The Announcement of 14 June 2000 sent to all members and the Summary Annual Report 2000 sent to pensioners and contributing members in October last year set out the financial position of the Old Section and mentioned changes in investment policy. The Report also advised the Trustee Board?s decision not to award a discretionary increase as at 1 April 2000 to Old Section benefits.
The purpose of this letter is to advise you of the results of the most recent financial investigation and to explain the actions which the Trustee Board is now taking.
The Fund is required to have an actuarial valuation at least once every three years, but can have one more frequently if the Trustee Board decides. A triennial valuation of the Fund was carried out as at 31 March 1999 and, in the Old Section, (which is valued quite separately from the New Section), a surplus of £20 million was disclosed. A further valuation was carried out as at 31 March 2000 which showed an increased surplus of £140 million (assets of £1,388 million and liabilities of £1,248 million).
In each of these valuations, the liabilities (i.e. Old Section pensions in payment and benefits from the Old Section for members who have not yet retired) have been valued without any allowance for future increases. The surplus of £140 million disclosed in the valuation as at 31 March 2000 therefore represents the excess of assets over the amount needed to pay pensions if they were to continue at the current level assuming that future financial conditions turned out to be the same as assumed in the valuation.
The main reason for the increased surplus is that in the year to March 2000, investment conditions have been favourable. In addition, a significant contribution was made to the investment returns by the sale of a particular stock for which the amount received was considerably above the amount at which it had previously been assessed. It is likely that the financial position has not changed significantly since March 2000.
The Old Section was closed in 1978 and has a mature age profile with a high proportion of its liabilities being pensions in payment. Furthermore, within the next twenty years, it is anticipated that virtually all of the remaining members will retire and their pensions will come into payment. In this situation, it is necessary to pay great attention to the security of assets which means ensuring that the Old Section has a regular and certain flow of income from investments so that it can pay pensions due. This can be achieved by investing in fixed interest securities which provide this regular flow of income.
Consequently, a major change was made to the Old Section?s investments in the summer of 2000. Prior to that, fixed interest investments accounted for less than 20% of the total value of Old Section assets. Following this change, fixed interest investments accounted for approximately 70% of the total value of Old Section assets. The valuation results set out above allow for this change in investment policy.
The change in investment policy has given a greater degree of security to Old Section members. Fixed interest investments (which include corporate and government loans - the latter commonly known as gilts) are relatively low risk investments compared to investing in company shares (known as equities). However, the price of greater security is a likely lower level of investment return. The alternative would be for the Trustee Board to invest more of the assets in equities which have the potential for a higher rate of return, but this could only be achieved by exposing the Old Section to downturns in the stock market and possibly even jeopardising the ability to pay the level of pensions currently in existence.
The Trustee Board has an obligation to consider at intervals not exceeding twelve months whether to grant any discretionary increases.
As explained in the Summary Annual Report 2000 and in previous announcements, the impact of low inflation and correspondingly low interest rates in recent years and the expected continuance of this for some time in the future, has resulted in the Trustee Board adopting a cautious policy towards awarding discretionary pension increases. To remind you, Old Section pensions are basically fixed pensions which the Trustee Board may increase at its discretion if, on the advice of the Actuary, the assets are sufficient. The extent to which pension increases are possible therefore depends, amongst other things, on investment returns.
However, as mentioned above, there is a balance between risk and reward. As the Old Section becomes more mature, the concern of the Trustee Board has increasingly become centred on ensuring that future pensions can be paid. An investment policy has therefore been adopted with a relatively high degree of security, but with the consequence that investment returns will probably be relatively lower. However, as shown above, even with a relatively secure investment policy, the Old Section has a surplus on the financial assumptions used in the valuation.
The Trustee Board is very mindful that some of this surplus could be used to increase benefits and is giving this serious consideration. However, as part of their consideration of the increase, the Trustee Board wishes to look further at the question of long term security for Old Section benefits. There are two alternatives being considered by the Trustee Board:
1the whole of the Old Section assets could be invested in fixed interest securities such that the income from those investments match, as far as possible, the payments of pension which have to be made in future. Increases to pensions may be possible to some extent in this situation. This effectively removes most of the investment risk and gives a high level of security. However, it does not remove risk entirely and, in particular, there would still be what is known as ?mortality risk? which is the possibility of pensioners living longer than assumed in the actuarial valuations; or
2 in order to remove both the investment risk and the mortality risk, the Trustee Board could use the assets of the Old Section to purchase annuities with insurance companies. This course of action would give a very high level of security and, if the assets are sufficient, it may be possible to include some level of permanent increases when purchasing these annuities.
The Trustee Board is therefore conducting an investigation into these alternatives with a view to obtaining the best long term balance between security and pension increases for Old Section members. This is an extensive exercise and will take a number of months. It is not therefore possible for the Trustee Board to come to a conclusion about an increase to benefits at this time. Your Old Section benefit will therefore continue at its current level for the time being.
If you are also entitled to a New Section benefit, you have previously been advised that this Section has a shortfall. The valuation at 31 March 2000 indicates that there is a slight improvement, but whilst there remains a shortfall, there are no surplus assets out of which pension increases can be paid. New Section pensions from April 2001 will therefore remain at their present level, except to the extent that any statutory increases are required.
Once the investigation into the Old Section is complete, I will write to you again with details of the decisions the Trustee Board has taken. In the meantime, if you have any queries, please telephone the Member Liaison Service on 01372 200200 or write to the Director of Pensions at the address on this letter.