How will reductions in pension projection rates impact DC members?
Follow @PwC_North How will reductions in pension projection rates impact defined contribution (DC) scheme members and their expected retirement targets?
The Financial Services Authority (FSA) and the Financial Reporting Council (FRC) have issued a joint consultation proposing changes to the investment projection rates used by financial institutions when providing benefit projections to pension savers.
The proposals were prompted by research commissioned by the FSA and carried out by PwC as part of the FSA’s periodic review of how financial companies should project investment returns.
The research focussed specifically on the underlying financial assumptions used in calculating the projection rates. This was to determine whether these remain relevant and appropriate in view of evolving market conditions.
What could this mean?
If the consultation is approved, future illustrations (including those provided within annual benefit statements) will show much lower returns for pension scheme members than previously anticipated.
The assumptions used in calculating the projection rates include allowances for earnings growth, price inflation and the investment performance of equities, property, corporate bonds and government gilts.
Unsurprisingly, given recent volatility in equity markets, the collapse in gilt yields and the weakened wider economic position, the findings indicated that the underlying investment return assumptions previously used were - in the main- too high and should be reduced.
Currently, benefit statements illustrate projected pensions at retirement under three alternative scenarios for future investment returns, which are dubbed “lower”, “intermediate” and “higher”. As a result of the changes to the assumptions and in order to give investors a more realistic indication of their potential future returns, the FSA has put forward proposals to reduce the three projection rates of return as follows:
|
|
Current* |
Proposed |
|
Lower |
5% |
2% |
|
Intermediate |
7% |
5% |
|
Higher |
9% |
8% |
*As at July 2012
What does this mean for DC scheme members?
Member expectations may need to be managed- If the projection rates are reduced, this will have a knock on effect on the illustrations that members receive. Therefore, a member comparing last year’s benefit statement to one which has been prepared on the new basis is likely to see a significant reduction in their projected benefits at retirement.
Projected not actual value - It is important for members to remember that the projections are only estimates of what they might see in retirement. Therefore, whilst there is a reduction in the projected value, this does not necessarily equate to a decrease in the actual value of their benefits.
Saq Hussain, who leads the DC Pensions Consulting team in North, said
“A perceived reduction in benefits for the casual investor does nothing to engender confidence in pension savings. In addition, members, trustees and plan sponsors should keep in mind the underlying reasons for the reduction in the projection rates – the likelihood of deficient investment returns, at least over the medium term. The impact of seeing a lower projected pension could have a negative impact on future pension scheme membership, particularly in the light of auto-enrolment, and this needs to be managed carefully.
“There is no getting away from the fact that challenging economic conditions are having an impact on savers. Therefore, members need to understand whether or not their savings are likely to generate an adequate level of retirement provision”.
To discuss this in more detail, contact Saqib Hussain on +44 161 245 2554
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