2 April 2009

As you would expect from the global economic situation, this newsletter contains concerns for all scheme members.  That fact should be qualified by noting that our fund has resources to pay pensions for many years, that actives are still accruing more pension, that the company is making payments to the fund according to previously agreed plans, and that there will be pension increases soon according to formulae in the deeds and regulations.  Regulation to protect pensions is far stronger than it was a few years ago, and our "guarantee" prevents IBM Corporation by-passing those regulations by allowing IBM UK to default.  There is a small degradation of benefit earned coming soon for actives, but most concern is about the effect of losses (noted in newsletter 37) on longer term prospects.

Increases, RPI, and costs.

The April increase on pension earned by service before April 1997 is now known.  It is effectively zero.  This looks curious when compared to the increase on pension earned between April 1997 and April 2005, which is 5.0%.  Much of the difference arises because the Retail Prices Index changed a lot between September 2008 and January 2009, the dates that provide the different RPI figures for the different increases.

Such fluctuations increase the doubts that some people have about the usefulness of the RPI index.  The RPI index cannot go away - the government has sold "national savings" and "gilts" that pay out at the end of their lifetime on the basis of the RPI then, thus incorporating RPI into the contract.  (The State Pension is also RPI based, although that is expected to change to an index of wage increases in 2012.)

Hence other indices are analogous to the RPI index but cannot entirely replace it.  The Consumer Prices Index is now a favourite for the government and the media to quote, because is a closer match than the RPI to the way inflation is measured in most of the European Union.  It is the CPI that the Bank of England attempts to manage.

There is another index that appears in regulations - the Rossi index.  This is RPI less the elements that represent housing costs. It is used for upgrading some benefits, where the recipients are likely to have their housing costs already paid for by other benefits.  Hopefully, it won't be relevant to many retired IBMers.

Outside of the regulations, anybody can create an index of prices. In an earlier newsletter we referenced 2007 data.  More recently there are figures from the Institute for Fiscal Studies and some interesting comments on why indices for different groups are different.  In summary, inflation as actually experienced by the elderly remains much higher than that for the general population.

The details of how the RPI is used in calculation can be important.  The date of the RPI figure can be important, as in the September to January change noted above.  Cut-offs matter also.  Almost all increases across all trusts have cut-offs, where the number used in the calculation is bounded if the RPI goes beyond the cut-off.  This makes predicting the cost of increases more reliable.  In our case, the cut-offs are 0 and 4%, making it impossible for the pension to reduce in amount (even when there is deflation) and impossible for the increase to be more than 2.4%.  (60% of 4%).

While on the subject of increases, here is a hint for those of you who keep personal spreadsheets relating to future finances.  Nothing is fixed about increases on pension from pre-1997 service after year 2020, and that adds uncertainty to the spreadsheet.  The regulations for transfer values (the amount you move if you change from our trust to another pension provider) require trustees to use "best estimate" assumptions in calculations.  "Best estimate" is not defined, so it is being used in its everyday English sense.  The assumptions adopted by the trust board (available on request from Pension Services) include zero relevant increases in the calculation.  Logic says that zero increases on pre-1997 service, after 2020, is the trust board's best estimate.

This topic of different increases on service from different times is not relevant to M-Planners.  That can lead to different views on what is "fair".  There are clear ethical grounds for suggesting that where employees have been induced to work for the employer by statements about the pension, then it is unfair if the expectations raised are not met.  It also seems unfair when different employees doing the same job to the same standard for the same employer are provided with pension benefits differing greatly in value.  Should these unfairnesses be traded against each other?

If you think more action should be taken to press the company to maintain the value of pensions, now or later, you will need to recognise that such an employer move is more a matter of ethics than duty.  The number of employees in the DB sections N, C, and I is already down to around 11% of the scheme membership totalled over all sections.  It is these sections where most discretion lies.  (For the M-Plan it is the insurance companies and annuity providers who essentially decide the pension, once the employer and employee contributions to the section are fixed.)  There are probably a significant number of scheme members amongst the deferred who are now working for IBM's competitors.  DB members have a better pensions deal than M-Planners (as 2008 demonstrated).  Should Armonk see DB increases that it is not forced to make as the best way to spend on pensions? 

The use of RPI is different during deferment:

Deferment, Revaluation, and Actives.

Deferreds will usually get a pension at retirement which is an increased (revalued) amount based on what they had earned when they left the employment.  There may be no revaluation but the usual case is "The increase must be at least in line with the full RPI increase over the whole period of deferment or 5% compound per annum whichever is the lower".  Notice that the only cut-off applies to the full period.  During the period both inflation and deflation will influence the eventual revaluation.

From April 6th 2009 the 5% in the rule above will be replaced by 2.5% but the new rule will only apply to deferments starting after that date.  So current deferreds are not affected, while current actives will be earning pension with a lesser benefit.  (Of course, if you intend to go straight from work to retirement you won't be be concerned about this particular benefit loss.) 

M-Plan and Personal Saving

PwC have calculated that people who started investing only one decade ago will now be holding less in their retirement funds than the total value of all their contributions.  Because of inflation, this is worse than standing still.  (PwC is a well established firm - they are the auditors for our scheme).

PwC are referring to personal plans rather than occupational DC plans, but the figures imply that without company contributions there would not be gains in occupational pension pots.

There is concern nationally about savers losing faith in DC saving, and preferring more salary (although taxed at receipt) to contributions (ultimately taxed on pension receipt).  If employees lose faith, employers will see less reason to provide schemes, thus creating problems in the future.

The Fund Deficit and Recovery Plan

AMIPP has cautioned before against reading too much into a single deficit number and its fluctuation.  There are various important numbers - see AMIPP's explanation of the valuation for December 2006.  We have explained in previous newsletters how such numbers can be altered significantly by tweaking the assumptions used, which reflects the uncertainty in predicting the future.  (This point hardly needs emphasis when the assumptions for December 2006, which were made with expensive advice, have proved wrong to the tune of a £1B after a couple of years).

So for most scheme members it will be enough to measure deficits on a scale of none, some and huge. There is complication because of the distinction between a formal and an informal deficit.  "None" is important because if there is no deficit there is no need to have a recovery plan (an agreement about a schedule of payments intended to eradicate the deficit over a fixed period).  Technically our scheme currently has "none" because the valuation for December 2006 showed a small surplus and hence we have no recovery plan.  "Huge" is important because it justifies urgency beyond the traditional three year cycle of valuations and recovery plans.  Our informal deficit is now huge (although technically not requiring a recovery plan because there is no valuation that shows a deficit.)

AMIPP does not know what will happen about a recovery plan, but documentation tells us what should happen.  The Statement of Funding Principles is required by regulation and is available to members from Pensions Services, on request.   Ours allows for an early valuation if "there is a significant fall in the value of the assets, or  other change in market conditions which could have a significant adverse impact upon the financial position of the Plan".  Perhaps the board will not think the current market conditions are severe enough.  But if they think them severe enough they will require an early valuation.  "Valuation" is a technical term - the regulations distinguish an actuarial valuation from an actuarial report.  The former is the responsibility of the trustees and the only basis in the regulations for a recovery plan.  The latter is advice from the actuary.  Valuations require the fund assets to be audited.  So if the documentation is followed there will be a valuation for December 31st 2008, in parallel with the annual accounts for 2008, which would normally be approved in the middle of 2009.

IBM has a poor record in supporting the C-Plan.  When the fund had a significant surplus in 1996, the surplus was used in a way that benefited IBM but no scheme member.  In 1997, IBM was one of the first to close its scheme to new entrants.  When increases were discretionary, IBM increases were worse than those of other schemes.  When the deficit was previously allowed to get huge, the result was an increase in employee contributions followed by a severe degrading of the scheme.  In short, IBM has preferred degrading to supporting.

It is to be expected that the tendency to degrade will increase with the size of the deficit.  Our deficit is currently increasing because the outflows to pay pensions exceed the income.  Nothing is certain, but you can judge for yourself whether an earlier recovery plan, with lower amounts, is more likely to avoid scheme degradation than a later valuation would.         

Benefit Nominations

This paragraph is more than the usual reminder that it is good to have an up-to-date expression of your wishes.  It is a reminder that for some people, the best use of nomination may require thought about what benefit is under consideration and what chances there are of your wishes being implemented.  An active with life cover of four times salary can be expressing a wish about hundreds of thousands of pounds.  Somebody retired for a few years may have only the Life Assurance After Retirement (maximum £700 for the N-Plan, £1000 for the C-Plan) to be allocated at the discretion of the trust.  You might think it more reasonable in the first case to nominate a split of the sum between several people.  

You can nominate organisations.  If you nominated a UK charity you would have a reasonable expectation that the trust would follow your wishes, in the absence of any special reason not to.  But could the same be said if you nominated the PLO?

In general, if you see any possibility of your wishes being regarded as abnormal, you might want to provide Pension Services with the reasoning behind your choices.  That cannot be used to constrain in any way the choices that the trust has, but it could influence the choice made.  It is logical to suppose that the trustees would prefer hearing about your wishes over having to guess them after you die. Bear in mind that the trustees have very wide powers.  (For one of the choices, the deeds say the trustees may do something "for any reason they see fit", although that is presumably not meant to include whether you were born on the same day of the year as the IBM CEO !)

The Saving Gateway scheme

Proposed legislation, intended to be fully operational by 2012, will provide a national cash saving scheme for working age people on lower incomes, providing a financial incentive to save through a government contribution of 50p for each pound saved.  The scheme aims to kick-start a saving habit among working age people on lower incomes, enabling them to plan for the future and cope with financial pressure, and to promote financial inclusion by encouraging people to engage with financial institutions such as banks, building societies and credit unions.

Another example illustrating that the problem is not a lack of opportunity to save, it is a lack of motivation to save.

Oddments

We have mentioned "buy-out"s before, where the company passes responsibility for a scheme to an insurance company.  One of the reasons why that is not currently relevant to IBM UK is that our fund is too large for the insurance market to want to take on.  The largest buy-out yet is for £1B, several times short of the size of our fund.

You might remember Grangemouth, where union members were able to save their pension scheme by disrupting fuel supplies countrywide.  The resolution has now been detailed.  It is complicated but the general level of compromise is illustrated by the fact that the final salary scheme is retained and open to new recruits, although employees now make a 2% salary contribution instead of none.  Perhaps this shows that to save a final salary scheme these days needs not only a union but the power to inconvenience the public.  (There is a train workers pension dispute in the pipeline.) 

There are persistent stories about IBM in talks to spend $6.5B on buying Sun.  Those of you who became IBMers as a result of IBM's hostile takeover of Lotus may well have views about that. Sun has had successes in software - if you access elaborate web pages you probably have Java installed.  And if you want to work with Microsoft Office files without paying for Microsoft Office software then you need OpenOffice - free and originally promoted by Sun.  However, it is Sun's server business that IBM will most want.  Since the deficit in the IBM UK pension fund is some $1.4B, an interest free unsecured loan from the trust to the corporation, it is not unreasonable to say that we will have a 20% stake in buying Sun-under-IBM.

IBM Corp.'s chairman and chief executive, Sam Palmisano, received a compensation package valued at nearly $21 million in 2008, only slightly higher than the year before, according to calculations by The Associated Press.  (The calculations don't include changes in the present value of his pension benefits.)  (Maybe $21m is cheap, given that Lou Gerstner took around $1B from the company in his time?)

The pay for being chairman of our trust board was raised to £40,000 for 2008.  (From £25,000, equivalent to a raise of 12.5% over each of four years.)

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