Actuarial and Benefits Consulting

1. Actuarial and Benefits Consulting Jonathan Mowbray CARES 1 December 2003 Aon Consulting Limited is regulated by the Personal Investment Authority for investment business

2. Why Money Purchase fails • Members take all the risk • Transience • No pooling of investment risk • Members cannot afford the risk • Safer investments • Lower benefits for same cost

3. Ancient History Preservation / 5 year vesting 1975 GMP / Requisite Benefits 1978 GMP revaluation 1978 Anti-franking 1985 Pension revaluation 1986

4. Modern History 2 year vesting 1988 GMP increases 1988 Debt on employer 1991 Pension revaluation again 1991 LPI / wind-up / surplus 1992 LPI 1997 MFR / debt on employer 1997 Wind-up / debt on employer again 2003

5. What’s gone wrong? • Targeted, minimum ongoing and guaranteed discontinuance benefits • Only difference is real salary growth • To pay lower than target benefits must break final salary link

6. Why Final Salary fails • Company takes the whole of the risk • Cost has progressively increased • Increased contribution volatility risk • FAS, FRS & IAS liabilities • Loss of investment freedom

7. What do companies want? • Value for money • Stable contributions • Guaranteed benefits for members • Staff retention • Low risk

8. CARE Schemes Career Average Revalued Earnings Schemes

9. CARE Schemes Example - Each year member earns: • Salary ¸ 60 as a pension • Each year pension earned to date is increased by the Trustees • Increase guaranteed to be at least RPI • More if investment returns etc allow it

10. CARE Schemes • The vital issue is the reintroduction of discretionary benefits • Guaranteed benefit increases in line with RPI • Target benefit increases in line with national average earnings etc • Difference between target and guaranteed allows funding flexibility

11. Not just a cheaper option • If switch from Final Salary to CARES to reduce cost, potentially increasing risk • Targeted, minimum ongoing and guaranteed discontinuance benefits

12. Risk - Advantages Risk is shared • Members receive a guaranteed benefit, more if affordable • Company cost is relatively stable • Benefits relatively easily understood

13. Funding Flexibility • The vital issue is the reintroduction of discretionary benefits • Guaranteed ongoing benefit increases in line with RPI • Target benefit increases in line with national average earnings etc • Difference between target and guaranteed allows funding flexibility

14. What CARES offers members • A benefit which is guaranteed to be adequate • A possibility of a larger benefit if affordable • Ability to plan retirement as benefit becomes more certain over time

15. CARES - For the Company • Predictable cost • Removal / reduction of FRS deficit • Flexibility in sharing risk with members • Pooled investments • DB - so more saleable to workforce • Golden handcuff aids retention • No reduction to benefits???

16. Why CARES can work • Discretionary benefits • Target benefit is around 30% larger than guaranteed benefit at revaluation of 2% pa above RPI • Similar effect to discretionary increases in payment

17. Is now the right time? • Many companies moving to DC – alternative may be discontinuance • Possibly no reduction to benefits? • If remain with Final Salary… • Assets fall - problems worsen • Assets rise - problems disappear

18. Reasons given • Reduction of accrued liabilities to minimum guaranteed • Cost containment • Risk management • Middle way

19. Some issues • Past service conversion? • Same or separate Trust? • Contributions and bonus policy • Valuations & bases

20. Contributions / bonus policy • Company funds for target benefits & bonus paid in line with target unless unaffordable • Co pays flat rate unless outside limits - bonuses paid on funding level between target and guarantee • Fluctuations shared equally

21. Alternatives - Hybrids 5 main types: • Underpin schemes • Split benefits • Top up schemes • DC feeder to DB • Cash balance plans