Types of pension schemes
Broadly speaking, there are two types of pension arrangements: defined benefit schemes and defined contribution schemes.
Defined benefit schemes are arrangements where a company promises to pay a certain amount of pension to members when they retire for the remainder of their life.
By contrast, defined contribution schemes are where the company pays a percentage of an employee’s salary into an investment account which can be drawn on by the employee upon retirement.
Defined contribution schemes are relatively easy for companies to manage – their costs are predictable and stay roughly proportionate to the business’s size at any given time.
Defined benefit schemes are more complicated because they require companies to make careful assumptions about a variety of factors such as how long members of the scheme are expected to live after they retire and the level of investment return required to meet the scheme’s commitments. As such, defined benefit schemes carry a higher degree of uncertainty and risk for companies.
What pension arrangements does RSA manage?
The vast majority (over 90%) of RSA’s total defined benefit liability is held in two big UK schemes, amounting to around £7bn at the time of writing. Both schemes were closed to new members in 2002.
These schemes are well-funded, that is to say, RSA has ringfenced enough capital to fulfil its pension commitments. As reported in RSA’s 2015 year end results, the UK schemes are in an aggregate surplus position of around £140m, based on a ‘best estimate’ calculation.
Clearly, that’s important for scheme members, but that surplus figure also factors into the Solvency II minimum capital calculations which are closely monitored and approved by the Prudential Regulation Authority (PRA).
How are RSA’s pensions governed?
The pension schemes are run as trusts; separate legal entities to RSA, controlled by trustees independent of RSA. The UK schemes are regulated by the Pensions Regulator.
The pension scheme trustees are advised by an external scheme actuary who analyses data pertaining to each scheme (the age and status of members, what the company has promised to pay them, expected future returns) to come up with ‘prudent’ assumptions to work out the level of assets needed to ensure that the pension commitments can be met.
The three-yearly review process
Every three years, UK companies are required by law to go through a process to agree the valuation of their pension liabilities with pension scheme trustees.
When calculating their valuation of liabilities, pension scheme trustees tend to take a more conservative approach than companies which are required to use in their balance sheets. The Pensions Regulator expects trustees to use ‘prudent assumptions’ that allow for greater margins.
These differences in how pension schemes are valued means that the liability value that pension scheme trustees calculate is typically significantly higher than the ‘best estimate’ figure used on the balance sheet. Where a shortfall exists on this more prudent calculation, the company and its pension scheme trustees are required to come up with a plan to address that shortfall over a reasonable period of time.
What was the outcome of RSA’s most recent pensions review?
RSA successfully concluded a review of its pension schemes with trustees in December 2015. The next review will be carried out with an effective date of March 2018.
Using its ‘best estimate’ assumptions, RSA calculated that both schemes together are funded at a surplus of approximately £140m.
The figure agreed with the pension scheme trustees, using their more prudent assumptions, was a £392m shortfall. This is a marked improvement on the £470m shortfall agreed at the end of the previous review in 2012, which in part reflects the significant contributions already made by RSA in recent years.
RSA has committed to pay £65m into the schemes for the next three years to meet the shortfall which is a sustainable and affordable amount, broadly in line with the contributions the company has already been making.
Another important outcome of the pension review was an agreement to further de-risk RSA’s UK pension schemes by reducing the proportion of assets invested in equities and other more risky assets from around 25% to 15%. The difference will be transferred into bonds that better match the schemes’ liabilities.
This is a move that reduces volatility in our solvency capital position while also increasing the security of members’ benefits. By the end of February 2016, RSA expects to be half-way through the process of implementing this de-risking.