and the employer

· Member communication and the risks entailed in not communicating well or providing unclear or ambiguous information

· Administration; inaccurate or missing data, the security of IT systems etc

· Legal and governance issues; is the scheme managed in accordance with the trust documentation, does the governance structure work effectively

· Reputation; including the risk of “naming and shaming” by regulators.

Having identified a list of risks facing the scheme, one approach then is to assign to each risk a probability ranging from high to low, and a consequence ranging from disastrous to insignificant. Trustees can then concentrate their efforts on attempting to control those risks that appear to offer the greatest threat to their schemes.

This is not just a theoretical exercise; even obscure areas can reveal hitherto unrealised weaknesses. We discovered one scheme where the Articles of Association of the corporate trustee reflected Companies Act conventions rather than Pension Act requirements. If a meeting had been called at short notice for some urgent matter – permitted under the Pensions Act – a single trustee director could, even after the event, have declared all decisions taken invalid.

In this example the risk was real, but having been identified was very easily remedied. Other risks are not so easy to control. But identifying them is the first step towards controlling them. Not making any effort to identify risks is an indefensible position.

What is Data?

We have all got used to registering our schemes and our businesses under the Data Protection Act, but few of us have had experience of the Act being tested in practice.

The Tory peer Lord Ashcroft, recently brought a High Court case against the Government. In this he alleged a smear campaign against him and sought to use the provisions of the Act to gain access to secret files referring to him.

Government departments argued “these [files] were so disorganised or unstructured that they failed to meet the statutory definition of a filing system”.

The case was settled out of court and, although significant costs were payable to Lord Ashcroft his lawyer commented that “from a legal perspective it is perhaps a shame that the High Court will not have an opportunity to clarify the Data Protection Act legislation which has been likened to a thicket or even treacle.”

Would that same defence of being “disorganised or unstructured” be available in respect of other filing systems?

Swaps

Many pension schemes, particularly large ones and mature schemes trying to match cash flows against liability profiles, now use interest rate or currency swaps as part of their investment process. Swaps are in common use by corporate treasuries, and the documentation is standard. But until recently the tax position of pension schemes using such instruments was unclear. Are they investments, or would their use by pension schemes be considered as trading?

In a recent bulletin (tax Bulleting 66) the Inland Revenue has attempted to clarify the position. They state “Where an approved pension scheme uses interest rate swaps, currency swaps, equity swaps, credit derivatives or similar instruments:

· To hedge risks inherent in its existing investment portfolio of shares, bonds or similar securities, or

· As part of a strategy to enhance the return from its existing investment portfolio, or

· To create a synthetic exposure to investments of a particular type or in a particular market in line with the fund’s normal policies of investing directly in such instruments

The Revenue will normally regard such swaps as investments.”

But…. ”The question of whether a swap is held for the purposes of a trade is one of fact. Where a swap transaction by an approved pension scheme appears to fall close to the trading/investment borderline, the Revenue will look at the case on its merits.”

If in doubt, trustees should take appropriate advice.

The BESTrustees Service

BESTrustees plc is one of the UK’s two leading independent pension trustee companies. It combines the security of a financially sound corporate trustee, with the talents of experienced individuals, who are well-known experts in the pensions industry. Our team has a great deal of hands-on pensions experience. This covers all aspects of trusteeship including investment, scheme administration, actuarial, accountancy and management issues.

We also provide statutory independent trustees as required under legislation.

Professionalism and independence are key to our role and our credentials are first class in both. We believe in offering a high quality service in all we do

We are pleased to announce three additional Associates who have joined us over the past few months; Mike Duncombe, Warwick Jones and Philip Nash. This brings our total of Directors and Associates to eleven.

Michael is an actuary with over 35 years pensions experience including fifteen years as Chief Executive of Royal Mail Pension Trustees. He was a Council member of the NAPF from 1996 to 2002 and a Council member of the Nationalised Industries Pension Group from 1988 to 1998. He is a frequent conference speaker both in the UK and internationally and is a Justice of the Peace.

Warwick has recently retired as Group Pensions Manager of Chubb plc, having been involved in the pensions industry for thirty years. He was a Council member of the NAPF for seven years during which time he chaired the benefits and membership committees. He is an Associate of the PMI and an Associate Chartered Management Accountant.

Philip has had a varied career spanning consultancy, pension scheme management and investment management. Following a period as head of pensions for Bowater he consulted with Wyatt, Wigham Poland, and Sedgwick where he was joint CEO. He also spent six years as MD of Fidelity Pensions Investment. Philip is a Fellow of the PMI and a Fellow of the Chartered Insurance Institute.

Anthony Davey has retired as an Associate. We wish him well and thank him for his contribution over the past five years.