Pensions Benchmarking Survey

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Benchmarking Survey 2009

Pensions Benchmarking Survey

Companies in the Infrastructure and Facilities Management Sector

involved in PFI/PPP contracts

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Introduction

Lane Clark & Peacock LLP (LCP) has conducted a survey of the pension benefits provided by 16 major companies in the infrastructure and facilities management sector. The survey specifically covered companies involved in public sector outsourcing contracts such as PFI/PPP contracts, and was carried out by LCP’s Public Sector Outsourcing Group. 10 of the companies surveyed are in the FTSE 350 index, of which three are in the FTSE 100.

The survey included a follow-up on several of the issues investigated in LCP’s major PFI/PPP Pensions Study carried out in 2006, the report on which is available at wwwwww..llccpp..uukk..ccoomm//ppssoogg. It also looked at the pension benefits being provided to new employees not joining on public sector contracts to see how these compare for these companies. The survey results were obtained from telephone conversations with company contacts and analysis of information available from other sources, and have not been confirmed in writing. The survey participants were asked about the main pension benefits their companies provide – it is likely that some employees receive different benefits, or have done so in the past, which are not reflected in the survey results.

Overview

The survey showed a considerable degree of commonality between the approaches to pension provision adopted by the 16 companies, both for mainstream employees taken on in the normal course of business, and for employees transferring under TUPE on public sector contracts.

Mainstream pension provision

The companies in our survey demonstrate a very similar pattern to pension provision for their mainstream employees (ie those not transferring from the public sector) as has been followed in recent years by many companies in the UK. This has been characterised by an increasing reluctance to bear the financial risks of providing defined benefit (DB) pensions, with first the closure of most DB schemes to new entrants, and then more recently an increasing move to close off future accrual for existing DB scheme members.

15 of the 16 companies surveyed have a DB pension scheme for some of their existing employees, but these schemes are now all closed to new entrants (except for public sector transferees). All 16 companies provide only defined contribution (DC) pensions for new recruits.

There is more variety in the handling of pension provision for future service for existing DB scheme members. Two companies have already closed their DB schemes to any further benefit accrual (and offered DC pensions instead), two have

Survey of pension benefits provided by 16 companies involved in PFI/PPP contracts

- 10 in the FTSE 350

15 companies have defined benefit pension schemes

-all are closed to new entrants

All 16 companies now provide defined contribution pensions for new employees

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switched to a career average basis for future accrual, and 11 continue to provide traditional final salary pensions (though many have adjusted benefits and member contributions in recent years to address rising costs). Of the 13 companies still providing DB pensions, 5 have considered closure to future accrual – this is a trend we believe is likely to continue, particularly as current financial pressures cause companies to look at all possible methods of reducing cost and risk.

Turning to the DC benefits provided for new recruits, there is a range of approaches to employer contributions, both in terms of the absolute level of contributions and the extent to which these are linked to age, grade and/or the level of contributions paid by the employee. Overall, however, in most cases the level of contributions being paid means that new recruits will generally build up significantly smaller pensions than provided by the DB schemes now closed to new members.

This raises the question of whether these new employees will in practice be able to afford to retire when they, and their employers, currently expect them to. For those companies with a DB scheme still open to future benefit accrual, it can also mean the development of a two-tier workforce, with similar employees receiving pension benefits of very different value depending on whether they joined before or after the DB scheme closed.

Public sector transferees

Although some changes have been made in recent years to contain costs, all the main public sector pension schemes continue to provide high quality DB pensions. Government rules (known as the “Fair Deal”) require that, if public sector employees are transferred under TUPE to the private sector, the new employer must provide very similar pension benefits, which need to be DB. This means that, in order to win public sector contracts which involve a transfer of employees, companies must be willing to take on the financial risks of providing ex-public sector employees with DB pensions, even though they no longer feel able to offer such pensions to their normal recruits.

Our survey indicates however that, notwithstanding their aversion to DB pensions risk, most of the companies surveyed are in practice still prepared to offer DB pensions as required by the Fair Deal in order to qualify to tender for public sector outsourcing contracts. Furthermore, all but one is willing to consider participating in the Local Government Pension Scheme as an admission body in order to be able to bid for local authority contracts.

On the face of it, this appears to indicate that the Fair Deal requirements are not in practice proving a significant obstacle to the tendering of public sector outsourcing contracts. However we are aware, both from the survey discussions and more generally, that there is increasing concern about the impact of the Fair Deal. Bidders on public sector contracts are less willing to accept the open-ended risks of DB pensions, and indeed two of the surveyed companies have considered closing their existing GAD passport sections to future benefit accrual, even though this would clearly have serious implications for future contract bids.

Are the DC contributions being paid high enough to provide adequate pensions

when employees retire?

...but the financial risks of doing so are a major and

increasing concern Most companies are prepared to offer DB pensions in order to be able

to tender for public sector contracts...

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Furthermore, bidders often aim to negotiate risk containment measures with the contracting authority, particularly for LGPS admission agreements on local authority contracts (in fact two survey participants indicated that they would not proceed with such a contract unless there were no material financial risks taken on relating to pensions). This increases significantly the complexity (and hence cost and duration) of contract negotiations, and can make it much more difficult to maintain a level playing field between bidders.

Conclusions

Our survey has reflected the increasing divide between public and private sector pension provision in the UK, and the difficulties this causes companies bidding for public sector outsourcing contracts.

There has been very little change in the Government’s Fair Deal requirements since we carried out our 2006 PFI/PPP pensions study. Yet, since then, companies faced by an increasingly uncertain financial environment have accelerated their retreat from DB pension provision. A significant proportion of companies have now closed, or are considering closing, their main DB pension schemes to future accrual. Furthermore some have considered doing so for members in GAD passport sections, even though this would clearly affect their ability to bid for future public sector contracts.

This represents a serious, and growing, disconnect - between public policy and the ability and willingness of companies to take on pensions risk. Inevitably this will impact adversely on the ability of companies to make competitive and cost-efficient bids, and hence on best value for the tax-payer. We therefore continue to believe that the Government should undertake a fundamental review of the principles of pensions risk transfer on outsourcing contracts so as to address these issues.

The Government should carry out a fundamental review of pensions risk transfer on outsourcing

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Benchmarking Survey 2009 - Survey results

Defined Benefit Schemes

Of the 16 companies surveyed, 15 have a defined benefit pension scheme. Two of these defined benefit schemes are career-average in nature for future accrual of benefits.

GAD Passports for transferring public sector employees

11 of the 16 companies surveyed currently possess a “passport” issued by the Government Actuary’s Department (“GAD”) enabling them to admit employees transferring from the public sector to their defined benefit schemes under the Government’s Fair Deal requirements. One of these companies held its passport via the Prudential Platinum multi-employer scheme, with the other 10 holding their passports within their own defined benefit pension scheme. One other company had previously held a GAD passport but this had expired and had not been renewed.

All of the companies which had a passport stated they were able to specifically identify those members who had transferred via the passport, separately from those that had not.

All of the companies surveyed who possess a current GAD passport stated that they would consider tendering for contracts in the future which involve the transfer of employees from the public sector on passport terms.

New entrants

All of the 15 surveyed companies with defined benefit schemes indicated that these schemes were closed to new entrants except for transfers from the public sector on outsourcing contracts, echoing the trend being shown in the private sector generally.

63% 6%

6% 25%

Current passport through own scheme Current passport through Pru Platinum No longer possess passport

Never had a passport

GAD passports

10 companies possess a GAD passport through own

scheme and one through Prudential Platinum

Firms with GAD passports are still willing to tender for PFI/PPP contracts involving

DB pensions transfers

All DB schemes closed to new entrants except for public sector transferees

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Defined Benefit Schemes (cont.)

Future accrual

Two of the 15 companies have closed their defined benefit schemes to future accrual for non-public sector transferee members. However, all 11 companies with public sector transferees in GAD passport sections of their schemes allow such members to continue accruing benefits.

For the companies with defined benefit schemes that are open to future accrual, we asked whether or not closure to accrual had been or was being actively considered, both for public sector transferees and for non-passport members. 5 companies indicated they had considered closing to accrual for non-public sector transferees. Two companies stated that they had considered closure to accrual for passport transferees.

0 2 4 6 8 10 12 14

Public sector transferees Non-public sector transferees

N um be r o f c om pa ni es

Open to future accrual Closed to future accrual

Future accrual 0 2 4 6 8 10 12 14

Public sector transferees Non-public sector transferees

N um be r o f c om pa ni es

Actively considered closure to accrual Not actively considered closure to accrual

Closure to accrual

87% of schemes open to future accrual for non-public

sector transferees

All GAD passport sections still open to future accrual

Two companies have closed their main DB schemes to future accrual and 5 more have considered doing so

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81% 13%

6%

ABS in place

In process of agreeing an ABS No ABS

Defined Benefit Schemes (cont.)

LGPS admitted body arrangements

13 of the 16 companies surveyed currently participate in one or more Admitted Body Status (“ABS”) arrangements within Local Government Pension Scheme (“LGPS”) funds, under which employees who have transferred from local authority employment are able to continue to accrue LGPS benefits. A further two of the companies surveyed indicated that they are in the process of entering into such agreements.

We asked whether those companies with (or applying for) Admitted Body Status would still be prepared to take on ABS arrangements for future contracts. All 15 companies indicated that they would be willing to go down the ABS route again in future, but generally only where the associated financial risks have been mitigated to a substantial extent through the project agreement. Two companies indicated they would only be prepared to do so if there were no material financial risks taken on at all.

Admitted Body Status

15 companies have LGPS ABS agreements in place or

in process of doing so

Generally, companies are willing to consider further ABS agreements in future,

but only subject to significant risk mitigation

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Defined Contribution Schemes

All 16 of the companies surveyed have a defined contribution scheme for new employees. All of these companies stated that they did not see a change within the foreseeable future from providing pure defined contribution benefits for new employees (except where required to for ex-public sector employees under the Fair Deal). 15 of the 16 companies surveyed provided detail on the general contribution levels within their schemes.

Employer contribution rate

For the defined contribution schemes, employers contribute up to a maximum of 12% of basic salaries. Contribution rates vary in some schemes depending on the age of members, job grade of members, and the member’s choice of contribution rate. The graph below shows the maximum and minimum contribution rates available from each scheme.

Employee contribution rate

The employee contribution rates vary between nil and 8% of pensionable salaries (though members can typically contribute more than this, but without any corresponding increase in employer contributions). The rates vary in some schemes depending on the age of members, scheme options chosen or job grade, and in others the employer matches or more than matches the employees’ contributions. The graph below shows the maximum and minimum contribution rates available from each scheme.

0% 2% 4% 6% 8% 10% 12% 14% A B C D E F G H I J K L M N O Individual scheme Minimum rate Maximum rate

Employer contribution rate

0% 2% 4% 6% 8% 10% 12% 14% A B C D E F G H I J K L M N O Individual scheme Minimum rate Maximum rate

Employee contribution rate

Employer contributions up to 12% of basic salary

Contribution rates can be age or grade dependent

Employee contributions up to 8% of basic salaries to obtain maximum employer

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Defined Contribution Schemes (cont.)

Interaction and variability of contribution rates

Employee contributions are to some extent matched by the employer in all of the defined contribution schemes surveyed. There are however significant variations in the level of matching. Certain schemes, rather than simply matching the employee contribution rate, will more than match the employee contribution rate (in some cases up to two times the employee rate).

As previously highlighted, contribution levels within the defined contribution schemes surveyed can also vary depending on the age of the member and/or the job grade/seniority of the member. The chart below indicates the extent to which the schemes surveyed have contribution rates which are either age or grade related (as opposed to contribution rate scales which are the same for all employees).

Average individual contribution rates

To illustrate what may be seen as “average” contribution rates for the schemes surveyed, we have looked at what the mean contribution rate payable would be for a 40 year old member at a mid ranking job grade who has chosen to pay contributions which maximise the associated employer contribution payment. We have also illustrated what the average associated employer contribution rate would be in this scenario. Based on the schemes surveyed and the information supplied, the average rates are estimated at 6.7%

13%

33% 54%

Age-related contribution rates Grade-related contribution rates Same scale for all employees

Variability of contribution rates

40%

60%

Single matched

More than single matched

Degree of matching of contributions

40% of schemes more than single-match employee

contributions

Over 50% of companies have same DC scale for all

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Defined Contribution Schemes (cont.)

for the employer, and 5.7% for the employee. The light blue box in the chart below indicates the difference between the highest contribution rate (as set out on page 8) and the average.

Death in service benefits

On death in service, all the companies surveyed provide employees with a lump sum of between two and four times their basic salary. Four of the companies surveyed indicated that the lump sum benefit is dependent on employee type; the chart below shows the maximum lump sum payable in these cases.

Other benefits

In addition to the main pension benefits granted, we also asked the 16 companies surveyed whether or not they provided additional benefits in the form of an additional spouse’s or dependant’s pension from their defined contribution schemes, or any income protection / permanent health insurance. In some cases these additional benefits are only provided to specific employees, and where this is the case we have included the companies in question in the chart below.

0% 2% 4% 6% 8% 10% 12% 14% Average employer contribution rate Average employee contribution rate

Average contribution rates for a mid-grade 40 year old member to obtain maximum employer contributions

12% 25% 63% 2x 3x 4x

Lump sum multiple on death in service

13%

44% 6%

37% Spouse / dependant’s pension only Income protection / PHI only Both spouse / dependant’s pension and income protection / PHI No spouse / dependant’s pension or income protection / PHI

Additional benefits

Average employer contribution roughly 1% higher than corresponding

employee contribution

Death in service lump sums are typically three or four

times salary

Some companies provide additional spouse’s pension

or income protection

50% of companies surveyed provided PHI, or Income protection, alongside DC

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Defined Contribution Schemes (cont.)

Personal accounts

Finally, we asked all companies surveyed whether they had yet actively considered how the introduction of personal accounts from 2012 may affect the level of benefits they provide, or how personal accounts may interact with the benefit schemes currently provided. 5 of the companies surveyed stated they had not yet spent any time looking into the implications.

Next steps

LCP’s specialist multi-disciplinary Public Sector Outsourcing Group has over 15 years’ experience advising on all aspects of the pensions and redundancy benefits of employees transferring from the public sector.

We have developed a range of modelling tools to help our clients understand and manage the specific risks that arise on public sector outsourcing contracts. Further information on these tools is available on our website at: www.lcp.uk.com/psog.

We can provide advice on:

• The best route for meeting the “Fair Deal” requirements, including the benefit design for GAD passport sections.

• Liaison with GAD over obtaining and maintaining GAD passports. • The cost allowance to be included in contract bids for pensions and

redundancies.

• Negotiations on bulk transfer terms.

• Reviewing contract and/or LGPS admission agreement wording from an actuarial perspective.

• Liaison/negotiation with pension scheme trustees over implementation of the agreed arrangements.

• Dealing effectively with the employee issues that arise from significant changes to benefits, for example closure to future accrual of benefits. • Analysis and financial modelling of the investment and funding risks on

fixed-term contracts.

• Calculation and modelling of redundancy cost obligations transferred under TUPE from public sector employment.

Personal accounts not considered yet by 30% of

companies

Our team can help manage pensions risks inherent

within public sector outsourcing contracts

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Bart Huby

Tel: +44 (0)1962 870 060 Email: [email protected]

Alex Whitley

Tel: +44 (0)1962 870 060 Email: [email protected] Benchmarking Survey 2009

About LCP

Lane Clark & Peacock LLP (LCP) is a limited liability partnership and offers a full range of actuarial, benefit consultancy and risk services to clients in the UK and internationally through LCP Trustee Consulting, LCP Corporate Consulting, LCP Financial Dynamics Practice, LCP Insurance Consulting and LCP Investment Consulting.

The LCP Trustee Consulting_{practice focuses on providing advice on pensions issues that are of concern to trustees, such as governance,}

implementing the new pension scheme funding regime, assessing the adequacy of contribution plans, advising on investment issues, trustee governance, risk management, communications and risk insurance, assessing the strength of the employer covenant, and advising on the issues surrounding insolvency and the winding up of pension schemes. The practice also provides a client focused quality Pensions Administration service.

The LCP Corporate Consulting_{practice specialises in advising companies on how best to manage their pension schemes’ finances through}

contributions, investment policy and other approaches. The practice also advises companies on how best to manage the impact of their pension schemes on company finances, how to represent pension schemes in company accounts, ensuring that UK and international benefit plans attract and retain employees effectively, project management, scheme design, DC, risk insurance, global management of costs and risks and managing benefit issues in mergers and acquisitions.

The LCP Financial Dynamics_{practice specialises in offering a new dimension to risk appraisal, business modelling and valuations of}

companies. The practice uses advanced financial models to give companies a competitive advantage when considering business decisions.

The LCP Insurance Consulting_{practice is a leading non-life actuarial consultancy. We provide a full range of services to insurers and}

reinsurers, including advice on all aspects of Solvency II.

The LCP Investment Consulting_{practice specialises in advising both corporate sponsors and pension scheme trustees on the appropriate}

investment policy, as well as on the broader areas of risk management. The practice is able to identify the potentially complex and conflicting needs, explain clearly how to address those needs and help with the implementation of the chosen solution.

LCP employs more than 500 staff including over 200 full and part qualified actuaries. We serve a wide range of clients around the world, including some of the largest global multinationals, such as ABN-AMRO, Hilton International and Smith & Nephew. We also serve a number of private equity houses, charities and unions.

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Contact us

For more information on this survey, or on LCP’s Public Sector Outsourcing Group, please contact Bart Huby or Alex Whitley using the details below: