PRAG SORP - The Pensions Management Institute

The Pensions Research Accountants
Group
Statement of Recommended Practice:
Financial Reports of Pension
Schemes
Response from
The Pensions Management Institute
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15 July 2014
Response from the Pensions Management Institute to the Pensions
Research Accountants Group’s (“PRAG”) Statement of Recommended
Practice: Financial Reports of Pension Schemes (the “SORP”)
Introduction
PRAG in conjunction with its SORP Working Party has prepared a draft revised Pensions SORP
following the introduction of FRS102. This will be effective for accounting periods commencing on
or after 1 January 2015, requiring comparative data for the previous year. We note that to a large
extent the changes to the existing SORP are intended to reflect requirements imposed by FRS102,
but in some areas there have been updates to reflect emerging practice in UK/Irish occupational
pension schemes. We welcome the opportunity to respond to this consultation.
The PMI
The Pensions Management Institute (PMI) is the professional body which supports and develops
those who work in the Pensions Industry. PMI offers a range of qualifications designed to meet the
requirements of those who manage workplace pension schemes or who provide professional
services to them. Our members (currently some 6,000) include pensions managers, lawyers,
actuaries, consultants, administrators and others. Their experience is therefore wide ranging and
has contributed to the thinking expressed in this response.
PMI’s response
General comments
We welcome a periodic revision of the SORP as pension practice develops. We note that on this
occasion, the changes are made within the context of FRS102. However, we do have concerns
that the new SORP will add to the burden of operating occupational pension schemes, both at
transition and on an on-going basis.
We suspect that many trustee boards and scheme sponsors will see the new SORP as a source of
additional costs with little, if any, additional value. In many schemes, the trustees’ annual report
and accounts is generally seen as a compliance document, with most pension scheme members
relying on the trustees’ “popular report” and external parties then relying on a variety of other
documents which more specifically address their needs. If anything, we suspect that trustees (and
scheme members) would prefer shorter and more straightforward financial statements which may
encourage member engagement. The changes to the SORP will make accounts longer, with more
detail and are likely to have the opposite effect.
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We note that in many areas these additional burdens directly arise from the requirements of
FRS102 and as such must be reflected in the SORP. However, we encourage PRAG to feedback
to the Financial Reporting Council any areas where it appears that there is a universal concern or
where the compliance costs appear to outweigh any benefits from the revised requirements, so that
these can be borne in mind when FRS102 is itself reviewed.
We encourage PRAG to allow a pragmatic view where possible within the strictures of FRS 102,
and, in turn, to encourage auditors to accept pragmatic approaches where they do not consider the
matter is material to a fair understanding of the operation of a scheme. When commenting on
PRAG’s specific questions, we have indicated where we believe a pragmatic approach is suitable.
PRAG asks specifically for input on cost and cost savings; we therefore assume that to date PRAG
has not completed a cost-benefit analysis of the effect of introducing the new SORP. In the context
of our comments above, we think this is essential and the results of this analysis should be
considered and published for external scrutiny before the new SORP is introduced.
From a cost perspective for the majority of schemes there will be additional implementation costs
and higher running costs, coming at a time when managing such costs (including adviser fees)
remains challenging for the majority of trustees and scheme sponsors. We do not believe that
schemes will see a reduction in costs following the introduction of the new SORP. We encourage
PRAG to be proactive in obtaining feedback from a variety of pension schemes, the major
accounting firms and the accounting teams of the major pensions administration outsourcers, which
may be possible through polling PRAG members.
Response to specific questions
Q1 –Annuities - FRS 102 requires annuities to be reported at the amount of the related obligation.
What practical issues do you see arising from this requirement? The Draft SORP envisages the
annuity value will be based on the trustee perspective of the related obligation and therefore most
likely determined by the Scheme Actuary. Do you agree with this approach? (3.12.18 to 3.12.22).
We agree with the basic principle that, if the value of annuities is to be included as an asset in the
accounts, then the annuities should be valued from the trustee perspective on a consistent basis to
the related obligation, and that it should normally be valued by the scheme actuary. However, we
have serious reservations over the inclusion of annuities as scheme assets in the financial
statements as envisaged by the SORP. We believe these views will be shared across the industry:
Typical practice currently is for trustees to include as a scheme asset within their financial
statements the value of a bulk buy-in annuity policy, but to not include as an asset any
other annuities. This appears a reasonable approach, but means that the changes
proposed by the SORP will have a material impact on the preparation of most schemes’
financial statements
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15 July 2014
We note that the other circumstance in which trustees are currently required to make a
regular valuation of annuity policies is in relation to PPF valuations. These are typically
made on a three yearly basis and the PPF acknowledges that some information may be
hard/expensive to collate so it allows schemes to take a pragmatic approach to such
valuations if it is necessary.
We also note that between formal valuations (and on whatever basis is used to value the
annuity) there will be a degree of subjectivity over the appropriate valuation assumptions.
So the annuity valuation will by necessity be to a certain extent an approximation in each
set of accounts.
We do not see the arguments around PPF entry as being compelling – this does not apply
to schemes with money purchase benefits, and only applies to DB schemes where they are
discontinuing, whereas the financial statements are being prepared on a “going concern”
basis.
If, and only if it is not acceptable under FRS 102 to retain the current SORP approach, we suggest
that PRAG adopts a more pragmatic framework for their valuation under the SORP than currently
drafted, for example:
Requiring a valuation only where the annuity policies relate to benefits provided from the
defined benefit section of the scheme (with disclosure for money purchase annuities only of
the number secured in the trustees’ names and the trustees’ current policy in this regard
when purchasing annuities)
Requiring a valuation only where it is anticipated that the value to be placed on the annuity
policies will exceed 5% of the market value of the assets of the scheme
Unless an accurate valuation of annuities is fundamental to a proper understanding of the
accounts, being able to rely on the most up to date valuation of the annuity policies which
should be at an effective date no earlier than the effective date of the latest completed
formal actuarial valuation of the scheme
Allowing trustees to update the value placed on annuity policies between formal valuations
by deducting any payments made from the policy from the value at the previous formal
valuation.
All of these suggestions are put forward as pragmatic ways of managing costs in a way that is
unlikely to be material to a true and fair understanding of the financial position of a scheme.
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As well as these general points we believe there are a number of practical issues that we see
arising from the FRS requirement:
Not all bulk buy-in policies will exactly match the amounts and timing of the benefits
payable – there may be pragmatic adjustments for ease of insurance or on materiality
grounds, for example trustees may choose to insure pension increases on an RPI basis
where a scheme rules provide CPI as this would be more cost effective; if RPI exceeds CPI
then the fund would benefit from the excess. You may wish to recognise this in 3.12.18
which currently suggests exact matching, since there would appear sound grounds to treat
these annuities in a similar manner to exactly matched annuities but reflecting the actual
details of the benefits secured.
The valuation of annuity policies may need to be a separate (and possibly additional)
exercise to the work normally completed by the scheme actuary which would add costs to
the operation of a scheme. For example, accounts need to be completed within 7 months
of the accounting date, whereas an actuarial valuation could take 15 months, and in
intermediate years typically approximations are used.
In many schemes, there may be annuities secured in the name of the trustees from many
insurers, and over a significant period (where to all intent and purpose the trustees believe
that responsibility for the benefits passed to the insurer at that time). While many of these
may relate to AVC payments, this is not necessarily the case. For example, annuities may
relate to death in service claims, and possibly a historical policy of securing retirement
benefits with an annuity in the name of the trustees. This does not cause any technical
issues but highlights that the compliance cost may be high; data collection could be
onerous and valuations may need to be done on an individual basis, for example if different
levels of pension increase are secured.
As well as significant obstacles in collecting data at transition (and the preparation of three
valuations of policies as a part of transition), trustees will need to remain in regular contact
with insurers. Where benefits are paid direct, trustees will be reliant on the insurer notifying
payments made, deaths etc on an on-going basis. Without this continuing dialogue any
financial reporting will be unreliable. This will add costs to annuity providers who may be
unwilling to cooperate.
We note that receipts from the annuity provider can be apportioned to sales proceeds and
investment income or reported all within investment income. We do not think this is
necessary and only one option should be permitted. However, the effect of annuities
should be isolated from that of other investments since, otherwise, payments from policies
and their valuation could obscure the actual financial performance of a scheme.
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Focusing more on DC benefits, while we note that 3.12.22 acknowledges there is a
question of significance, significance is being judged by reference to all annuities and not
the position of an individual annuity:
o
The SORP highlights the difference between annuities bought in the name of the
trustees and those bought in the name of the member and their consequent
treatment in the accounts. This is an important legal distinction but the position in
an individual scheme is more likely to be due to the drafting of scheme rules and
historical practices than a conscious policy decision at the time. In the normal
operation of the scheme it also has little relevance; it is only where a scheme is
winding up or an insurer is in distress where it may be of relevance. Winding up
does not seem to be relevant to accounts prepared on a “going concern” basis, and
there would be other considerations not covered in the accounts were the annuity
provider to be in difficulties. A requirement to include in the accounts a valuation of
such annuities in trustees names may lead to a change of policy in the future, and
(if possible) an assignment of policies into individual names. It is not clear that this
would always be in the best interests of the members concerned, and would seem
to be an undesirable outcome of the new SORP.
o
The additional costs of compliance will need to be met from somewhere; although
there is a tendency to assume that such additional costs would just fall into the
general running costs, be paid out of scheme assets and so ultimately met by the
employers this is not always the case. In some schemes costs are deducted from
members’ funds, which would again be an undesirable outcome.
Our view is that all annuities matching money purchase benefits should be excluded from
the financial statements, and we do not believe that this would have any detrimental impact
on the statements themselves.
Q2 – Investment risk disclosures – has the Draft SORP taken the right approach to risk
disclosures? (Section 3.16). In particular is the approach to pooled investment vehicles and the
look through and asset class approaches considered appropriate? (3.16.1 to 3.16.15).
Is the
approach to direct credit risk for pooled investment vehicles, which recommends disclosing an
analysis of types of pooled vehicles held, appropriate? (3.16.10 – 3.16.13). Are there alternative
approaches that could be considered? (3.12.8 to 3.12.10).
We note that PRAG are directly responding to the requirements of FRS 102 in this area. As
general principles, we are concerned that the words around the disclosures could quickly become
“boiler plate” wording, and that much of the content is already included in the Statement of
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Investment Principles, which is arguably a better place to discuss risks. This is acknowledged in
3.15.11.
Generally, we are concerned whether the additional quantification of risks will provide a meaningful
insight into the finances of the scheme; for example the quantification of the foreign exchange risk
exposure example in 3.16.8 is simple and clearly communicated, but does not provide a meaningful
disclosure out of context of other risks, and without a material commentary. Some of the
information will require input from investment managers, and may be difficult to obtain where it may
be a different measure from that used for the on-going risk management in the scheme;
undoubtedly there will be additional costs as the extensive disclosures will require professional
advice. It is not clear to us for whom this information will be of benefit – it is dealing with matters
that the trustees will be addressing already in a different forum, and which are consequences of
decisions they have made; it is not clear what benefit members or other parties will obtain from the
disclosures.
We suggest that the SORP provides for a more narrative form of communicating investment risks
which does not involve significant financial disclosures, which will often be out of date by the time
they are published, and will never be used as a basis for decision making. To this end, PRAG
could consider requiring a summary of the risk factors as addressed in the current Statement of
Investment Principles.
More specifically:
While it will involve more work, if the disclosures are to be extended in this way, we agree
with the SORP recommendation in paragraph 3.15.5 that the inclusion within FRS 102 of
just financial instruments is too focused and that it should be extended to cover all
investments.
We agree with the comments in 3.15.10 about DC investment risk at a scheme level not
being relevant. However, we do not believe that the report and accounts is the best place
for disclosures at a member level, particularly as our experience is that very few members
will ever read the document. Even where members read the document, we do not believe
that the proposed disclosures will be of use because members will often be invested in
several funds (with different risk characteristics). We would expect risk disclosures to be
included in other member communications and believe these (and not the financial
statements) are the best forum in which to communicate and educate members.
Focusing on pooled investment vehicles, we consider that with the evolution of investment
strategies and the availability of increasingly sophisticated investment products, there is a
continuing and increasing blurring within pooled arrangements of the purpose of all types of
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investment, including equity and bond holdings as well as hedge funds. Whilst it is right to
raise this issue in 3.16.2 to 3.16,5, we believe that there should be more flexibility for the
trustees to account as they see fit for their specific scheme with a consistent approach
taken from year to year. This could then be dealt with much more succinctly in the SORP.
Q3 –Fair value hierarchy – is the distinction of investments valued using a valuation approach
(Category C investments) between those using market observable data (C (i)) and non-observable
data (C(ii)) considered helpful?
We consider that other respondents are better placed than us to comment on this question.
Q4 – Financial statement presentation – Do the example financial statements provide sufficient
practical guidance on the application of the Draft SORPs’ new disclosures? Is the alternative
combined presentation of investment risk and derivative notes to the example financial statements
helpful? Is having a choice of examples helpful? Are there better alternative approaches?
In our general comments, we have raised our concerns that the overall impact of the changes to the
SORP is to lengthen the accounts, which will make them less appealing to the internal parties
identified.
We recognise that the SORP example is only meant to be an example presentation. However we
expect in practice that most schemes will use this as a model for their own disclosures. We would
therefore encourage PRAG to remove any options from the presentation of the accounts (for
example the alternative combined presentation on page 101, and whether the compliance report
forms a part of the trustees’ report or is shown separately), as this would allow more streamlined
processes, particularly for third party administrators (who will only need to develop a single
template) and auditors.
At a more detailed level (and some of these comments relate also to the relevant drafting in the
SORP itself):
The split of employer and employee contributions is unnecessary in the Fund Account as
this is shown in the notes.
We suggest taxation and expenses are shown before the change in market value on the
Fund Account.
We suggest the Fund Account example includes ‘Transfers between sections’, as this will
be a typical disclosure for hybrid schemes.
There is unnecessary duplication on the net asset statement investments with the main
investment table in the notes. We do not see any benefits of this duplication, and suggest
the net assets statement reverts to the current disclosures.
The administrative expenses note should be expanded for the more common headings
such as administration, actuarial, consultancy, audit, legal, trustee and miscellaneous fees.
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In our experience these are a useful disclosure and one which readers of pension scheme
accounts do scrutinise.
Q5 –Auto-enrolment – do you agree with the approach taken by the Draft SORP in relation to
accounting for the first contribution arising from employees who are auto-enrolled? (3.8.2).
Yes, although we suggest that any employer contributions that become overpaid contributions
should be netted off against future contributions rather than shown as refunds.
Q6 – Legislative disclosure requirements – do you agree with PRAG’s view that the legislative
disclosure requirements in relation to investment classifications as set out in the Audited Accounts
Regulations are updated to come into line with FRS 102 and the Draft SORP?
We agree and, in turn, when it is revised FRS102 should be brought into line with IFRS in relation
to investment hierarchy disclosures.
Q7 – Concentration of investments – in addition to the detailed investment classification
disclosures referred to above, the Audited Accounts Regulations also require the disclosure of any
investment (other than UK Government securities) in which more than 5% of the total value of the
net assets of the scheme is invested. Do you think this disclosure is necessary in light of the risk
disclosures required by FRS 102 (section 3.15) and the separate requirement to disclose employer
related investments (section 3.32)? If you do think it is required should it apply to investments in
pooled investment vehicles at the unit level or should investments held indirectly through pooled
investment vehicles be taken into account (the “look through” approach)?
No, we do not consider that this disclosure is necessary.
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