CTC Pensions Technology’s operations director, Sam Al Hamis, explains that much needs to be done regarding valuation projections before a scheme will be ready to join the pensions dashboards.
Every single scheme and every single penny will need to assign volatility ratings to all those funds under the final Technical Memorandum 1 dashboard rules.
Despite the recently announced further delays, we think it is important to dispel the perception that the dashboards is just a plug and play proposition.
While the necessary dashboard technology is critical, much work needs to be done on the significantly improved basis for valuation projections before a scheme will be ready to join.
While the changes to the basis for projections including the ABS will inevitably cause some member confusion, the bigger challenge for schemes is the change to accumulation rates based on tiered volatility rate basis
It is also worth noting that while the greatest challenge will be for DC schemes, the same issues apply for defined benefit schemes and the fund management industry that serves them.
What’s changed with valuations?
Since its inception in 2003, TM1 provided flexibility to how the scheme members’ projection rules for the likes of the annual benefit statement rules apply specifically in terms of the form of an annuity (income) resulting from the conversion of funds.
The old rules also recognised that most people take tax-free cash and may ask for different proportions of reversionary annuity. It also allowed the pension to be calculated at different increase rates in payment or, indeed, to remain level.
This flexibility has had an adverse effect where different companies produced benefit statements using different formulae, which can produce very different answers.
Two exemplary schemes
For the purpose of illustration, we have assumed that a member has worked for two different companies and has built up the same fund size in both. Assumed aged 75 when pension taken with a monthly income guaranteed for five years or until death.
However, company one illustrates on its ABS a 50 per cent spouse income, while company two does not.
There are many other permutations, but it is easy to see how a member who has worked for multiple employers could become very confused.
Schemes need to be prepared for member enquiries regarding why their new projections do not necessarily match their historic paperwork.
Historical ABS could look very different for the same fund value
Typical ABS data (abridged) | Employer 1 | Employer 2 |
At age 75 your fund could then be worth in real terms | £470,000 | £470,000 |
Your 25% lump sum, in real terms could be worth | £117,000 | £117,000 |
Your remaining fund buys an annual income | £14,300 | £21,600 |
And a spouse pension income of | £7,150 | None |
Old versus new projection criteria
New projection criteria | Old projection criteria |
Annuity projection | Annuity projection |
Non-increasing annuity | Increasing permitted |
Payable monthly in advance | Payable monthly in advance |
No spouse pension | Spouse pension permitted |
Five-year guarantee | Default tended to be five-year guarantee although some opted for zero guarantee |
Pension expressed as annual amount | A per frequency amount was permitted |
Pension commencement lump sum: no PCLS can be assumed. | PCLS could be included |
Inflation and earnings assumptions: 2.5% a year after volatility calculations | 2.5% per annum |
Interest rate: must use the FTSE Actuaries Government 15-year Fixed Interest Yield Index | Option to calculate rate for inflation indexed annuities with a 3.5% adjustment. |
Annuity expenses: 4% | 4% |
Mortality Unisex PFA16 and PMA16 tables | Unisex PFA08 and PMA08 tables |
Accumulation rate changes
While the changes to the basis for projections including the ABS will inevitably cause some member confusion, the bigger challenge for schemes is the change to accumulation rates based on tiered volatility rate basis.
Currently, the accumulation rate assumptions for statutory money purchase illustration calculations are determined by individual providers based on their expectations of future fund performance. There is a degree of subjectivity in these assumptions.
From October 1 2023, the approach changes. The Financial Reporting Council has specified a set of accumulation rates assumptions that apply based on the volatility group into which an investment falls.
New volatility group accumulation rates
Volatility group | Accumulation rate |
1 | 1% pa |
2 | 3% pa |
3 | 5% pa |
4 | 7% pa |
The volatility group calculations are specified in TM1 sections C2.7 to C2.15 and are based on a formula that is not part of fund providers current calculations or data feeds.
It will be necessary to work with managers of every fund offered to members to provide both the volatility category and appropriate projection based on monthly fund returns over a five year period up to September 30 each year.
Where the investment does not have a full history required to carry out the volatility calculations, the methodology specified in C2.9 of the new rules must be used.
Where with-profits funds and unquoted assets are contained within an investment and are reflected within the investment’s unit price, no adjustment is required. This will also require a real-time calculation.
Some fund managers may include the costs for making these calculations and providing data feeds, others will provide them at the dashboards interface.
Schemes need to address this urgently, as there are potentially thousands of funds across multiple fund managers without a mandated solution.
What happens next?
Schemes should ask their fund providers and dashboard interface providers how the volatility calculations will be executed. This is especially urgent where less mainstream investments or providers are being used.
Sam Al Hamis is operations director at CTC Pensions Technology
