Actuarial and Benefits Consulting Jonathan Mowbray CARES 1 December 2003 Aon Consulting Limited is regulated by the Personal Investment Authority for investment business

Why Money Purchase fails Members take all the risk Transience No pooling of investment risk Members cannot afford the risk Safer investments Lower benefits for same cost

Ancient History Preservation / 5 year vesting 1975 GMP / Requisite Benefits 1978 GMP revaluation 1978 Anti-franking 1985 Pension revaluation 1986

Modern History 2 year vesting 1988 GMP increases 1988 Debt on employer 1991 Pension revaluation again 1991 LPI / wind-up / surplus 1992 LPI 1997 MFR / debt on employer 1997 Wind-up / debt on employer again 2003

What’s gone wrong? Targeted, minimum ongoing and guaranteed discontinuance benefits Only difference is real salary growth To pay lower than target benefits must break final salary link

Why Final Salary fails Company takes the whole of the risk Cost has progressively increased Increased contribution volatility risk FAS, FRS & IAS liabilities Loss of investment freedom

What do companies want? Value for money Stable contributions Guaranteed benefits for members Staff retention Low risk

CARE Schemes Career Average Revalued Earnings Schemes

CARE Schemes Example - Each year member earns: Salary ¸ 60 as a pension Each year pension earned to date is increased by the Trustees Increase guaranteed to be at least RPI More if investment returns etc allow it

CARE Schemes The vital issue is the reintroduction of discretionary benefits Guaranteed benefit increases in line with RPI Target benefit increases in line with national average earnings etc Difference between target and guaranteed allows funding flexibility

Not just a cheaper option If switch from Final Salary to CARES to reduce cost, potentially increasing risk Targeted, minimum ongoing and guaranteed discontinuance benefits

Risk - Advantages Risk is shared Members receive a guaranteed benefit, more if affordable Company cost is relatively stable Benefits relatively easily understood

Funding Flexibility The vital issue is the reintroduction of discretionary benefits Guaranteed ongoing benefit increases in line with RPI Target benefit increases in line with national average earnings etc Difference between target and guaranteed allows funding flexibility

What CARES offers members A benefit which is guaranteed to be adequate A possibility of a larger benefit if affordable Ability to plan retirement as benefit becomes more certain over time

CARES - For the Company Predictable cost Removal / reduction of FRS deficit Flexibility in sharing risk with members Pooled investments DB - so more saleable to workforce Golden handcuff aids retention No reduction to benefits???

Why CARES can work Discretionary benefits Target benefit is around 30% larger than guaranteed benefit at revaluation of 2% pa above RPI Similar effect to discretionary increases in payment

Is now the right time? Many companies moving to DC – alternative may be discontinuance Possibly no reduction to benefits? If remain with Final Salary… Assets fall - problems worsen Assets rise - problems disappear

Reasons given Reduction of accrued liabilities to minimum guaranteed Cost containment Risk management Middle way

Some issues Past service conversion? Same or separate Trust? Contributions and bonus policy Valuations & bases

Contributions / bonus policy Company funds for target benefits & bonus paid in line with target unless unaffordable Co pays flat rate unless outside limits - bonuses paid on funding level between target and guarantee Fluctuations shared equally

Alternatives - Hybrids 5 main types: Underpin schemes Split benefits Top up schemes DC feeder to DB Cash balance plans