IFSL RESEARCH In partnership with: PENSION MARKETS 2010 FEBRUARY 2010 WWW.IFSL.ORG.UK OVERVIEW The climate for pension schemes across the world remains challenging despite some recovery in 2009 Global pension assets are estimated to have grown by 14% from $25.9 trillion at end-2008 to $29.5 trillion at end-2009 (Chart 1) This follows an 18% drop from $31.7 trillion during the previous year The US, with 60% of pension assets continues to dominate worldwide A further seven countries, including the UK, Canada and the Netherlands, account for a third of assets A pensions market is emerging amongst many of the 60 further countries for which data are available The sharp rise in liabilities in major economies in the past two years poses a major challenge to the funding of defined benefit (DB) pensions globally In 2008 and 2009, the asset/liability indicator in 11 major economies fell to its lowest level during the past decade (Chart 2) The 2009 indicator of 75 (25% below the 1998 base year indicator of 100) represented a partial recovery from end-2008, when a combination of a 15% drop in assets and a 12% rise in liablities contributed to a sharp fall in the indicator from 90 to 68 Following the rise in most asset classes rising in 2009, returns of global pension funds returns have been positive Equities markets have recovered from a low point; hedge funds have seen a rebound; and bond returns have been steady In 2008 pension fund returns in most countries had turned negative as most asset types fell in value The UK faces a number of challenges relating to the financing of both public and private sector provision Increasing costs have resulted in the closure of many private sector DB schemes Only 22% of DB private sector schemes remain open to new members in 2009, down from 35% in 2006 and membership of active DB schemes has halved to 2.6m since the early 1990s Contributions to the defined contribution (DC) schemes that have replaced them, at 9% of salary, are only about half that to DB schemes The real return on UK pension funds reached 15% in 2009 but the average real return of 1% over the past decade is depressed by four years of negative returns The aggregate deficit for FTSE 100 companies rose to £96bn in July 2009 Business written in the insured buyout market declined in 2009 due to volatility in credit markets and rising costs of buyouts caused by the fall in the value of pension fund assets Following the Pensions Act 2008, a workplace personal accounts scheme for those not currently contributing to a pension scheme is to be phased in from 2012 DB remains the dominant form of provision in the public sector While there have been some reforms to public sector schemes a substantial deficit remains estimated at £764bn for major schemes in March 2008 In recent years, more people of pensionable age have been supplementing their pension by staying in work UK employment amongst those of pension age has been rising: by 70,000 in the first 11 months of 2009 and by over 500,000 in total since 2002 to reach 1.4 million in November 2009 Chart Global pension assets Pension assets, $ trillion, end-year Non-OECD countries OECD: Other managed funds 28.5 OECD: Pension insurance 32 28 OECD: Autonomous pens funds 24 29.5 25.9 25.1 22.6 19.8 20 17.1 16 31.7 16.3 12 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: OECD, UBS, IFSL estimates Chart Asset/liability indicator for global pension funds Pension fund assets, liabilities & asset/liability indicator for 11 major economies, 1998=100 180 Liabilities 160 140 Assets 120 100 Asset/liability indicator 80 60 1999 2001 2003 2005 2007 2009 Source: Towers Watson IFSL Pension Markets 2010 INTERNATIONAL PENSION MARKETS Detailed figures for global pension assets for end-2008 were published by OECD in October 2009 As indicated in the overview, the total value of pension assets managed globally fell by 18% from $31.7 trillion at end-2007 to $25.9 trillion at end-2008 (Chart 1) IFSL estimates that global pension fund assets rose by 14% to reach $29.5 trillion by end-2009 The global market is dominated by the US, which accounts for 60% of assets (Tables & 2) The next largest markets are the UK with 9% of assets, Canada 6%, the Netherlands and Australia each with 4% and Japan 3% The large value of assets accumulated over many decades means that these countries will remain the dominant source of assets for years to come Pension assets in Brazil were the largest outside the OECD, followed by South Africa and Singapore The large drop in the value of assets during 2008 was caused by negative returns from equities and alternative asset classes, the latter having much higher correlation to equities in a market sell-off than anticipated Previously, growth in assets in the years to 2007 was based on expansion in funding aided by pension reform and recovery in equity markets from 2002 The steep decline in assets in 2008 coincided with a rise in liabilities which resulted in an unprecedented deterioration of 36% in the asset liability ratio in Table Global pension assets Pension fund assets managed in each country, $bn, 2008 Banks Pension Inv cos Autonomous Book insurance managed managed pension funds funds OECD countries funds reserves contracts 1532 391 2151 US 8292 482 325 UK 1511 66 Canada 186 760 Netherlands 988 Australia 947 Japan 874 61 297 Denmark 162 Switzerland 497 229 Sweden 35 175 France 22 21 Finland 160 Germany 172 Spain 22 114 Mexico 113 Ireland 93 10 Italy 78 11 33 Korea 28 Poland 58 Other OECD 167 2023 476 3306 OECD total 218 15070 Total Other pension % funds assets share 3246 15612 60.3 2318 9.0 511 1523 5.9 988 3.8 30 977 3.8 874 3.4 519 2.0 497 1.9 280 1.1 199 0.8 181 0.7 172 0.7 137 0.5 130 0.5 93 0.4 88 0.3 71 0.3 58 0.2 170 0.7 3796 24889 96.2 Non-OECD countries Brazil South Africa Singapore Chile Israel India Hong Kong Other non-OECD Non-OECD total - - - - - - Global total - - - - - Source: OECD, UBS - 288 150 91 89 86 62 60 164 990 1.1 0.6 0.4 0.3 0.3 0.2 0.2 0.6 3.8 25879 100.0 Table Global pension assets $bn, pension fund assets, end-year % change 2008 2008 15612 -23 1523 -7 2001 12523 743 2007 20244 1636 UK Netherlands Denmark Switzerland Sweden France Finland Germany Spain Ireland Italy Poland Portugal Norway Iceland Austria Belgium Russian Fed Hungary Other Europe 1486 411 154 261 73 70 65 35 46 25 13 13 2 3323 1058 438 505 261 179 195 154 129 119 77 51 35 27 28 18 20 15 15 28 2318 988 519 497 280 199 181 172 137 93 88 58 32 27 20 18 17 15 15 37 -30 -7 19 -2 11 -7 12 -22 15 13 -8 -1 -27 -18 -1 31 Australia Japan Singapore Chile Korea India Hong Kong Thailand New Zealand Other Asia 268 756 24 1000 944 91 106 77 62 65 13 15 14 977 874 91 89 71 62 60 14 14 14 -2 -7 -15 -7 -7 -6 Brazil Mexico Colombia Argentina Peru Other L.America 27 - 288 120 31 30 20 21 288 130 35 30 17 22 12 -11 South Africa Israel Other Africa & M.East 29 150 55 150 86 58 17079 31661 25879 -18 US Canada World total Source: OECD, UBS IFSL 2008, adding to the challenge of funding defined benefit (DB) pensions over the long term (Chart 2) The subsequent rise in assets and drop in liabilities during 2009 has only partly redressed the previous year’s deterioration in the asset liability ratio The 30% fall in pension assets in 2008 recorded by the UK was the largest in the dataset, partly caused by the depreciation of the pound Large falls in assets were also recorded by the US Ireland and Chile Despite the decline in 2008, growth in value of assets is expected across a broad range of countries over the long term, including countries with established systems as well as those where pension markets are at an earlier stage of development The latter include the Pacific Basin, such as China and South Korea; Latin American countries as well as countries in central and eastern Europe Pension assets of $24.9 trillion in 30 OECD countries accounted for 96% of the end-2008 global total (Table 2) The main categories consist of: - - - - Autonomous pension funds invested in occupational pensions in 30 countries accounted for the bulk of assets: $15.1 trillion, 58% of the global total Pension insurance contracts are operated by life and pension insurance companies: $3.3 trillion reported in 11 countries Book reserves consist of pension reserves or provisions in the balance sheet of the sponsoring company: $0.2 trillion identified in three countries Investment companies’ managed funds: $2.0 trillion in five countries Banks’ managed funds: $0.5 trillion in six countries Other funds: $3.8 trillion Pension Markets 2010 Chart Pension assets relative to size of economy Pension assets as % of national income, 2008 Denmark Netherlands US Canada Switzerland Australia UK Finland South Africa Chile Singapore Israel Sweden Ireland Hong Kong Brazil Japan Portugal Mexico Poland New Zealand Spain Korea France India Germany Italy Russian Fed 25 50 75 100 125 150 Source: IFSL estimates based on OECD & World Bank data Assets of non-OECD countries: - Pension assets identified in 37 non-OECD countries reached $0.99 trillion Many developed countries have extensive funding pension arrangements At end-2008 pension fund assets exceeded 100% of national income in Denmark, the Netherlands, the US, Canada and Switzerland (Chart 3) Chart Pension funds nominal rate of return Nominal rate of return, 2008 & first half 2009 Assets between 50% and 100% of GDP have been accumulated in Australia, the UK, Finland, South Africa and Chile While autonomous pension funds remain the primary focus of investment in the US, the UK, Canada and the Netherlands, they remain scarce in other large countries of western Europe: Germany, France and Italy Pension insurance policies and personal pensions are also an important source of provision: accounting for the majority of pension assets in Denmark and Sweden, and for 14% in the UK Assets in retirement products, other than pension funds and pension insurance, make up 46% of assets in Canada and 33% in the US Rates of return OECD data for the first half of 2009 shows positive returns for most countries, particularly some emerging markets, such as Hong Kong, Chile and Israel, which emerged more quickly from recession (Chart 4) The gains were rather less for OECD countries with Norway and Switzerland at the upper end recording returns of 10% and 7% The outturn for the whole of 2009 was much higher for countries such as the UK and US with significant equity allocation due to the rebound in equity markets in the second half of the year Positive returns in the first half of 2009 represented a turnaround from 2008 Ireland Hong Kong US Australia UK Netherlands Canada Chile Poland Switzerland Israel Norway 2008 First half 2009 Spain Italy Czech Rep Korea Turkey -35 -30 -25 -20 -15 -10 -5 10 15 Source: OECD IFSL when nearly all countries experienced negative returns, the exceptions being South Korea and Turkey By contrast, Ireland, the US, Australia and the UK suffered the largest falls in 2008 with nominal returns dropping by at least 18% in each of these countries Asset allocation While changes year-to-year in asset allocation over the past decade been heavily influenced by volatility in equity markets, this is less influential when viewed over the period between 2003 and 2008 Trends in asset allocation in recent years amongst five of the major asset managing countries - the US, Japan, the UK, the Netherlands and Australia - are shown in Chart 5: - - The share of equities fell in all five countries, with the exception of Japan, mainly due to the decline in equity markets in 2008 Amongst these five countries at end-2008 the share of equities was highest in the UK at 56% and lowest in the Netherlands at 26% Allocation to bonds fell sharply in Japan, where it dropped from 45% to 32%, while in the UK allocation to bonds more than doubled from 15% to 34% It also rose sharply in the Netherlands, rising from 40% to 58% The share of assets invested in cash, real estate and other investments varies The most significant development in 2008 was in Australia where the share of these assets jumped from 27% in 2007 to 41% in 2008 The recovery in pension funds’ global rates of return in 2009 was based on a rebound in both equity markets and hedge funds, with bond returns steady (Chart 6) Broader trends in OECD The substantial allocation to equities in the five countries in Chart is not reflected in asset allocation elsewhere in the OECD, where bonds continue to rank first In 13 countries, including Denmark, Norway, Poland and Mexico, bonds accounted for over 50% of assets at end-2008 If cash is included then fixed interest investments make up over a half of assets in 19 countries altogether Equities make up over a half of portfolios in only two OECD countries and less than 25% in 18 countries, including Spain, Mexico, South Korea and the Czech Republic, where the share is 15% or less Factors driving reform of pension systems worldwide Pension systems in many countries have been closely reviewed as a result of demographic trends and also because of accounting standards that have increased the transparency of pension liabilities: Demographic trends Increased longevity, falling birth rates, and early retirement mean dependency ratios of many developed countries particularly in Europe and Japan are set to rise over the next half century In Europe in 2010 there were on average around four people of working age to every pensioner, implying a dependency ratio of about 25% However, by 2050 this dependency ratio will have increased to 62% in Italy and 59% in Germany (Chart 7) The increase to 38% in the UK is rather less than elsewhere in Europe Lower birth rates and increased longevity are also affecting countries of Central Pension Markets 2010 Chart Asset allocation of pension funds % share of pension fund assets Bonds Equities Other 2003 UK 2008 2003 US 2008 Japan 2003 2008 2003 Australia 2008 2003 Netherlds 2008 20 40 60 80 100 Source: UBS Pension Fund Indicators Chart Rate of return on assets worldwide Annual average % rate of return 30 20 10 Hedge funds Bonds -10 -20 -30 Equities -40 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009* *First 11 months of 2009 Source: Greenwich Alternative Investments, S&P 500, Barclays IFSL and Eastern Europe and some Asian countries: the dependency ratio is projected to be highest in Japan at 74% in 2050 It is set to soar in China from 11% to 38% over the period from 2010 to 2050, partly a result of the policy of one child per family that has been pursued over the past 30 years It will also rise to a lesser extent in India The dependency ratio in Latin America and Asia is projected to rise from 10% in 2010 to 29% and 27% respectively by 2050 Costs and inadequacies of state pension systems State pension systems are largely funded on a pay-as-you-go (PAYG) basis The impact of ageing populations and increased dependency has drawn attention to the rising cost of financing generous state pension systems on a PAYG basis This is most apparent in the measure of expenditure on PAYG pensions as a share of GDP being in the range of 9-14% in Italy, France, Germany and Spain, compared with 7% in the UK This cost burden is unsustainable and has been the key driving force in policy responses including pension reform that have taken place in the larger countries of continental Europe In many developing countries economic growth and rising living standards have highlighted the inadequacies of state pension systems and their failure to meet the increasing aspirations of individuals for a bigger income in retirement Inadequacies are revealed in poorly managed systems, high contribution rates, growing evasion and increasing likelihood of deficits Most emerging market countries that are members of the International Federation of Pension Fund Administrators (FIAP) have undertaken some reform of their pension system Key elements of pension reform are set out on page 10 Deficits in occupational defined benefit (DB) schemes Occupational DB pension schemes in a number of countries face long-term deficits caused by a gap between assets and liabilities Deficits have been highlighted by the convergence of international accounting standards which mean that unfunded pension liabilities must be reported on a marked to market basis, using bond yields for discounting the liabilities As a result deficits of pension schemes have become transparent on the balance sheets of sponsoring companies Pension Markets 2010 Chart Elderly dependency ratios by country Population aged over 65 as a percentage of working age population (15-64), UN projection 74 75 2010 2050 62 60 59 52 47 45 38 35 26 25 19 11 Japan Italy Poland France China India Germany UK US Source: UN Population Division: World Population Prospects: 2008 Revision Chart DB pension fund obligations Surplus or deficit, % share of pension fund obligations Australia end-2007 end-2008 mid-2009 Canada Switzerland Netherlands Ireland UK US Japan Spain -40 -35 -30 -25 -20 -15 -10 -5 An OECD comparison of companies’ DB pension fund obligations shows that Source: OECD most countries with available data reported an aggregate deficit at end-June 2009 As a share of obligations the deficit was highest in Spain at 31% and Japan 28%, with Ireland, the UK and the US at between 12% and 18% Table Pension deficits in global stocks (Chart 8) Canada, Switzerland and the Netherlands had deficits below 10% while Australia was the only country with a surplus measured at 12% Pension schemes of FTSE Global 100 Index Surp./def of obligations For most of the nine countries included in Chart the deficit Number of Surplus/deficit Mkt.cap as % of €bn €bn had widened in 2008 but narrowed in the first half of 2009 €bn mkt.cap companies Similarly, a survey of the FTSE100 Global indes by Lane Clark & Peacock found that for many of world’s largest companies the position on financing of pensions deteriorated in 2008 Only companies reported a surplus in 2008 compared with 21 in 2007, and the aggregate pension deficit ballooned from $19bn to $154bn (Table 3) As a percentage of market capitalisation, the average deficit in the survey was over 7% for German companies, 5% for French companies and around 3% for the Swiss, UK and US companies, although these averages mask a broad spread 20 19 15 35 31 31 30 38 France Germany Netherlands Switzerland UK US Asia Pacific Middle East Other EU Total 2008 6 14 47 98 2007 -11.8 -6.5 -0.3 1.3 5.1 10.9 -2.2 -0.1 -15.9 -19.4 2008 -14.0 -13.3 -2.7 -9.7 -19.3 -74.1 -4.2 -0.1 -16.9 -154.2 2008 276 175 48 359 615 2488 360 13 5368 9704 2008 -5.0 -7.6 -5.5 -2.7 -3.1 -3.0 -1.2 -1.0 -0.3 -1.6 10 15 Liabilities as % of mkt.value 2008 11 41 30 21 23 13 16 14 16 Source: Lane Clark & Peacock IFSL UK PENSIONS MARKET Analysis of the UK pensions market begins with recent trends in market size and allocation of assets as well as returns It continues with the key challenges facing the pensions industry and the UK’s policy response Market size The pensions industry in the UK is the second largest in the world after the US, with assets managed on behalf of domestic clients totalling £1,250bn at end-2008 The sizeable asset base arises from substantial funding of pensions and significant voluntary provision, with £815bn managed in occupational schemes; £175bn of funds in pension insurance contracts; and assets totalling £260bn in personal pensions The closure of many private sector pension schemes means that DC share is growing steadily There is less dependence on the state pension and the long-term demographic profile is more favourable than in many other European countries Asset allocation The majority of assets in UK pension funds are invested in equities although their share in portfolios has dropped from 75% in 1999 to 56% in 2008 The majority of equity investment is steered to international equities, which account for 31% of total assets, while the share of domestic equities has halved over the past decade to 25% The share of domestic bonds has also more than doubled from 13% to 29% during this period, in part reflecting the steady growth in the issue of government bonds as borrowing has risen Pension Markets 2010 Chart UK pension fund rates of return Average real rate of return (% per year)1 20 15 10 1963-2009 4.2% 2000-2009 1.1% -5 -10 -15 -20 1995 1997 1999 2001 2003 2005 2007 2009 1Change in average pension fund deflated by retail price inflation Source: UBS, BNY Mellon Rates of return BNY Mellon estimated that the nominal rate of return of UK pension funds rose by 14.0% in 2009, implying a real increase of 14.8%, as retail prices fell by 0.7% on average during 2009 (Chart 9) The rate of return was lifted by the recovery in equity markets and also by the depreciation of sterling which increased the sterling value of returns from overseas investments However, a total of four years of negative returns over the past decade mean that real returns have averaged only 1.1% a year between 2000 and 2009 Over the 46 years since 1963 UK pension funds have generated real returns averaging 4.2% a year Key challenges relating to financing of UK pensions The UK faces a variety of challenges in relation to the financing of both public and private sector pension provision Financing of private sector DB schemes The increasing cost of operating DB schemes in the private sector has resulted in closure of many such schemes to new members As a result the number of active members in private sector DB schemes dropped from a peak of 5.7m in the early 1990s to 2.6m in 2008 and 2009 (Chart 10) By contrast, membership of open public sector schemes has grown from 4.1m in 1995 to 5.4m in 2008 While members of occupational private sector DC schemes have been relatively stable at around 1m over the past decade, this does not include growth in stakeholder and group personal pension schemes The decline in DB is relected in the sharp drop in the share of schemes that remain open to new members, down from 35% to 22% between the 2006 and 2009 editions of the Pension Protection Fund’s Purple Book (Chart 11) A Chart 10 Membership of active occupational pension schemes in UK Millions of members Private sector DC Private sector DB Public sector 11 10 1991 1995 2000 2005 2006 2007 Source: ONS Occupational Pension Schemes Annual Report 2008 IFSL further 20% are closed to future accruals, while 55% are closed to new members For all private sector DB schemes, whether open or closed, the sponsor of the pension fund has to match assets and liabilities over the long term The value of UK pension funds is calculated on a going concern basis so schemes may require additional injection of funds for a variety of reasons: these include a decline in value of scheme assets, an increase in life expectancy and lower yields on long-term government bonds FTSE 100 pension schemes The financial position of FTSE 100 pension schemes deteriorated during 2009 with Lane Clark & Peacock estimating an aggregate deficit of £96bn in July, several times the £16bn shortfall at end-2008 (Chart 12) Companies with the largest pension deficits in 2008 were Royal Dutch Shell, BAe Systems, BP, Unilever, HSBC Holding and Royal Bank of Scotland Group Interim estimates of the deficit between mid-2008 and mid-2009 were volatile For example, the aggregate deficit was eliminated for part of the fourth quarter of 2008 due to soaring yields in the AA corporate bonds despite falling equity markets at that time The yield on high quality corporate bonds is set as the benchmark in IAS19 accounting regulations for discounting the net present value of future liabilities The higher long-term bond yields have stemmed from widening spreads related to the credit crunch Lane, Clark and Peacock note that volatility in the value of FTSE 100 pension schemes draws attention to two major issues relating to the IAS19 standard - - Firstly, the calculation of different companies’ pension schemes can no longer be easily compared because of the disparity in corporate bond yields At end-2006, yields were bunched between 5% and 6%, but by end-2008, they were dispersed between 2% and 12%, before narrowing somewhat to between 1% and 8% in September 2009 As a consequence, the valuation of pension liabilities can vary substantially Secondly, cash funding can no longer be directly related to valuation of pension schemes This is due both to the dispersion of corporate bond yields and to volatility in credit spreads since mid-2007 The stable relationship that previously existed between pension liabilities and trustee funding measures is much weaker Pension Markets 2010 Chart 11 Distribution of UK DB pension schemes by status* % share of UK DB pension schemes 1 100 15 17 18 49 50 52 20 80 60 Winding up Closed to future accruals 55 Closed to new members 27 22 Open to new members 2008 2009 40 20 35 32 2006 2007 Year of Purple Book publication *Excluding hybrid schemes that are a combination of DB & DC Source: Pension Protection Fund The Purple Book Chart 12 FTSE 100 pension schemes Aggregate surplus/deficit of FTSE100 pension schemes, June & December, £bn 20 Surplus -20 Deficit -40 -60 -80 -100 2002 2003 2004 2005 2006 2007 2008 2009 Source: Lane, Clark & Peacock About a quarter of FTSE100 companies that took steps to mitigate pension-related investment risks, through reduction of equity exposure, use of financial swaps and purchase of annuities, have been better protected during the financial crisis On a wider front, the increased pressure on cashflow means that companies are having to balance trustees requirements for contributions to meet ever increasing deficits; shareholders’ demands for dividends; and companies’ need for capital expenditure Pension Protection Fund The Pension Protection Fund (PPF) was established in 2005 to compensate members of eligible defined benefit pension schemes in the event of their employer becoming insolvent and where there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of IFSL compensation Out of around 7,375 eligible schemes, there were 363 in a PPF assessment period in January 2010, up from 240 in March 2009 (Chart 13) The PPF is funded by levies on all eligible pension funds The levy is currently indexed to rise in line with average earnings so is projected to rise from £651m in 2008/09 to £700m in 2009/10 and to £720m for 2010/11 The levy was equivalent to 0.08% of eligible assets in 2007/08 The number of eligible schemes has fallen from over 7,700 in March 2008 as a result of scheme mergers, schemes buying out benefits with an insurance company (insurance buyouts) and schemes transferring into the PPF compensation scheme Insurance buyout market The buyout market provides a means of securitising pension liabilities with an insurance company with the eventual aim of winding up the scheme For companies that have closed their defined benefit schemes, the insurance buyout market represents an option for full or partial exit from managing their pension liabilities Traditionally, the main recourse to this market was for businesses that were insolvent or in serious difficulty Although business written in the insured buyout market rose in 2007 and 2008, aggregate deal levels have since fallen off due to volatility in credit markets as well as the rising costs of buyouts as insurance companies factored in the fall in the value of pension fund assets Financing of DC schemes The rising cost of DB schemes has led companies and other organisations to switch funding of pension schemes to DC particularly for new employees Average investment into DC schemes is substantially less than the DB schemes they have replaced The Occupational Pension Schemes Survey found that in 2008, open DC schemes were only contributing 9% of salary, compared with 20% for open DB schemes (Chart 14) These rates of contribution were much the same in the two previous years Employer contribution was 6.6% in the open DC schemes less than half the 14.6% of open DB schemes Member contributions to open DB schemes were typically 5% of salary compared to 3% for DC schemes There are concerns that retirement income generated from these schemes will prove to be inadequate because funding is on average only half that of a DB scheme Moreover, expected payouts on annuities financed by DC schemes have fallen as expectations of lower inflation over the long term have reduced the yield on long term government securities Retail price inflation rose to an average of 4% in 2007 and 2008, but fell to -0.7% in 2009 The 18 year period from 1991 to 2009 has seen a relatively low rate of inflation averaging 2.7% a year sustained (Chart 15) As a result yields on government securities, which are used as the basis for payouts on annuities, have fallen The average yield on 2.5% index-linked bonds eased back to 1.1% in 2009 from an average of 1.8% in the previous five years The yield was an average of 3.6% in the 15 years to 1997 The average yield on government securities with a 10 year term, fell back to 3.7% in 2009 from 4.6% in 2008 The impact of low levels of pensions and other retirement income is reflected in growing employment in those of pensionable age Having risen only slightly during the 1990s employment in this group has increased at a faster pace in recent years: by around 73,000 a year or 510,000 in total from 900,000 at end-2002 to 1.41m in November 2009 (Chart 16) This rise was sustained Pension Markets 2010 Chart 13 Pension Protection Fund Annual levy, £m 800 700 Number of qualifying schemes, March 400 Levy 350 600 300 Qualifying schemes 500 250 400 200 300 150 200 100 100 50 2007 2008 2009 2010* Year ending March 2011 *Number of qualifying schemes in January 2010 Source: Pension Protection Fund Chart 14 Contribution rates to UK pension schemes Type of pension scheme, contribution rates as % of salary 2006 8.9 Open 2007 DC 9.0 2008 9.0 Employer Employee 2006 19.7 Open DB 2007 20.5 2008 19.7 12 15 18 Source: ONS Occupational Pension Schemes Annual Report 21 IFSL during the first 11 months of 2009 with a further increase of 70,000 despite the recession Financing of public sector DB schemes The substantial shift to DC in the private sector is not reflected in the public sector where employees are largely financed through DB schemes As indicated in Chart 10, members of public sector pension schemes have grown to 5.4m Some reforms have been put in place to address the growing liabilities These include a move in some cases to career average salary instead of final salary; a move to sharing costs above a certain defined level between employees and employers; and a move to higher pension ages for new entrants Despite these reforms a substantial unfunded deficit is outstanding Liabilities for the four largest centrally-administered unfunded schemes - NHS, teachers, civil service and armed forces - were officially estimated at £605bn in March 2008 In addition the funded Local Government Pension Scheme had liabilities of £159bn at that date, making total identified liabilities of £764bn in March 2008 Without further reform, this shortfall will have to be funded on an ongoing basis by the taxpayer UK policy response Recent years have seen a raft of measures to reform pension provision and map out the proposed way forward on pensions in the UK These measures culminated in the legislation as set out in The Pensions Act 2007 and The Pensions Act 2008 The Pensions Act 2007, set out in the side panel on page 10, focused on long term structural reforms in the state pension system and state pension age, with the latter to be implemented over the period to 2046 The Pensions Act 2008 set out reforms to workplace pension provision including auto enrolment with minimum employer contributions The overall intention is to put the financing of pension provision on a sustainable basis over the long term and to ensure appropriate pension provision for each individual These measures followed other reforms to personal and workplace pensions that have come into force in recent years The Pension Protection Fund (noted on page 7) was established in 2005 while key measures in 2006 were intended to simplify and standardise pension provision These included: a lifetime limit on the value of any personal pension fund, initially set at £1.5m; tax-free lump sum on retirement fixed at a maximum of 25% of the fund; and pension contributions of up to £2,800 a year to be eligible for tax relief even when the contributor is not a taxpayer Pension Markets 2010 Chart 15 UK inflation rate & bond yield Retail prices index, annual % change, Bond yield, % annual average 12 10 Yield on 10 year govt securities Yield from 2.5% Index Linked Treasury Stock 2016 Retail prices index -2 1988 1991 1994 1997 2000 2003 2006 2009 Source: Office for National Statistics, Bank of England Chart 16 UK employment in people of pensionable age Employment of women over 60 and men over 65, Thousands, end-year Total 1400 1200 1000 800 Women over 60 600 400 Men over 65 200 1993 1996 1999 2002 2005 2007 2009* *November 2009 Source: Office for National Statistics, The Pensions Act 2008 The Pensions Act 2008 contains a number of measures aimed at encouraging greater workplace pension saving It is planned that all eligible workers, who are not already in a good quality workplace scheme, will be automatically enrolled into either their employers’ pension scheme or a new savings vehicle This scheme, originally entitled the personal accounts scheme, has been rebranded the National Employment Savings Trust (NEST) by the organisation responsible for its delivery: Personal Accounts Delivery Authority (PADA) To encourage participation, employees’ pension contributions will be supplemented by contributions from employers and tax relief Automatic enrolment to NEST The plan as set out in the Act is that from 2012, IFSL employers will automatically enrol eligible workers’ between the ages of 22 and State Pension Age who are not already in a qualifying scheme into a qualifying workplace pension scheme (which can include the new ‘personal accounts’ scheme) Automatic enrolment means instead of choosing whether to join a workplace pension scheme provided by their employer, all eligible workers will have to actively decide not to be in a scheme, if for any reason they take the view that this is not a suitable form of personal saving for their situation Minimum employer contribution For the first time all employers will eventually be required to contribute a minimum of 3% (on a band of earnings) to an eligible employee’s workplace pension scheme This will supplement the 4% contribution from the employee and around 1% from the Government in the form of tax relief Personal accounts Personal accounts are aimed at employees who don’t have access to a good quality work based pension scheme - in the main, median to low earners The scheme, which will run as an occupational pension scheme, will have low charges and have a contribution limit of £3,600 per year and a general ban on transfers in and out of the scheme, to focus the scheme on the target market Auto-enrolment of elible workers into personal accounts will begin in October 2012 and will be fully phased in by October 2017 The largest businesses with over 120,000 employees will pay into a pension scheme from October 2012 Employers will then be staged by size from largest to smallest through to 2016 Start up small business will be given additional time to prepare to comply: those created from 2012 will be given until 2016 to start enrolling staff Employer contributions will be phased in from 1% in 2012 to 2% in October 2016 and to the full 3% by 2017 IFSL Pension Group: Key elements of pension reform Pension Markets 2010 The Pensions Act 2007 The Pensions Act 2007 put into law reforms to the state pension system set out in the White Paper, Security in retirement: towards a new pension system published in 2006 Reforms cover the Basic State Pension and the State Second Pension and will change some of the qualifying conditions for both Key changes include: Basic State Pension (BSP) The number of qualifying years needed to receive a full BSP will be reduced from 39 for women and 44 for men to 30 years for both Annual cost of living increases in BSP will be linked to earnings rather than price Subject to affordability and the fiscal position the intention is to start in 2012 but, if not then, by the end of the next Parliament at the latest State Second Pension (S2P) From 2010 national insurance credits will be introduced for those with longterm disabilities and people with caring responsibilities so that they can build up additional pension entitlement State Pension Age State pension age will be increased gradually, between 2024 and 2046, to 68 for both men and women to reflect increasing longevity in society and make the state pension affordable in the long term The guiding principle is for government to develop a framework that enables pension funds to take appropriate account of risks in the investment of retirement savings Key factors include: institutions; separating assets of pension funds from employers control; meeting capital requirements or solvency rules and establishing minimum funding rules; and effective supervision and self-regulation Establishing a pension system that is affordable by future generations through: constraining the size of benefits particularly state pensions to a sustainable level, but that also ensures poverty is alleviated; adjusting earnings-related pensions so that there is a direct link between lifetime benefits and contributions; and raising advance funding in countries where pay-as-you-go dominates to meet future liabilities Encouraging people to save: introducing fiscal incentives Experience has shown that precisely targeted tax incentives are required if people are to save for their own retirement Care has to be taken to avoid interaction of the tax and benefit systems which might encourage early retirement or distort the general savings and investment markets Commitment to macroeconomic stability, low inflation and a balanced fiscal strategy to facilitate effective functioning of securities markets and institutional investment Establishing an efficient financial market infrastructure including a legal framework, a financial and accounting system, regulatory and supervisory framework, clearing and settlement systems and a structure for the trading of securities A risk-based supervisory framework should identify any weaknesses in the funded pension system through the use of sensitivity analysis and stress testing Ensuring the financial security of pension funds and protection of pension beneficiaries This will help to maintain the confidence of beneficiaries and the public at large It includes a number of features: licensing of pension 10 Applying prudent investment principles The application of rules that follow the 'prudent man' principle have proven their worth, enabling asset managers to access international financial markets while also ensuring a high degree of investor protection The taxation of pension assets can in principle be applied at any one of three points: to contributions, investment income and payment of pensions The most favourable model from the investors’ viewpoint is to exempt the contribution and investment income but tax the payment of pensions This arrangement is known as EET (exempt, exempt, tax) EET and other models less favourable to the investor are set out in Chart Developing an appropriate framework for each country This commonly includes one pillar of state provision and another of private provision, although different forms of provision may be included under each pillar IFSL SOURCES Pension Markets 2010 Department for Work and Pensions The Pensions Act 2007 The Pensions Act 2008 www.dwp.gov.uk International Federation of Pension Fund Administrators (FIAP) Annual report & Quarterly reports www.fiap.cl Lane Clark & Peacock Accounting for Pensions 2009 European Pensions Briefing 2009 www.lcp.uk.com OECD Pension Markets in Focus, Newsletter October 2009, Issue www.oecd.org/daf/pensions Office for National Statistics (ONS) Occupational Pension Schemes Annual Report 2008 Economic & Labour Market Review www.statistics.gov.uk Pension Protection Fund Scheme funding: Analysis of recovery plans, November 2009 The Purple Book: DB Pensions Universe Risk Profile 2009 www.pensionprotectionfund.org.uk Pensions Week www.pensionsweek.com Towers Watson 2010 Global Pension Assets Study www.towerswatson.com UBS Global Asset Management Pension Fund Indicators 2009 www.ubs.com United Nations Population Division World Population Prospects: The 2008 Revision, Population Database esa.un.org/unpp 11 IFSL IFSL Pension Markets 2010 Report author: Duncan McKenzie Director of Economics, Duncan McKenzie d.mckenzie@ifsl.org.uk +44 (0)20 7213 9124 Senior Economist: Marko Maslakovic m.maslakovic@ifsl.org.uk +44 (0)20 7213 9123 International Financial Services London 29-30 Cornhill, London, EC3V 3NF This report on Pension Markets is one of seven reports highlighting UK product expertise All IFSL’s reports can be downloaded at: www.ifsl.org.uk © Copyright February 2010, IFSL IFSL Pension Group IFSL is taking a leading role in facilitating the promotion of UK expertise in pension reform throughout the world through its Pension Group This group draws on the wide range of experience in the UK amongst skilled professionals covering asset management, pension providers, legal services and actuarial, tax and investment consultancies For further information on the work of IFSL’s Pension Group please contact: Mairead O’Sullivan Senior Manager, International Group +44 (0)20 7213 9110 m.osullivan@ifsl.org.uk Data files Datafiles in excel format for all charts and tables published in this report can be downloaded from the Reports section of IFSL’s website www.ifsl.org.uk Sign up for new reports If you would like to receive immediate notification by email of new IFSL reports on the day of release please send your email address to download@ifsl.org.uk International Financial Services London is a private sector organisation, with nearly 40 years experience of promoting the UK-based financial services industry throughout the world 12 City of London Corporation administers and promotes the world’s leading international finance and business centre and provides free inward investment services UK Trade & Investment helps UK-based companies succeed in international markets and assists overseas companies to bring high quality investment to the UK’s vibrant economy This brief is based upon material in IFSL’s possession or supplied to us, which we believe to be reliable Whilst every effort has been made to ensure its accuracy, we cannot offer any guarantee that factual errors may not have occurred Neither International Financial Services London nor any officer or employee thereof accepts any liability or responsibility for any direct or indirect damage, consequential or other loss suffered by reason of inaccuracy or incorrectness This publication is provided to you for information purposes and is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or as the provision of financial advice Copyright protection exists in this publication and it may not be reproduced or published in another format by any person, for any purpose Please cite source when quoting All rights are reserved ... the full 3% by 2017 IFSL Pension Group: Key elements of pension reform Pension Markets 2010 The Pensions Act 2007 The Pensions Act 2007 put into law reforms to the state pension system set out... each pillar IFSL SOURCES Pension Markets 2010 Department for Work and Pensions The Pensions Act 2007 The Pensions Act 2008 www.dwp.gov.uk International Federation of Pension Fund Administrators...IFSL Pension Markets 2010 INTERNATIONAL PENSION MARKETS Detailed figures for global pension assets for end-2008 were published by OECD in October