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Subject SA4
CMP Upgrade 2013/14

CMP Upgrade

ActEd often produces a free CMP Upgrade, which provides details of changes to the
syllabus, Core Reading and ActEd materials. This year, however, due to the large
number of changes to the Course Notes, Q&A Bank and X Assignments, it is not
practical to produce a full upgrade.

We offer a full replacement set of up-to-date Course Notes/CMP at a discounted price if


you have previously bought the full-price Course Notes/CMP respectively in this
subject. The prices are given in Section 0 below.

This document provides a summary of the major changes so that you are aware of the
main themes of these changes and the chapters that have been subject to the greatest
change.

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1 Summary of the changes


Numerous references to the expected introduction of auto-enrolment with effect from
October 2012 have been updated to reflect the fact that this has now occurred.
References have also been added concerning the proposed abolition of contracting out
through defined benefit arrangements by April 2016.

The Transformations TAS now forms part of Core Reading.

The names of various bodies have changed and been updated throughout the course as
follows:

From To

The Board for Actuarial Standards Financial Reporting Council

The Financial Services Authority Two regulatory authorities;


The Prudential Regulation Authority
The Financial Conduct Authority

UK Actuarial Profession Institute and Faculty of Actuaries

Accounting Standards Board The Accounting Council

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2 Changes to the Core Reading


Below is a summary of the significant changes to the Core Reading:

Chapter 1, Page 13

Later versions of various documents in the required reading have been updated as
follows:

Scope & Authority of Technical standards - August 2012


Pensions TAS - November 2012
Transformations TAS - December 2010

Chapter 1, Page 17

The 2013 version of the Pensions Pocket Book is referenced ie:

Pensions Pocket Book 2013

Chapter 2, Page 5

The first paragraph now reads:

The full basic state pension (BSP) payable during the 2013/2014 tax year is
110.15 per week. The married persons pension for 2013/14 is 176.15 per
week.

Chapter 2, Page 7

The penultimate paragraph of the page now reads:

The QEF is equal to the lower earnings limit and for 2013/2014 is 5,668. The
LET for 2013/2014 is 15,000.

Chapter 2, Page 10

Two new paragraphs have been added to the after the third paragraph on page 10 as
follows:

As part of its single-tier pension reforms (see section 1.6), the Government is
intending to abolish contracting out through defined benefit arrangements by
April 2017 at the earliest, to coincide with the introduction of the single-tier
pension.

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At the time of writing (May 2013) this date has been moved forward to April 2016 and
it is expected that:
accrual under S2P and the ability to contract out will cease from a date to be
agreed (April 2016 at the earliest).
a single tier State pension will be introduced to replace all State pension benefits
(ie the BSP, S2P and Pension Credit). A current amount of around 140 per
week has been proposed.

Chapter 2, Page 15

The final paragraph under the section on eligibility is now:

To protect individuals, employers must not offer employees incentives to opt out
of a workplace pension, either during employment for existing employees or
during recruitment for prospective employees.

The part from the Core Reading onwards under the section on qualifying schemes has
been changed to:

Minimum contributions required to qualifying schemes, including NEST are described


below.

Broadly, auto-enrolment is being phased in depending on the size of the


employer as follows:
120,000 or more employees: auto-enrolment started from 1 October 2012
Less than 120,000 but 250 or more employees: auto-enrolment will be
phased in between October 2012 to February 2014;
50-249 employees: auto-enrolment will be phased in from April 2014 to
April 2015;
49 employees or less: auto-enrolment will be phased in from June 2015 to
April 2017.

For employers established after April 2012, auto-enrolment will be phased in


from May 2017 to February 2018.

For employers who choose to use defined benefit or hybrid schemes, auto-
enrolment can be delayed to September 2017.

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Chapter 2, Page 16

The section on NEST now reads:

NEST

The National Employment Savings Trust (NEST) was set up by the Government
to provide a vehicle for auto-enrolment which may be offered to employees by
employers who do not wish to set up their own scheme, or do not currently
support a suitable arrangement. NEST will operate as a single multi-employer
defined contribution scheme.

Minimum contributions required to qualifying schemes, including NEST, are a


total of 8% of Upper Band Earnings, with the employer paying at least 3% and the
employee making up the difference. Contributions will be set out in legislation
and will attract tax relief. If an employee opts out of the scheme, the employer
would not be obliged to contribute.

Contributions to NEST are actually based on qualifying earnings rather than Upper
Band Earnings. However at present the definition is actually the same as Upper Band
Earnings were earnings between the Lower Earnings Limit and the Upper Earnings
Limit (which are 5,668 pa and 41,450 pa for 2013/14).

The eligibility and contribution requirements will be phased in, in stages, from
October 2012, as follows:

Minimum contribution (% of earnings)


Employer Total
1 October 2012 to 30 September 2016 1% 2%
1 October 2016 to 30 September 2017 2% 5%
From 1 October 2017 onwards 3% 8%

Employees will be required to make up the difference between the employer


contributions and the total. Employers may pay more than the minimum
specified, in which case employees contributions can be lower to reach the
overall minimum total.

More information about automatic enrolment can be found on TPRs website at:
http://www.thepensionsregulator.gov.uk/automatic-enrolment.aspx

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Chapter 2, Pages 16 and 17

Section 1.6 now reads:

The UK Government published its White Paper on pensions reform in January


2013, focusing primarily on the introduction of a higher flat-rate State pension,
but also considering the future direction of the State Pension Age.

The main reason behind this reform is the view that unless people save more, work for
longer and/or pay more tax they will have a standard of living in retirement which is
worse, in real terms, than those currently retiring.

State Pension benefits

The key features of the proposals are:


The new single-tier pension will replace the current BSP and S2P and will
be set above the level of the Pension Credit Standard Minimum Guarantee
(see section 1.1).
Currently a single tier State pension of around 140 per week has been
proposed.
The minimum legislative requirement for pension increases is in line with
earnings. However, it is anticipated that, as for BSP, this pension will
increase in line with the triple lock.
The new pension will apply only to individuals who reach State Pension
Age after the implementation date, expected to be no earlier than April
2017 (at the time of writing (May 2013) this has been moved forward to April
2016). Older individuals will continue to receive State benefits under the
current system.
The full pension will require 35 qualifying years of National Insurance
contributions or credits, but those with less than a minimum qualifying
period (expected to be between seven and ten years) will not receive any
entitlement. Those with fewer than 35 qualifying years, but more than the
minimum will receive a pro-rated benefit.

Contracting out

Contracting out of S2P will cease from the implementation date so employees
and employers in contracted-out schemes will see an increase in their national
Insurance contributions.

Remember that many private DB schemes are closed to new hires and some are also
closed to future accrual. In the latter case, the cessation of the ability to contract out is
irrelevant. Those DB schemes open to future accrual for some members will need to
cease contracting out and this will impact on these members benefits.

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Employers will be allowed to reduce future service benefits in order to offset


these increased costs. The Government is proposing to enable employers to do
this without trustee consent to safeguard the ongoing viability of defined benefit
pension schemes. However, there are concerns that this will be another catalyst
for the closure of defined benefit schemes.

It is proposed that a power be introduced through legislation to allow employers to


amend a schemes rules to offset the impact of these increased costs without trustee
consent, regardless of what is set out in the amendment power of the scheme, for
example by reducing future benefits or increasing employee contribution rates.

This power will be available for a limited period of time and will only allow an
amendment to be made insofar as the value of the change is not more than the annual
increase in the employers National Insurance contributions in respect of that member.

Various transitional arrangements will be in place. For example individuals who


have been contracted out at any time since 1978 can expect to see their State
benefit reduced to reflect the private scheme benefit earned through contracting-
out. However such individuals would be able to accrue further State benefits.
Individuals who have already accrued a State benefit in excess of the new single-
tier amount will be able to retain that higher benefit.

State Pension Age

Currently the State Pension Age for men is 65 and for women will be rising from
60 to 65 gradually from 2010 to 2020. The Pensions Bill 2011 proposes that SPA
for females will increase to 65 by 2018 rather than 2020, in order to comply with
the EU Directive for equal treatment for men and women. It is then proposed that
the SPA will increase gradually to 66 between 2018 and 2020 with further
increases planned after that time.

As part of the review of the single-tier pension the Government has announced
that it will carry out a review of the State Pension Age every five years.

At the time of writing (May 2013) it is further proposed that:


SPA will increase to age 67 between 2026 and 2028
subsequent increases in SPA will be linked to changes in life expectancy.

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Regulatory reforms

The UK Government is proposing to:

allow schemes to convert Guaranteed Minimum Pension rights into


scheme benefits

Increases to GMPs are different from those that apply to other pension benefits.
Converting GMP into scheme benefits should simplify scheme administration
and make communication to members easier in the long run. However, it is
difficult to achieve without making some members worse off.

introduce a rolling deregulatory review of pensions regulation, in the light


of the Pensions Act 2004.

Many commentators believe that the UKs pension legislation and regulation is
too complicated. Any ongoing review would hopefully aim to simplify it.

Chapter 2, Page 28

A paragraph has been added, after the first paragraph, as follows:

The duties above outline the trustees fiduciary duties. A fiduciary duty is
defined as a legal or ethical relationship of trust between two or more parties. In
such a relationship one party, in this case the trustees, acts in a fiduciary
capacity to the other one, in this case the scheme beneficiaries, in a manner
which gives rise to a relationship of trust and confidence.

Chapter 3, Page 6

The contracting-out rebates are now as follows:

The reductions for the 2012/2013 tax year are 3.4% for the employer and 1.4% for
the employee. These rates will apply up to and including the 2016/17 tax year.

Chapter 3, Page 10

The second sentence of the final paragraph has been updated, with an additional
sentence added, as follows:

The AA for the 2013/14 tax year is 50,000. From the tax year 2014/15 onwards,
the AA will reduce to 40,000.

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Chapter 3, Page 12

The final sentence in the section Lifetime Allowance of the third paragraph has been
updated as follows:

The LTA is currently 1,500,000 from the 2012/13 tax year but will reduce to
1,250,000 from 6 April 2014.

Chapter 4, Page 31

The fourth sentence of the second paragraph of Section 7.1 has been updated as follows:

The cap for the year 2013/2014 is currently set at approximately 34,867 for an
NPA of 65 and will increase in line with earnings.

Chapter 4, Page 34

The first four paragraphs are now:

Schemes will be invoiced each year.

The cost of the PPF is met by a combination of scheme-based and risk-based


levies.

At the start of each financial year, the PPF Board estimate the total levies
required to fund the PPF. The levy estimate for the 2013/14 financial year is 630
million.

This is lower than the levy estimate had the parameters remained unchanged
from 2012/2013 which would have been some 765 million, breaching the
legislative restriction that a levy estimate can be no greater than 25% higher than
the previous years estimate (of 550 million). However, to reflect the current
economic environment, the PPF has changed the levy parameters to target a levy
of 630 million. The PPF has announced that it expects to increase the levy for
2014/2015 and thereafter should the current economic conditions continue.

The PPF did intend to maintain a stable levy of 550 million for three years from
2012/13 but this was not possible due to economic conditions.

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Chapter 4, Pages 34, 35 and 36

Various parameters have been updated as follows:

SLM is the scheme-based levy multiplier, set at 0.000056 for the 2013/14
levy year.

LSF = risk-based levy scaling factor, set at 0.73 for the 2013/14 levy year.

The risk-based levy will be capped at a maximum of 0.75% of unstressed


liabilities for the 2013/2014 levy year.

To determine the smoothed deficit, the values of the assets and liabilities will be
smoothed using five-year financial market averages up to March 2013.

Chapter 5, page 7

The second paragraph is now:

Version 1 of TAS P applies to reserved work and work performed for aggregate
reports completed on or after April 2011 and before 1 January 2013. Version 2
(which is summarised below) applies subsequently.

A final point is added at the bottom of the page as follows:

incentive exercises.

Chapter 6, Page 11

A new paragraph has been added after the The sponsor heading:

Over the years an increasing number of employers are finding the risks
associated with defined benefit pension schemes to be unacceptable. As a
result, the majority of defined benefit schemes are now closed to new entrants
with a significant proportion also closed to future accrual. Employers are still,
however, left with past service liabilities which have to be managed.

Chapter 6, Page 13

A new section was added to the bottom of the page. As a convenient way to add to your
notes, this follows on the next page:

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De-risking

A number of options exist for the employer to facilitate de-risking of the defined
benefit scheme as follows.

Investment strategy

Chapter 12 discusses various approaches the employer may wish to consider in order to
mitigate investment risk.

Investments are covered in detail in Chapters 11 and 12. Most de-risking


strategies involve a switch of assets from return-seeking assets to those which
provide a better match for the liabilities. Such switches can be driven by the
investment manager, or triggers can be set up, both asset and liability based, in
order to lock into favourable returns.

Insurance products

Insurance products are covered in Chapters 11 and 26. The scheme can either
undertake a buy-out, where all or part of the schemes liabilities are passed to an
insurance company at an agreed price, or a buy-in, where annuities are
purchased and held as scheme assets to protect against the investment,
inflation and longevity risks.

In order to extinguish the defined benefit risk the liabilities would need to be bought out
in the name of each member with an insurance company (this is known as a buy-out).

A buy-in is where annuities are purchased by the scheme, usually to match specific
liabilities, and are an asset of the scheme. A buy-in would mitigate risks but not
extinguish them.

Incentive Exercises

These are exercises where the members are given an incentive to take up an
option. The two exercises most commonly undertaken in the UK are Enhanced
Transfer Values and Pension Increase Exchanges.

Incentive exercises are discussed in Chapter 23 Options and guarantees.

Chapter 6, Section 7

Section 7 has been moved back to become Section 8 and a new Section 7 has been
added. As a convenient way to add to your notes, this follows on the next page:

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7 Defined Ambition
In November 2012 the Department for Work and Pensions published a strategy
document entitled Reinvigorating workplace pensions which proposed a new
category of pension known as Defined ambition (DA).

This document discusses the desire to increase the range of products available to savers in order
to provide more certainty.

At the time of writing (May 2013), this document can be found as follows:
http://www.dwp.gov.uk/docs/reinvigorating-workplace-pensions.pdf

The aim of DA is to provide greater certainty for scheme members about the
value of their pension fund in a DC arrangement, but also less cost volatility for
employers than a DB arrangement. The intention is that these aims are met by
sharing the risks among a number of parties including scheme members,
employers and insurance and investment businesses. The rest of this section
covers defined ambition schemes in more detail.
These arrangements are often DB or DC schemes which have been adapted to transfer
some risk from one party to another eg from the employer to the member in a DB
scheme and the member to an investment business in a DC scheme.

Defined Ambition is a proposed structure for risk-sharing among the different


parties involved in pension schemes. An Industry Working Group has identified
a number of existing arrangements and proposed a number of new
arrangements as shown below.

7.1 Defined benefit schemes

Current defined benefit arrangements which involve some sharing of risk include
the following:

Career Average Revalued Earnings (CARE) schemes: (see section 3


above);
Here the risk of high salary increases (resulting in larger benefits and higher
costs) associated with a final salary defined benefit scheme is reduced. So
effectively the salary risk to the employer is passed to the member.
cash balance schemes: (see section 3 above);
Here a defined lump sum is provided at retirement, and so the post-retirement
risks are transferred from the employer to the member.

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longevity adjustment factors: the retirement age is increased for future


service in light of increasing longevity, thus mitigating the financial cost
to the employer of increasing life expectancy;
In this case, the variable retirement age means that the post-retirement longevity
risk is transferred from the employer to the member.
risk management options: including longevity swaps & bonds and
insurance company investments (see Chapter 11).
Investments can be chosen to mitigate some of the defined benefit risks. In this
way the risk is shared between the employer and the provider of the investment
(usually investment business or insurance company). This will be discussed
further in Chapter 11.

New defined benefit models

Some proposed new models for risk-sharing arrangements include:

Simplified/Core DB schemes: a basic, core level of DB benefits is


offered with other benefits such as indexation and spouses benefits
being discretionary and subject to less regulation;
New legislation would be required before such an arrangement could be set up.
This is because for some periods of service and some types of benefit current
legislation requires indexation and dependants benefits to be provided.
Here the cost and risk associated with these other benefits (eg inflation risk in
respect of indexation, longevity risk of the dependant) is reduced. So effectively
these costs and risks to the employer are passed to the member.
Conversion of Benefits: a defined level of benefit is promised to the
member which is converted to a DC fund of equivalent value when the
member leaves the scheme (through withdrawal, death or retirement);
Fluctuating Pensions: the scheme provides a core non-increasing
pension on retirement with an additional element which is entirely
discretionary and subject to the financial status of the scheme;
Simply put, this may be the provision of flat pensions with discretionary pension
increases provided out of surplus. This was common practice for private defined
benefit schemes in the UK before statutory pension increases were introduced
(post April 1997 accrual). However, at that time there were fewer statutory
funding restrictions, and schemes in surplus were more common.
In this case the inflation risk and cost is passed from the employer to the
member.

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Links to changes in SPA: the schemes retirement age would be permitted


to be adjusted in line with revisions to the State Pension Age (SPA).
In this case, the variable retirement age means that some of the post-retirement
longevity risk is transferred from the employer to the member.

7.2 Defined contribution schemes

Current defined contribution arrangements which involve some sharing of risk


include the following:

with-profit funds: (see Chapter 11)


In such funds, the risk is shared between the member and the provider of the
fund (usually the investment business or insurance company). This will be
discussed further in Chapter 11.
deferred annuities: (see Chapter 11)
The Core Reading refers to Chapter 11 which discusses both with-profit and
non-profit deferred annuities. In the former case this is an investment option
and in the latter case this is an insurance option. These policies can be used to
mitigate some investment risk, and in the latter case longevity risk, to the
member. In this way the risk is shared between the member and the provider of
the policy (usually investment business or insurance company). This will be
discussed further in Chapter 11.
targeted DC benefit (see below).

New defined contribution models

Some proposed new models for risk-sharing arrangements include:


Mutualised guarantees and risk-sharing: to include a money-back
guarantee where members are guaranteed to get back the contributions
paid in, and a retirement income guarantee where a guarantee fund is set
up to pay pensions on survival beyond a certain age, thus taking on some
of the longevity risk. Guarantees would be funded by a levy on members
funds.
The money-back guarantee is effectively an investment guarantee. The value of
the fund would be guaranteed not to fall below the amount of the member (and
possibly employer) contributions. This removes some of the investment risk
from the individual member.

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The retirement income guarantee means that members will need to purchase a
fixed term annuity rather than a whole of life annuity. Members who live
beyond the fixed term would then receive their subsequent pension from the
guarantee fund. This removes some of the longevity risk from the individual
member.
Guarantees are discussed further in Chapter 23.
Guarantees and risk-sharing provided by the insurance industry:
guarantees on the return on the fund and the income at retirement
whereby the member is not subject to the downside risk but takes a share
in the upside risk, as opposed to a standard DC arrangement where the
member shoulders all of the downside and upside risk.
Examples here could be with-profit and deposit administration arrangements
with insurance companies as discussed in Chapter 11.
Plan design; employer-funded smoothing fund: the employer pays a
percentage of core contributions into a central fund which is used to
manage a targeted income at retirement. There is no longevity risk for the
employer, but there is some uncertainty surrounding the contributions
payable.
The intention would then be that some risk is shared between the members and
investment returns can be smoothed and contributions adjusted accordingly.

A further consideration for a DA arrangement is a collective DC scheme such as


those which exist currently in the Netherlands and Denmark. The key features of
such a scheme are as follows:
the employer pays a fixed rate of contributions into the fund
the risk is shared collectively by the members rather than individually
benefits paid to members on retirement are dependent on the funding
level of the scheme
pensions may be subject to variation once in payment, depending on the
funding level of the scheme, with a minimum level payable and the
balance being discretionary
as the fund is collective, it can follow a more risk-seeking investment
strategy in the long-term compared to individual funds where members
traditionally opt to switch into low-risk, low-yielding assets in the years
before retirement.

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Chapter 7, Page 16

The final paragraph has been replaced with the following:

Future legislation changes may also cause problems, such as the proposed
State Pension reform as described in Chapter 2. For example, the deduction
stated in methods (2), (3) and (4) could be changed by legislation.

As noted in Chapter 2, under the proposals to cease contracting out of S2P,


employers may be allowed to adjust future service benefits without the need for
trustee consent, in order to offset the increased National Insurance costs.

The proposed changes to State benefits, as discussed in Chapter 2, mean that sponsors
who want their schemes to integrate with State benefits may need to take action, in
particular:
as the ability to contract out for a DB scheme will cease, integration through this
approach will no longer be possible
a single tier State pension will be introduced as a level expected to exceed the
BSP and therefore a lower amount of private provision may be appropriate.

However, the scheme is unlikely to be able to reduce accrued rights and so may only
make changes in respect of future accrual of benefits.

Chapter 15, Section 3.2

Section 3.2 has been moved back to become Section 3.3 and a new Section 3.2 has been
added. As a convenient way to add to your notes, this follows on the next page:

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3.2 Smoothing
Smoothing is a process whereby short-term fluctuations in the market are
reduced. One possible approach is to use an average discount rate, taking
market yields over an averaging period, such as 2-5 years, rather than the yield
as at the date of the valuation.

Due to concerns raised in the light of current low gilt yields, the Department for
Work and Pensions undertook a consultation on whether smoothing should be
permitted.

DWPs consultation asked for views on:


whether the smoothing of assets and liabilities would be appropriate in schemes
undertaking SFO valuations, considering impacts on members, sponsoring
employers and the PPF
how smoothing might be applied.

However, in early 2013 it (the DWP) announced that it would not be introducing
smoothing following concerns raised that smoothing would mean that the effect
of low gilt yields would still be felt after the economy had recovered, and the loss
of transparency when using smoothed asset and liability values. In addition the
call for evidence had not revealed a strong case for pursuing such measures.

DWPs consultation also asked for views on whether a new statutory objective for TPR
is necessary and this is to go ahead. The new objective will ensure an employers need
for sustainable growth is considered during scheme funding negotiations and is properly
reflected in trustees dealings with the employer.

Chapter 22, Section 3.1

Section 3.1 has been amended. As a convenient way to add to your notes, this follows
on the next page:

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3.1 Introduction

FRS 17 was introduced in December 2000 by the UK Accounting Standards


Board (ASB). The Accounting Council replaced the ASB in July 2012, and reports into
the Codes and Standards Committee of the FRC.

The full requirements were introduced for accounting periods beginning on or


after 1 January 2005 and replaced the Statement of Standard Accounting
Practice (SSAP24). (SSAP24 was an accounting standard under which pension
assets/liabilities and pension costs were calculated on smoothed long-term
actuarial assumptions.) In the next few years, the ASB is proposing to withdraw
FRS17 and defer substantially to the international accounting standards.

FRS 102 (Section 28 applies to employee benefits) replaces FRS 17 for accounting
periods beginning on or after 1 January 2015. Early application of FRS 102 is
permitted for accounting periods ending on or after 31 December 2012.

Note that any requirements to account under International Accounting Standards (IAS)
override country-specific requirements. IAS came into force in the UK for accounting
periods beginning on or after 1 January 2005 from this date, listed companies had to
use IAS 19 to account for pension costs in their group consolidated accounts.
Therefore, some UK companies may have moved directly from SSAP 24 to IAS 19.

The purpose of FRS 17 is to ensure that:


company pension assets and liabilities are measured at fair value
operating, financing, and other costs are recognised in the appropriate
period
there is proper disclosure.

FRS 17, and not FRS 102, is discussed in the rest of this section in detail. The focus of
FRS 17 is that a realistic assessment of the difference between the pension and assets
should be recognised in the balance sheet, ie it is a balance sheet focused standard.

For accounting periods beginning on or after 6 April 2007, the disclosure


requirements were aligned with IAS19.

The Accounting Council amended the disclosure requirements of FRS 17 to bring them
broadly into line with the disclosures required under the previous version of IAS 19 (but
not the current version of IAS 19). FRS 102 will replace FRS 17 but its disclosure
requirements are not aligned with the current version of IAS 19.

The Accounting Councils best practice disclosure guidelines, which apply to both
FRS 17 and IAS 19, are described in Section 5.

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Chapter 15, Section 4

Section 4 has been updated and is reproduced below:

4 IAS 19

4.1 Introduction

The current international practice standards are set out in International


Accounting Standard 19 (IAS 19) as revised in 1998, and subsequently amended.
A revised IAS19 was issued in June 2011, being applicable to accounting years
beginning from 1 January 2013.

IAS 19 has become a requirement in the UK for listed companies consolidated


accounts replacing FRS 17. For unlisted companies, the use of IAS 19 is
optional.

The emphasis in this standard is towards the balance sheet.

4.2 The pension cost

With the exception of actuarial gains and losses the elements of the pension
cost under IAS 19 are calculated using much the same method as FRS 17.

The pension costs should be calculated as:

service cost

+/ interest on the net liability / asset

+/ remeasurement effects

The first two elements of the pension costs (ie the service cost and interest) are
disclosed through the profit and loss account. The final element, the remeasurement
effects, is disclosed through Other Comprehensive Income (OCI). This is discussed
further in section 4.5 below.

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The service cost is equal to:

current service cost

+/ past service cost / credit (including changes to the DBO due to


curtailments)

+/ the effects of settlements.

The remeasurement effects consist of the gains or losses arising from:


changes in the assumptions used to measure the DBO
differences between actual and assumed experience in the scheme
differences between the actual return on the scheme assets and the
interest income assumed using the assumed discount rate
changes in the asset ceiling not included in the interest cost.

The asset ceiling is defined as the present value of the sum of refunds of surplus to
which the sponsor has an unconditional right and reductions in future contributions. It
is discussed further in section 4.6 below.

Thus the element of pension cost which passes through the profit and loss account, and
set out consistently with the other standards, is calculated as:

the current service cost

plus interest cost on the liabilities

less interest income assumed using the assumed discount rate on assets

plus past service cost the liability arising due to benefit improvements can be
amortised over the period until the benefit vests

less gains (losses) on settlements or curtailments.

Do note however that this is not how the pension cost would be presented in the
accounts.

4.3 Valuation of assets and liabilities

Assets are measured at fair value at the balance sheet date. Auditors now
require this to be bid value rather than mid-market value (based on wording in
other international accounting standards).

The liabilities are calculated using the Projected Unit method.

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There is no guidance under IAS 19 on the treatment of risk benefits. One


possible method is the attribution method (as used under FAS 87/158) whereby
benefits that are not service related are allocated in proportion to the ratio of
completed years of service to either the vesting period or, if the benefit is
unvested, total projected years of service.

In practice, this usually means that the uniform accrual to date of payment method is
used as described in Chapter 16.

In some circumstances, administration expenses may be capitalised and that


part attributable to non-actives added to the present value of the liabilities.

4.4 Assumptions

As for FRS 17 the assumptions are the responsibility of the directors. The
involvement of a qualified actuary is encouraged but not required.

The assumptions should be unbiased and mutually compatible and overall


should represent the best estimate of the future cash flows from the scheme.

Financial assumptions should reflect market conditions at the balance sheet


date.

The discount rate used to value the liabilities should be determined by reference
to market yields at the balance sheet date on high quality corporate bonds of
consistent term and currency or, if there is no deep market in such bonds, the
market yields on government bonds.

In the UK, actuaries and auditors often base the discount rate on the yield on long-dated
AA-rated corporate bonds. This discount rate is used to value the liabilities and also
used to determine the interest on the difference between the assets and liabilities.

Allowance should be made for discretionary benefit increases if there is a constructive


obligation to award them.

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4.5 Actuarial gains and losses

Under the current version of IAS 19, all gains and losses are to be recognised
immediately outside the profit and loss account, under Other Comprehensive
Income (OCI).

In fact these gains and losses are the remeasurement effects discussed above. They
therefore are the result of:
the impact of any changes in the assumptions in valuing the liabilities
the difference between the expected value of the liabilities and the actual value
due to experience differing from that assumed
the difference between the expected value of the assets (calculated using the
discount rate to determine the expected return on the assets) and the actual value
due to experience differing from that assumed
and any changes in the asset ceiling not included in the interest cost.

This method is analogous to the recognition of gains and losses through the Statement
of Total Recognised Gains and Losses (STRGL) under FRS 17 where gains and losses
are recognised immediately and not through the profit and loss account.

Prior to the current arrangement, many companies adopted the 10% corridor
option a method of delaying recognition of gains and losses. These
companies are likely to see a one-off significant change in their balance sheet
liability the first time they adopt the current approach as any currently
unrecognized gains and losses are taken onto the balance sheet.

IAS 19 previously offered companies a choice of approaches in respect of the treatment


of actuarial gains and losses. One approach was similar to that prescribed by
FAS 87/158 (the 10% corridor option referred to above) another was the current version
(similar to FRS 17).

4.6 Balance sheet

The amount recognised as a liability in the balance sheet should be calculated


as:

The present value of the defined benefit obligation (DBO)

less the fair value of the scheme assets.

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If the result is negative ie an asset, then it should be limited to the asset ceiling
which is defined as the present value of the economic benefits in the form of
refunds from the scheme (more specifically, refunds to which the sponsor has an
unconditional right) or reductions in future contributions.

In practice, the calculation of the asset to be shown on the balance sheet can be very
complicated. For example:
it may be difficult to determine the extent to which an employer has an
unconditional right to a refund of surplus
arguably, even if the scheme is in surplus on an accounting basis, a reduction in
future contributions may not be available if these funds are needed to meet past
service liabilities under the SFO.

As noted above, companies which adopted the corridor approach in their


balance sheets will see an immediate effect on the balance sheet of
implementing the new approach and this is likely to result in a balance sheet
deterioration. Going forward, balance sheet positions will become more volatile
for these companies as the effects of gains and losses from scheme experience
will be recognised immediately.

4.7 Disclosure

The disclosures required under IAS 19 include the following:


Objectives: an explanation of the characteristics and risks associated with
DB schemes and how the characteristics of the scheme may affect the
amount, timing and uncertainty of the companys cashflows.
Characteristics: a description of the scheme benefits and any risks the
scheme poses to the company, in particular unusual risks or
concentrations of risk.
Benefit obligation: a reconciliation of the opening and closing balance of
the schemes liabilities.
Scheme assets: a reconciliation of the opening and closing balance of the
schemes assets and any asset / liability matching strategies. Detail of
any self-investment included in the fair value of assets.
Pension cost: the pension cost recognised in the profit and loss accounts
consisting of:
- current service cost
- interest on net liability / asset
- remeasurement effects.

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Cash flows: expected employer contributions over the coming year


together with a description of the funding arrangements and the weighted
average duration of the scheme.
Assumptions: the significant assumptions used and the sensitivity of the
value of the liabilities to changes in these assumptions, together with
commentary on the methods used in the sensitivity analysis.
Multiple plans: disclosures for plans with materially different risk
characteristics should be separate rather than combined.

Disclosure items no longer required under the current version of IAS19


compared to the previous version include:
Reconciliation of funded status (though this can be determined from other
information disclosed).
Detail of the net periodic cost (though this information is included in the
reconciliation of the liabilities and assets).
Five-year history of asset value, liabilities, surplus/deficit and experience
gains and losses.

4.8 Example

In this section, we show by way of a worked example the figures that might appear in a
companys accounts relating to pension costs under IAS 19. In practice figures would
probably be rounded and some detail may be ignored due to materiality.

You will gain the most benefit from this example if you attempt the calculations
yourself.

We will consider how the figures calculated in the previous example would differ if the
company were reporting under IAS 19. We will assume the same assumptions can be
used for IAS 19 in this instance.

Summary of results

The calculations in the previous example showed that, using the FRS 17 methodology
and assumptions:
Current service cost (CSC): 0.68m
Past service cost and gains/losses from settlements and curtailments are nil

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The table below shows the value of the liabilities on the FRS 17 basis and the bid value
of the assets at 1 January X and 1 January X+1:

Value at 1 Value at 1
January X January X+1

Bid value of assets 40.0m 35.0m

Value of liabilities 38.4m 42.0m

Contributions totalled 0.6m (0.15 4m) during year X.

Additional information

In addition:
During the year X actual benefit outgo was as expected, ie 1.0m.

Calculation of the pension cost for year X

The interest cost on the net liability / asset is calculated as:


Interest on liabilities of 2.11m as under FRS 17.
less
Interest on assets of
40m 0.055 15% 4m 1m 1.0550.5 1 2.19m

Net interest cost = - 0.08m.

This could also be calculated by determining the interest on the net asset/liability at the
start of the year and the net cashflow as follows:
1.6m 0.055 0.68 10% 4m 1.0550.5 1 0.08m

The pension cost which passes through the profit and loss account for year X is:

CSC 0.68m
Interest cost on net liability / asset (0.08)m
Past service cost 0.00m
Gains/losses from settlements/curtailments 0.00m
Pension cost 0.60m

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Calculation of the balance sheet item at 31 December X

The expected value of the defined benefit obligation at the year-end is:

Value of obligation at 1/1/X 38.40m


Value of accruing benefits (CSC + employee contributions) 0.88m
Interest on liabilities 2.11m
Past service cost 0.00m
Benefits paid (1.00m)
Expected value of the obligation at 31/12/X 40.39m

Employee contributions are equal to 0.2m (5% of 4m).

The actual value of the obligation is 42.0m. Therefore, there is an actuarial loss on the
obligation of 1.61m (42.00m - 40.39m) .

The expected value of the assets at the year-end is:

Value of the assets at 1/1/X 40.00m


Interest on the assets 2.19m
Contributions received 0.60m
Benefits paid (1.00m)
Expected value of the assets at 31/12/X 41.79m

The actual value of the assets is 35m. Therefore, there is an actuarial loss on the assets
of 6.79m (35.00m - 41.79m) .

Therefore, overall there is an actuarial loss of 8.40m (1.61m + 6.79m) during year X
and this will be recognised through the OCI.

The pension liability shown in the balance sheet at 31 December X will be:

Value of obligation 42.0m


Value of assets (35.0m)
Obligation recognised in the balance sheet at the year-end 7.0m

Chapter 23, Section 8

Section 8 has been moved back to become Section 9 and a new Section 8 has been
added. As a convenient way to add to your notes, this follows on the next page:

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8 Incentive exercises

8.1 Description of the option

These are exercises where the members are given an incentive to take up an
option. The two exercises most commonly undertaken in the UK are Enhanced
Transfer Values and Pension Increase Exchanges.

As discussed in Chapter 6 an incentive exercise is one of the options that can be


considered in order for the employer to facilitate de-risking of the defined benefit
scheme.

Enhanced Transfer Values

Enhanced Transfer Values (ETVs): these are options offered to non-pensioners.


Members are offered an enhancement to their benefits in order to encourage
them to transfer out of the scheme. Enhancements are usually in the form of an
uplift to the transfer value or a cash lump sum incentive.

ETVs may also be offered to members as an alternative to buying out their deferred
benefits with an insurance company. Which option is beneficial to each member
depends on a number of factors, including the level of the enhancement and the
members personal circumstances. For example, single members may benefit from the
ETV option as they may be able to use all the funds to provide benefits for themselves
only.

Pension Increase Exchange

Pension Increase Exchange (PIE) exercise: these are options offered to members
whereby they exchange their entitlement to non-statutory pension increases for
a one-off uplift to their pension. This option can be offered to existing
pensioners as a one-off exercise and also to future pensioners as an option on
retirement. The level of uplift can be set such that the overall liability is reduced.

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Non-statutory increases on a pension would be reduced or removed and the amount of


initial pension would be increased. The reduction in the non-statutory increases may be
applied to a tranche of pension:
which is receiving increases but has no statutory entitlement to increase, or
which has a statutory entitlement to increase but is receiving a higher level of
increase than required by law and the reduction will not take it below the
statutory entitlement.

8.2 Restrictions

Concerns have existed as to whether pension scheme members are being


treated fairly and fully understand the implications of taking up the option. A
voluntary Code of Good Practice for Incentive Exercises has been published with
the purpose of ensuring that such exercises are carried out to a high standard.

A Code of Good Practice for Incentive Exercises was introduced in response to industry
and government concerns that incentive exercises could be conducted in a way that
disadvantaged pension scheme members. The Code was written by an industry working
group and published in June 2012.

More details can be found at:


http://www.incentiveexercises.org.uk

The key features of the Code include:


Cash and other non-pension incentives are not permitted if they are to be
paid only if the member agrees to exercise the option.
Incentives include anything which has a value to the member that is not a
pension benefit arising from a UK registered pension scheme. This includes cash
payments and receipt of goods and services.
Cash payments designed to encourage engagement with the process are allowed,
eg incentives to encourage members to seek advice.
Communications with members should be fair, clear, unbiased and
straightforward.
Members cannot accept any offer until they have received impartial
financial advice, paid for by the party initiating the offer (usually the
employer).
Remuneration for advice must not be related to take up rates or involve
commission.

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Advice should be tailored to the individual and their circumstances as a whole


including consideration of all materially relevant factors known after reasonable
enquiries.
Exercises should allow sufficient time for members to make up their mind with
no undue pressure applied. Members must be given a cooling-off period
of at least two weeks after accepting the offer, during which they can
change their minds.
For PIE exercise this means designing option forms such that they allow
members to change their decisions within two weeks. For ETVs this means
retaining the transfer value within the scheme for two weeks, before transferring
it.
For PIE exercises, the percentage by which the present value of members
pensions would be altered should be communicated clearly and
prominently.
The percentage quoted in the Code is the Balanced Deal Percentage (BDP),
which is defined as:
Present value of the additional pension following the PIE
Present value of the pension increases given up as part of the PIE
This calculation must be undertaken using the framework for actuarial
equivalence tests as described in Chapter 4, Section 1- Modification of schemes.
Where a PIE exercise results in no change to the present value of the
liabilities (this is hard to determine and depends on the assumptions chosen, but
some advisers may consider this to be the case if for example the BDP is 100%),
members must receive guidance before accepting the offer.
Where it results in a reduction (similarly this may be considered to be the case
if the BDP is less than 100%), members must be offered advice.
For ETV exercises advice should be provided to the member.
For ETV exercises, advice should be given by a party regulated by the
FSA.
This is because this advice is regulated by the Financial Conduct Authority
(FCA) (previously the FSA) and therefore the adviser will need to comply with
the FCAs requirements.
Records should be retained by the various parties involved in an exercise so that
an audit trail is maintained and can be examined in future.
The Code is not retrospective but employers are encouraged to apply it
retrospectively.

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Incentive exercises should only be offered to members who are over age 80 on
an opt-in basis. Advisers should adhere to a vulnerable client policy when
providing advice.
All parties involved in an incentive exercise should ensure that they are aware of
their roles and responsibilities and act in good faith in the areas over which they
have direct control.

The Pensions Regulator has also issued guidance on incentive exercises and this can be
found at:
http://www.thepensionsregulator.gov.uk/guidance/incentive-exercises.aspx

8.3 Assumptions

Enhanced Transfer Values

ETVs are often calculated by adding a margin to the unreduced CETV (the ICE), for
example a margin of 20% could be added (ie applying a factor of 1.2 to the ICE).

However, a variety of techniques could be used, for example:


adding a margin to the reduced CETV
reducing the discount rate used in the calculation by 1% pa
adding 1,000 to each CETV.

Pension Increase Exchange

The same principles apply as for Section 7 but as the Code proposes that the calculation
must be undertaken using the framework for actuarial equivalence tests it would be
appropriate for the CETV basis to be used.

So the critical calculation is a ratio of two annuities that reflects the members sex, age
and marital status, and the different pension increases in the two annuities. Thus, the
key assumption is the level of pension increases in the two annuities. The level of
price inflation will be particularly important if the increases relate to price inflation.

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Glossary

Some new definitions have been added as follows:

Auto-enrolment

A requirement in the UK such that employees not currently in an employer-


related pension arrangement must be automatically enrolled into a scheme
provided by their employer. A multi-employer scheme has been set up to be
used as a vehicle for auto-enrolment (see NEST).

Fiduciary

A legal or ethical relationship between two parties. A fiduciary is a party who


typically takes care of money for another party and acts at all times for the sole
benefit of the other party. Pension scheme trustees have a fiduciary relationship
with the scheme members.

National Employment Savings Trust (NEST)

A multi-employer defined contribution scheme set up by the UK Government to


act as a vehicle for auto-enrolment which may be offered by employers who do
not wish to set up their own scheme.

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3 Changes to the ActEd Course Notes

We recommend that you read the whole of the new version of the Course Notes and
Study Guide to ensure that you are familiar with the course. There have been a large
number of changes to the ActEd text and we do not attempt to list all of these changes
here.

However, in order to help you focus your preparation we summarise the significant
changes to the content of the Course Notes not covered by the Core Reading changes
above. For example, there are various updates for the date of the latest professional
guidance which are referenced in the Core Reading changes (in particular in Chapters 1
and 5) and so these are not repeated again here.

This document should be read in conjunction with the Corrections document.

Chapter 1

The table of current UK data has been updated for the 2013/14 tax year.

Chapter 2

The objectives of the Pensions Regulator, which can be found on its website, have been
updated on page 14.

Chapter 4: Section 5.5

The ActEd text at the start of Section 5.5 has been updated. As a convenient way to add
to your notes, this follows on the next page:

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5.5 Regulation of funding of defined benefit schemes

TPR is keen to identify those schemes where members benefits appear to be at greatest
risk. The Regulator may question the trustees of such schemes further to see whether
they have taken all reasonable steps to maximise the security of members benefits.

The security of members benefits is influenced by the prudence of the assumptions


used to calculate the liabilities and the method and time period over which any deficit is
removed.

In order to identify these schemes TPR use a filter mechanism based on risk indicators.
This is a move away from setting triggers focused on individual items such as technical
provisions. These indicators include:
whether recovery plan contributions and the amount of investment risk
appropriately reflect the relative strength of the employer and also the
affordability of contributions
any specific issues and concerns relating to deterioration in sponsor covenant
strength or possible avoidance
the shape of recovery plans including initial low levels of contributions
the investment performance assumed over the life of the recovery plan
any significant issues from previous valuation submissions.

Further details can be found in the 2013 DB annual funding statement at:
http://www.thepensionsregulator.gov.uk/docs/db-annual-funding-statement-
2013.pdf

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Chapter 4: Section 8

Section 8 has been updated as follows:

The Pensions Act 2004 made provisions for the Financial Assistance Scheme (FAS).

The FAS compensates some people who have had benefits reduced because:
they were members of an under-funded defined benefit scheme that started to
wind-up between 1 January 1997 and 5 April 2005, and
their scheme began to wind-up and did not have enough money to pay members
benefits, and
the employer cannot pay the shortfall because it is insolvent, no longer exists or
no longer has to meet its commitment to pay its debt to the pension scheme, or
the scheme started to wind up after 5 April 2005 but is ineligible for help from
the PPF due to the employer becoming insolvent before this date.

The scheme came into operation on 1 September 2005 and the benefits have been
improved on a number of occasions since then and are now closer to those payable from
the PPF. The FAS will now top up members benefits so that, overall, they receive 90%
of their expected pension, subject to a maximum overall cap of 32,575 pa, payable
from scheme normal retirement age (but not before age 60), increasing with CPI up to a
maximum of 2.5% pa.

The cap is increased annually in line with inflation, as measured by the CPI, and the
figure of 32,575 pa applies to anyone whose entitlement starts between 1 April 2013
and 31 March 2014.

The FAS is administered by the Board of the Pension Protection Fund.

Chapter 7

Section 1 on eligibility has been updated to allow for the auto-enrolment provisions. In
particular a new paragraph has been added after the first Core Reading paragraph on
page 2, as follows:

Whilst membership must be voluntary, with the introduction of auto-enrolment the


emphasis has changed. Employers are required to place employees in a scheme to meet
the auto-enrolment requirements (if they are not in one already). Employees can then
opt out, which requires an active decision by the employee, and this should help
encourage provision. Auto-enrolment was discussed in detail in Chapters 2 and 3.

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Chapter 8

References to the European Court of Justices gender directive have been added on
pages 4 and 5. The directive states that with effect from 21 December 2012 it is not
lawful for insurers to take gender into account when deciding the price of insurance.
The judgment does not apply directly to pension schemes but implies that gender
specific calculations may contravene the European Unions general principles of non-
discrimination.

Chapter 27

Section 2.2 on multi-employer schemes has been updated and the ActEd text in this
section now reads as follows:

The rules governing debt on employer for multi-employer schemes are complicated and
were amended with effect from April 2010 and January 2012. However, in summary
the regulations permit an employer that is ceasing to participate in a multi-employer
scheme to pay less than its share of the statutory debt on employer (Section 75 debt),
provided certain conditions are met. Depending on the regulatory mechanism used, the
debt may not be triggered or may be modified or apportioned to another employer.

TPR has issued guidance on multi-employer schemes and employer departures. This
guidance, which was issued in July 2012, can be viewed on TPRs website at:
http://www.thepensionsregulator.gov.uk/guidance/multi-employer-schemes-and-
employer-departures.aspx

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4 Changes to the Q&A Bank and X Assignments

We have updated questions and solutions for the changes in the Core Reading and
ActEd text. There have been changes to the Q&A Bank, and in particular to the X
assignments. Assignments X2 and X4 have been extensively rewritten, and include a
number of new questions.

We only accept the current version of assignments for marking, ie those published for
the sessions leading to the 2014 exams. If you wish to submit your script for marking
but have only an old version, then you can order the current assignments free of charge
if you have purchased the same assignments in the same subject the previous year (ie
sessions leading to the 2013 exams), and have purchased marking for the 2014 session.

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