by Chris Parlour - Senior Consultant Punter Southall
We have seen a marked increase in the number enquiries for our pension and investment related expert witness services in recent years. This is perhaps unsurprising in what is becoming an increasingly litigious society. However, we strongly suspect that this isn’t the only driver in the uptick in pensions related disputes. The rising cost of pensions has surely been a factor and tipped the balance in favour of action in a proportion of cases where the cost of bringing the claim might otherwise have been considered prohibitive. In addition, the ever increasing complexity of the legislation surrounding pensions presents greater challenges for those working in the industry that will inevitably lead to more mistakes.
The rising cost of pensions
One needs only to glance at the news from time to time to realise that pension issues are getting lots of press coverage recently, possibly more than ever before. Indeed, with the collapse of British Steel and high street names such as Austin Reed and BHS, pensions are big news at the moment. In the case of BHS, the public spat between Frank Field (the Chair of the Work and Pensions Committee) and former BHS owner Sir Philip Green has given the press plenty of headline grabbing quotes.
Part of the reason for these high profile casualties is the rising cost of pensions, which has led to widening deficits in most UK defined benefit pension schemes. The main driver of the rising cost is the fall in bond yields, as pensions tend to be measured with reference to the yield on bonds. The graph below shows how the benchmark Bank of England 20 year gilt spot rate has fallen since the early 1990s, from a high of close to 10%, to around 1.3% at the end of August 2016:
Combining the effect of falling yields with rising life expectancies, the cost of providing a pension has sky rocketed during the course of the last 25 years.By way of example, in 1992 it might have cost a male aged 65 in normal health somewhere in the region of £10 to secure each £1 per annum of pension (increasing in line with inflation and with an attaching spouse’s pension of 50% of his own payable following his death) with an insurance company. Currently, the corresponding cost would be circa £41, an increase of more than 300%.
The UK vote’s to leave the European Union and the Bank of England’s decision to cut interest rates and increase quantitative easing has been the cause of the latest slump in bond yields. As yields fell, commentators were keen to get their names in the press with ever increasing estimates of how much the deficit across the FTSE 100 index or the FSTE 350 had risen. According to the official PPF 7800 Index, the aggregate deficit of the 5,945 schemes in the index was estimated to have increased to £459.4 billion at the end of August 2016, up from a deficit of £376.8 billion at the end of July 2016. Meanwhile, the press jumped on any FTSE 100 firms and big household names publishing results that showed an increased pension deficit, such as Associated British Foods and John Lewis. There have also been stories about the scheme closures recently announced by ITV and Marks & Spencer and the announcement from Carclo that it could not pay dividend due to its increased pension deficit.
The Bank of England has been criticized in the press for the impact that its monetary policy is having on defined benefit pension schemes. The Bank of England’s own pension scheme is itself extremely well funded as it is invested entirely in gilts, which have ncreased in value as the yields have fallen. It was widely reported recently that the Bank of England currently contributes a whopping 54.6% of salary to its scheme to fund the benefits that its staff are earning, whilst the employees themselves are not required to pay a penny of their own money into the scheme. All this publicity makes it hard for anybody to miss the fact that in any dispute involving a pension scheme, the quantum of loss could well be very large indeed. This extends not just to the sponsors and managers of such schemes. It also applies to individuals who might have lost the right to be a member of a defined benefit pension scheme (for example, through unfair dismissal or following a personal injury which has prevented them from working) or who might be entitled to a share of their spouse’s pension benefits on divorce.
The rising complexity of pensions
There is a huge amount of legislation surrounding pensions. Much of it is designed to protect the interests of members of defined benefit pension schemes and has its foundations in the Pension Act 2004. However, there have been Pensions Acts in 2007, 2008 and 2014 as well as a Pension Schemes Act in 2015, plus and numerous other tweaks introduced by various Finance Acts. Case law can also have a significant bearing on pensions, from the equalisation of retirement
ages arising from the Barber judgement in 1990 to the ruling on QinetiQ in 2012 relating to the indexation of benefits with reference to the increase in the Retail Prices Index. As a result, pensions are more complicated now than ever before.
One particular area where the complexity of pensions has grown almost exponentially is the way that individuals are taxed. The introduction of the Lifetime Allowance and the Annual Allowance in 2006 was supposed to simplify the taxation of pensions, when in fact they did anything but that, with all previous allowances and limits grandfathered rather than being swept away. Since then the Government has radically cut these limits to restrict the amount of pension savings that individuals can build up in a tax privileged arrangement. The Lifetime Allowance, initially set at £1.5 million and rising to £1.8 million by 2010, now stands at just £1 million after being cut three times in the last five years. Meanwhile, the Annual Allowance, which reached £255,000 in 2010, was slashed to just £50,000 the following year, cut again to £40,000 in 2014 and then reduced to just £10,000 for the highest earners in 2016. Every time there has been a change to the Lifetime Allowance, savers have been given the opportunity to protect the pension benefits they have already earned against the new lower limit. There are also complicated rules about the carry forward of past unused annual allowances.
All of this makes it very difficult for advisors, let alone individuals, to keep track of what the current rules are and how best to minimise their client’s personal tax liability. The complexity of the rules and the constant tinkering with them makes errors or missed opportunities to minimise future tax bills far more likely. Individuals who find themselves with an unexpected tax bill, or with a bigger tax bill than they might have expected, will undoubtedly be a little miffed with their advisors.
HM Revenue & Customs released figures recently which revealed that tax collected from individuals exceeding the lifetime allowance rose 62% to £126 million in the 2015/16 tax year, with 1,539 people exceeding the limit. The expectation is that these figures will rise significantly following the latest reduction to the Lifetime Allowance. Indeed, the Treasury said that reducing the allowance from £1.25 million to £1 million would bring in an extra £300 million in revenue in the first year of the cut.
Investment in another area where claims seem to be more frequent now than historically, which must surely be due in part to the advent of more complicated and opaque investment offerings, such as fiduciary management. The investment of pension scheme assets in a wider range of asset classes, including derivatives and credit default swaps, also offer greater scope for things to go wrong.
Pension disputes can arise in a number of ways. When claims are brought by the sponsoring employer and/or the trustees of a defined benefit pension scheme, they are often the result of alleged professional negligence against one or more of the advisers. As an actuary, I am pleased to say that the incidence of professional negligence claims against actuaries is quite low. However, claims for negligence against law firms and claims for negligence or breach of duty against investment consultants are reasonably common. For example, it might be claimed that the legal advisers made an error in amending the formal documentation governing the operation of the scheme, resulting in the scheme’s members being entitled to more valuable benefits than was ever intended. A “classic” example of this is the failure to properly equalise retirement ages for men and women in the 1990s.
Claims against investment consultants might arise where the characteristics of a particular investment do not match the stated objectives of the investor, or the risk of capital loses were not adequately explained to the client. For example, it might be claimed that an investment in so called “cash” fund, where the underlying investments included significant allocations to more risky assets, was not fit for purpose.
Of course actuaries are not entirely immune from professional negligence claims. However, most of the advice that an actuary gives contains a certain amount of subjective judgement and hence it can be hard to demonstrate that any opinion given falls outside of the acceptable range that a competent actuary would give.
Loss of earnings
Loss of future pension rights can form a significant part of any loss of earnings claim, particularly where the individual had access to a defined benefit pension scheme. For smaller claims, it used to be commonplace to use the Ogden tables, which were designed to assist those concerned with calculating lump sum damages for future losses in personal injury and fatal accident cases in the UK. However, the Ogden tables have not been updated since 2011 and are hence considerably out of date and no longer reflect the expected cost of providing pensions in the current low yield environment. The courts therefore tend not to use the Ogden tables anymore, at least not without adjustment. Assessing the value of a lost defined benefit pension therefore requires expert actuarial opinion. Settlements can be measured on a range of basis, from a best estimate of the cost of providing the pension through the scheme to the cost of securing the pension with an insurance company.
Pension sharing on divorce
On divorce, any defined benefit pension that the separating couple is entitled to will often be the largest asset outside of the marital home. Historically, pensions used to be shared by splitting the assessed value of the various pension entitlements between the husband and wife. An order would be applied to the pension such that a proportion of its value (typically half) would be used to provide benefit to the spouse instead of the member. It was then up to the scheme to calculate how much pension that value would provide to the spouse. Alternatively the scheme could force the spouse to transfer that value to an alternative pension arrangement.
Here again the process has become more complicated, as the courts have decided that pension incomes (or projected pension incomes) can be equalised rather than the value of those incomes. This can include, where applicable, the equalization of state pension and additional state pension benefits (e.g. arising from the state earnings relation pension scheme). It also requires any defined contributions pots to be shared in such a way that they provide the same level of income, allowing for the difference in the ages of the divorcing couple and, if applicable, the state of their health.
After the scandal of the late 1980s and early 1990s, where perhaps as many as two million people were wrongly advised to opt-out of generous defined benefit pension schemes and take out personal pensions, one might be forgiven for thinking that pension misselling claims would be consigned to history. Unfortunately that is far from the truth. Furthermore, the number of people being wrongly advised is sure to increase with the new flexibilities that became available to members of defined contribution arrangements in April 2016.
It has also been reported that two NHS trusts have been offering nurses a higher salary if they opt out of their pension scheme. The East and North Hertfordshire NHS Trust is the latest to make such an offer. Previously, Oxleas NHS Foundation Trust was criticised for this same deal and promptly withdrew it.
The Financial Conduct Authority (FCA) is consulting over updating the methodology used to calculate the levels of redress due in cases of unsuitable advice on transfers from defined benefit pension schemes to personal pensions. The current redress methodology used in the industry and by the Financial Ombudsman Service was originally developed for the Pensions Review of the 1990s. It is intended to put consumers back in the position they would have been in had they stayed in the defined benefit pension scheme but does not achieve that currently.
Why Punter Southall
Jonathan Punter, CEO of the Punter Southall Group, heads up our expert witness services team. Jonathan has a considerable amount of experience providing expert witness services and has a credible track record of giving expert evidence in court. He is highly regarded in the industry, having built up a wealth of knowledge and practical experience during the course of a long and varied career in pensions and investments.
Jonathan is supported by a team of experienced professional staff, made up of pension and investment actuaries. Where appropriate, Jonathan and the team can also draw upon the expertise of other specialists from across the Group’s businesses. Jonathan and his team have built up a vast amount of experience in the provision of expert witness services spanning a wide variety of issues. The team typically take on approximately ten to twelve instructions every year. The majority of those cases end in some form of settlement, but inevitably a number do result in court proceedings.
Scottish Widows case study
Jonathan Punter was appointed to provide an expert opinion on the validity of allegations made against Scottish Widows and one of their employees. The case centred on advice provided to the trustees of a pension scheme in 1999, which resulted in the surrender of a Scottish Widows deferred annuity contract in favour of a Scottish Widows managed fund. The trustees asserted that the advice provided by the Scheme Actuary and by his employer was inadequate, stemming from a clear conflict of interest. Scottish Widows has advised dozens of sets of trustees in similar terms, so the importance of this “test case” was particularly important to them.
Jonathan found that the Scheme Actuary and indeed Scottish Widows had acted entirely properly. Jonathan independently verified the quantum of the claim and prepared a formal expert report for the court detailing his findings and his reasoning. Jonathan also provided detailed comments on the expert report prepared on behalf of the trustees, identifying key flaws in the rationale provided and hence the arguments advanced by the claimants. Jonathan then attended a meeting with the expert appointed by the claimants and produced a joint note.
When the case went to trial in 2009, one of Jonathan’s team attended court during the evidence of the expert appointed by the trustees, to assist the legal team with matters of an actuarial nature arising out of his evidence. Jonathan then attended court to give his evidence.
At the Court of Session in Edinburgh, Lord Hodge found in favour of Scottish Widows, ruling that there was no professional negligence in respect of actuarial advice provided by Scottish Widows. After a similar process, a second case went to trial in 2014, with Lord Doherty also finding in favour of Scottish Widows, albeit in quite different circumstances due to differences in the two claimants’ cases.
The following is an extract from a press release made by Scottish Widows shortly after the first judgment was made “The actuarial advice provided to the trustees by Scottish Widows in 1999 was supported by an expert witness, Jonathan Punter of Punter Southall. Lord Hodge could not find any fault in Mr Punter’s assessment that the actuarial advice was within acceptable actuarial practice and noted Mr Punter as giving a convincing defence of the actuarial advice given to the trustees.”
Monster Worldwide Inc. case study
Jonathan Punter was appointed to provide an expert opinion on the value of a “no detriment” guarantee that an individual claimed he was entitled to; namely, a pension from his employer of no less than the pension he would have received had the defined benefit pension scheme he was a member of continued for the duration of his employment. As it was, the defined benefit scheme was closed and replaced with a defined contribution arrangement. The case was brought after the member sought to take advantage of the claimed guarantee on retirement in April 2006 and his employer disputed the existence of it.
Although the claim followed the individual’s retirement in 2006, it related to events which had taken place in the late 1970s and 1980s. As a result, there were a number of uncertainties on the detail of the claim. In providing his expert opinion, Jonathan presented results on a range of alternative scenarios, capitalising the loss of pension on a range of different bases.
The question of whether or not the claimant was entitled to such a guarantee was a legal one and therefore outside of Jonathan’s expertise. The judge decided that the individual did have a right to a “no detriment” guarantee and the focus then turned to the nature of the guarantee and the value of it.
Whilst the claimant had sought quantum of loss on a measure consistent with the cost of securing the guaranteed level of benefits with an insurance company, the judge ruled that a measure consistent with the statutory accounting basis that Jonathan had put forward was appropriate, which significantly reduced the loss.
In giving his judgment Judge Behrens set out that “Mr Whitney and TMP had the benefit of actuaries for them. Fortunately for me there was a large measure of agreement between them. Furthermore when they gave evidence it was perfectly plain that they were each highly expert and attempting to assist the court. Indeed it heartening to see how often they agreed with each other on points requiring their actuarial expertise.”