Publications

Bulletin 22 Spring 2005

Welcome to the 22^nd edition of BESTrustees bulletin. We do not need to tell you that, since our last newsletter there has been huge amount of change in the law relating to pensions and there’s still plenty more to come. In this issue we take a look at the new requirements for Trustee knowledge, changes to member nominated trustee requirements, funding issues and performance-related investment fees.

There have also been some changes at BESTrustees, with three new appointments. We would like to take this chance to welcome Miles Buckinghamshire , Peter Murray and Peter Thompson to the team. You will find short biographies on the back page. This now brings our pool of independent trustees to 13.

We have tried to provide information that trustees, pensions managers and their advisers will find interesting and useful, without the pressure of it being time critical. If any reader has ideas for future articles, please let us know.

Member nominated trustees

Existing opt-outs of the Member Nominated Trustee regulations under the 1995 Pensions Act will come to an end in April 2006. In many cases trustee boards opted out in order to satisfy the spirit but not the letter of the old regulations, because those regulations were so prescriptive.

Many trustee boards include members from a variety of constituencies, different sites for example, different sections of a scheme – DB and DC, or a trustee seat reserved for a pensioner member. Sometimes the selection procedure involves a Consultative Committee or suchlike rather than direct elections to the trustee board. Whilst under the old Pensions Act an opt-out was required to achieve the desired board composition, under the new regulations these types of structure will be permissible if agreed by the trustees and the sponsoring employer, provided that at least one third of the trustee board are member nominated in some reasonable way. By the time the new MNT regulations come into force almost a decade will have passed since the original legislation. Over that time many things could have changed; the number of sites from which the company operates may have reduced, the relative size or importance of those sites may have changed. The scheme itself may well be very different - closed to new entry or to future accruals, for example. In planning the size and shape of the future trustee board all these things should be considered.

Member nominated trustee

Trustee Knowledge and Understanding

During the course of this year, the new Pensions Regulator will publish various codes of practice including one on Trustee Knowledge and Understanding. This is expected to set out the level of knowledge trustees must have in order to take decisions on certain matters.

On the face of it this may appear reasonable, however trustee boards are like directors, not like managers. Trustees delegate to administrators, actuaries, investment managers etc. They then monitor and control their delegates in the same way that a board of directors monitors and controls the operational functions of a company.

A company board is assembled to ensure an optimal mix of skills and experience, both from within the company and from non executives. There is no expectation that everyone should possess the same knowledge set and no-one is precluded from, for example, discussing and voting on the budget merely because they are not an accountant.

Good trustee boards are assembled in the same way to provide a broad mix of skills and experience. Trustee boards frequently delegate their investment function to an investment committee. The members of such committees will, no doubt, satisfy themselves that they have appropriate ‘knowledge and understanding’. However investment committees are generally advisory bodies - they may take some decisions but significant ones are referred to the full board.

In future only members of the trustee board in possession of the appropriate knowledge will be permitted to take decisions – in this example the members of the investment committee. The same will apply to other types of decision – ill health discretions for example. Unless the entire trustee board possesses the full skill set subcommittees will need to be decision making bodies rather than advisory – a major change in the way that trustee boards conduct their affairs.

It is not suggested that lay trustees will be required to pass exams, yet in their deliberations the regulator and the Ombudsman must take account of an individual trustee’s level of knowledge and understanding. Why should a lay trustee take that risk?

Perhaps we should ask what would happen if the same rule applied to Government so that laws could be passed only by MPs who can demonstrate a ‘knowledge and understanding’ of the subject matter for decision? We fear that the new requirements will act to discourage even more people from offering to act as trustees.

Funding Issues

Britain’s funded private pension system is in serious decline” according to last year’s Pensions Commission report. Yet not so long ago we were the envy of our European friends, if not the world.

There have been a number of reports over the past year estimating aggregate ongoing deficits at between £42 billion and £75 billion. Emerging from the deepest bear market for 30 years, it is hardly surprising that pension scheme funding is weaker than in the boom years; but these are large numbers.

When employers chose to establish defined benefit pension schemes, they undertook that funds would be available to meet pension liabilities as they fall due. It was never suggested that schemes must be fully funded at all times; to be so in the depths of a bear market might result in significant over funding (with possible tax penalties) at other times. Nevertheless, a funding gap of many tens of billions of pounds is significant - as Ronald Reagan once said, “a billion here a billion there and pretty soon you’re talking real money”.

Trustees are faced with the unenviable task of having to persuade companies to increase contributions to levels way above the tolerance of finance directors who grew up in a more benign environment. At the same time schemes and sponsors are being hit from all sides with new accounting conventions, increased bureaucracy, more regulation, the Pension Protection Fund (PPF), etc.

None of this was envisaged when schemes were established and it is sad though hardly surprising that many employers are responding by withdrawing completely from pension provision.

In 1997 Advance Corporation Tax relief was withdrawn for pension scheme investors. Pension scheme members, both DB and DC, now pay tax twice on UK dividend income – once before distribution by the company and again when received as pension. ACT abolition cost pension schemes £5 billion a year, approaching £40 billion since 1997 – over half of the estimated current level of aggregate deficits. While mainstream Corporation Tax was reduced in 1997 (though by a much smaller amount), the link between mature pension schemes in deficit and large corporation tax payers is tenuous at best.

The Government announced last year that it would provide £20 million a year over the next 20 years to help support schemes in difficulty. Though welcome, this is a tiny fraction of what has been taken out. The Government refuses to stand behind the PPF arguing that it is wrong for taxpayers in general to support the pensions of a minority who are in DB schemes (though we have to do that for public sector scheme members). However, tax payers as a whole have benefited to the tune of £5 billion a year for the past seven years from that same minority of pension scheme members.

In his 1997 budget Gordon Brown’s justification of his stealth tax was “Many pension funds are in substantial surplus and at present many companies are enjoying pension holidays” (Hansard vol. 297). Well we are no longer in surplus and companies are no longer enjoying pension holidays. It is about time that we started asking for our money back.

Performance-related fees

On reading their scheme’s Annual Report and Accounts, members often question the level of fees paid to investment managers.

The Myners report urged trustees to understand the investment costs being incurred on their behalf. Much work has been done - benchmarking of costs, greater disclosure, elimination of soft commission etc. Yet according to a recent report by McKinsey, fund management costs have increased by 17% a year since 1998.

Reasons for fee increases include the increased use of specialist managers and moves towards performance related fees. But trustees should note that performance related fees are not incentive fees; they do not make the manager ‘try harder’. If a manager has two, otherwise identical, mandates the regulatory framework would not permit them to invest differently for the two clients, and certainly not to intentionally favour one client over the other. Performance fees are, therefore, a way of sharing the gain and sharing the pain, of rewarding success and penalising failure.

In considering performance fees trustees should consider the fee implications of possible performance outcomes and compare the costs on a fixed basis with performance fee alternatives. Some managers seem keen to share the gain without wishing to incur too much pain, in which case the trustees would probably be better off negotiating hard on fixed fees. In other cases fee formulae are more symmetrical, with similar fees payable for performance in line with target (not benchmark).

Consultants have been quoted as criticising trustees for their apparent reluctance to adopt performance fees. There should be no ‘policy’ that performance fees are better than fixed fees. They are a sensible alternative, but their use should depend on the terms being offered, not because they are ‘better’.

Performance fees can, however, help to align interests in regard to transaction costs. Managers using commission to pay for research are then doing so partly out of their own performance fee. These issues are important because the transaction and settlement costs incurred within portfolios often exceed the headline management fee. Myners principle 5 refers to “transaction-related costs including commissions” - it is the total costs that trustees should look to contain, not just the management fee.

Pensions reform timetable

April 2005

The New Pensions Regulator takes over from Opra
The Pension Protection Fund (PPF) comes into effect. The PPF levy for 2005/ 2006 is based on the number of members on 31 March 2005
The Financial Assistance Scheme for schemes already in wind-up comes into force
Limited price indexation (LPI) abolished for defined contribution schemes and reduced to 2.5% pa for future service under defined benefit schemes.

September 2005

Scheme specific fund requirement comes into effect
Trustees can introduce a single stage Internal Dispute Resolution Procedure. If they wish to retain a two stage procedure, the Trustees need to be involved in both stages

From April 2006

Risk based PPF levy payable
Trustees required to have a statutory minimum level of knowledge and understanding
New Lifetime Allowance and Annual Allowance come into effect under tax simplification measures
AVC provision becomes optional
Transfer values available as alternative to refunds for leavers with three or more months’ service
Members can take their pension while continuing to work for the same employer
Current member-nominated trustee opt out arrangements will cease and schemes will be required to have a minimum of one third of trustees to be member nominated

New Trustees

Miles Buckinghamshire has over 30 years experience in pensions and investments. He joined BESTrustees in June 2004, having retired as a Partner of Watson Wyatt LLP. As the Earl of Buckinghamshire, he was a member of the House of Lords between 1984 and1999 and was closely involved in pensions legislation. He also took part in the All Party Group on Occupational Pensions and the All Party Group on Ageing Issues.

Peter Murray recently retired as Chief Executive of The Railways Pension Trustee Company. Before that, he was UK National Pensions Manager of Unilever. Peter was a member of NAPF Council from1993 to 2001 and was NAPF Chairman from 1997 to 1999. He was also on the Board of The Occupational Pensions Regulatory Authority from 1996 to 1997. he is a Trustee Director of the railway pension schemes and is an adviser to an investment consultancy firm

Peter Thompson is an actuary with nearly 30 years’ experience in pensions. Peter worked as a consulting actuary with Mercer Human Resource Consulting for 25 years, in London, Leeds and Manchester, in both the actuarial and investment consulting practices. Peter has also been much involved with the NAPF, including being Chairman of the NAPF from 2001 to 2003. He is a frequent speaker at seminars and conferences and has contributed to TV and radio programmes on pensions, including Money Box and the Today programme.

The BESTrustees Service

BESTrustees plc is one of the UK ’s 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 aspect 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.

The BESTrustees Team

Clive Gilchrist – Managing Director

Miles Buckinghamshire

Michael Duncombe

Hugh Edwards

Sheila Gleig MBE

Warwick Jones

Brian MacMahon

Peter Murray

Philip Nash

Peter Styles

Peter Thompson

Iain Urquhart

Charles Woodward