CLERGY PENSIONS

SCENE-SETTING PAPER FROM ARCHBISHOPS’ TASK GROUP

1.     When the General Synod agreed changes to the Clergy Pensions Scheme in July 2007 there was a widespread hope that it would not prove necessary to return to major policy questions over clergy pensions for some years to come. A month later what has become known as the credit crunch began.

2.     Since August 2007 financial markets have been in turmoil. There was a moment in October 2008 when it looked as if the entire fabric of the international financial system was on the point of unravelling. Financial prospects remain volatile. We have entered recession for the first time since the 1990s. It now looks as if it may well be the worst since the Second World War. As has been widely reported, the steep fall in asset values, combined with a fall in gilt yields, has posed major difficulties for many defined benefit pensions schemes, seriously increasing what in many cases were already significant deficits.

3.     Concerned by these developments, the Pensions Board asked its actuaries to provide a snapshot of the financial position of the scheme as at 31 October. This indicated that the deficit on the scheme had increased significantly. On 28 November the Board’s Chairman issued a statement to all ‘responsible bodies’ alerting them to the serious impact which was being felt on the scheme. Market conditions since then indicate that the funding position will have worsened.

4.     In this new context, the Archbishops of Canterbury and York concluded in November that the Task Group first established in November 2005 should be reconvened to explore possible future scenarios and help the Church of England think through the implications for the Clergy Pensions Scheme.

5.     We see our role as members of the Task Group as being to marshal the relevant facts, to alert the Church to the serious impact which events are having on the scheme and to set out as dispassionately as we can what seem to us to be the relevant arguments. We are not speaking on behalf of our trustee bodies. Our aim is simply to help those with the various decision-making powers to understand more clearly the nature of the choices that will have to be made and, at the right moment, to offer some recommendations.

6.     We have not yet had time to assess in full the implications of the present situation or work up detailed options. Our aim is to produce a more detailed consultation paper no later than the end of June. But we thought it was essential to issue this earlier scene-setting note in order to get some of the key facts and considerations into the open and to initiate the process of reflection and discussion that will be needed before the Church is ready to come to decisions.

The nature of the problem

7.     The widespread expectation is that depressed market and economic conditions are likely to continue for the next year or two at least. Dividend returns are also likely to be lower than in recent years for some time to come. So, the new situation raises serious questions about the adequacy of the Pensions Board’s current funding plan for the clergy scheme.

8.     It is, of course, in the nature of pension funds that they are meant to be able to ride out short or medium-term fluctuations in the markets. The process of full evaluations every three years is designed to enable the trustees to take a fresh look at their assets and liabilities and, in the light of that, to make such changes as appear necessary to the contribution rate. The next formal valuation of the Clergy Scheme is due at the end of this year.

9.     The clergy pension fund is even more exposed than many other pension funds to the vagaries of the stock market because, in accordance with consistent professional advice, it is currently 100% invested in equities (i.e. stocks and shares). Despite the current turmoil, historical investment data continues to suggest that these offer the best prospect for securing sustained long-term growth. The key word here is, of course ‘long-term’. As is consistent with offering higher return prospects they are also more volatile.

10.  The reason why the Pensions Board can take an even more long-term view than many other pension trustees is that the funded pension scheme only came into existence in January 1998 and is liable only for pension benefits earned since then. The cost of all pension benefits earned up to the end of 1997 continues to be met by the Church Commissioners out of their capital and the returns secured on it.

11.  As a result the pension fund managed by the Pensions Board remains what is technically called ‘immature’. For many years to come the fund is due to receive each year much more than it has to pay out. It is only as the Board’s short and medium term liabilities increase that it will have to change its investment strategy in order to have an increasing proportion of its assets in more secure (but in all probability lower yielding) assets.

12.  While the present investment strategy should deliver the best long term returns, it does mean that the value of the Fund at any particular moment is hugely dependent on the state of the stock market. This exposure to the markets does, of course, cut both ways. It means that a strong period of recovery in the markets would rapidly increase once again the value of the fund. But the increased regulatory emphasis on caution means that trustees now have to test assumptions very rigorously before adopting smoothing mechanisms. Simply hoping for the best will not do.

13.  The Pensions Regulator has recently signalled its willingness to consider some increased flexibility in the light of the current state of the markets. Even so, the members of the Pensions Board are, like all other pensions trustees, required to weigh all the risks very carefully and be able to justify the conclusions they reach about acceptable levels of risk.

14.  The overall pension contribution rate currently payable by the employers participating in the funded clergy scheme is made up of two elements: (a) a future service rate and (b) deficit recovery contributions. The ‘technical annex’ attached to this paper explains these two elements in more detail and the factors that affect their calculation.

15.  At the end of April the Pensions Board will receive from its actuaries the statutory update of the financial position of the scheme at the end of 2008 but early indications suggest that if the position remained the same at the end of 2009, we could be faced with a contribution rate of between 50% - 60% if nothing is done and there are no changes to the current pension arrangements. This reflects recent stock market values and yields on government securities both of which have been volatile in recent months. The combination of these factors means that the cost of future service pensions and past service can be expected to have increased.

16.  It is important to stress that these estimates are very sensitive to the precise assumptions given to the actuaries in relation to such variables as inflation, the real return on investments, the growth of minimum stipends etc., as well as estimates of the expectation of life.

17.  It is, of course, ultimately for the Pensions Board to decide what assumptions it wishes the calculations to reflect and also what deficit recovery period it wishes to adopt (see technical annex). It has to be able to satisfy the Pensions Regulator that its judgements are reasonable.

18.  The scheme funding regulations now stipulate that deficit recovery periods cannot be continually extended. This probably means that the 2006 deficit will need to continue to be recovered over the original period of 15 years with any increased deficit recovered over a new (overlapping) period.

19.  In the normal course of events the Pensions Board would be considering in the summer of 2010 what change in the contribution rate might be necessary from April 2011 in the light of the next triennial review as at 31 December 2009. The Board did, however, announce following its meeting on 27 November that it would be monitoring the situation very closely and would be reviewing the position again by not later than June 2009 on the basis of updated assessments by the actuary.

20.  It is for the Board to decide whether some interim increase in the contribution rate is needed earlier than April 2011. Given the significant deterioration in the funding position, such an increase, effective from 1 January 2010, becomes a good deal more likely.

Choices

21.  As a matter of law changes in pension benefits can only apply to pensionable service that has not yet been earned. The cost of the past service deficit will change over time as market conditions and the value of the fund alters. But changes in benefits for future service, whether they were modifications or, more radically, a move to a completely new scheme structure, would not have any impact on the size of the past service deficit. Whatever it costs to meet past promises will, therefore, have to be met regardless of what is done for the future.

22.  It is already clear to us that, given the scale of the problem, there is no simple or pain-free way out of the present situation. At a time when Church income, both from giving and investments, will be under heavy pressure that will sharpen still further the difficult choices that will have to be made over other areas of expenditure.

23.  The experience over several years has been that the dioceses, in common with many other ‘employers’, are finding the rising and unpredictable costs of a defined benefit scheme increasingly difficult to meet. If the Church were to conclude that the present defined benefit scheme was not sustainable there would be some hard choices to be faced. For example, would the Church want, as many other organisations have done, to move to defined contribution arrangements for future service? Or would it prefer a hybrid approach under which a lower level of defined benefits was guaranteed by the scheme while the size of other pension entitlements would depend on how well the investments performed over time?

24.  In the event of moving away from a defined benefit scheme there would be two particularly difficult issues to address. The first would be how to mitigate the undoubted impact of a fundamental change in the scheme on the morale of the clergy. For them a guaranteed pension and access to affordable retirement housing have come to be seen as important ingredients of the compact between the Church and those who devote their working lives to full time ministry. Unlike others, most receive a stipend rather than a salary and are expected to live in tied housing rather than in a property that they own and that may, over time, generate a capital gain. At £13,093 p.a. (plus a lump sum) the current full service pension (from 1 April 2009) would, even together with the state pension, be hard to describe as excessive.

25.  Setting any defined contribution or hybrid scheme at a relatively generous level would be one way of easing the pain for clergy involved in any change, but it would have to be at a significantly lower rate than the existing defined benefit scheme, if an overall cost saving was to be achieved.

26.  The change would, in effect, be phased in over a considerable period since, even assuming it would apply to all future service, including for existing clergy, most people retiring for many years to come would continue to have earned most of their pension on the old basis. Nevertheless the immediate impact on clergy morale of transferring to them the financial risk now borne by their ‘employers’ should not be underestimated.

27.  The second difficulty about changing the fundamental basis of the scheme is that the present deficit would still have to be funded. There would thus be a tension between wanting to make the new scheme as generous as possible and the objective of containing costs over the period of many years during which the deficit on the old scheme still had to be paid off.

28.  All that said, the scale of the increase in costs we are now facing raises very serious issues regarding affordability for those who ultimately fund the scheme. The discussions which took place when the last review was carried out suggested that a contribution rate of around 40% represented a threshold that some would find difficult to cross. It is now hard to see how an increase above that rate can be avoided. But a contribution rate in the range suggested by the most recent actuarial estimates would probably take us into very different territory.

29.  The Task Group will be urgently addressing all the options which are available and will produce a second report no later than June. It is clear now that we will be presenting some very hard choices. This is because:

• There is no way of reducing the cost of the scheme without, one way or another, reducing the benefits that are offered. Following the changes agreed in 2007 there are no obvious and easy further adjustments that can be made. One possibility that would not in itself diminish the value of the pension and lump sum, although it would involve people working longer to take it in full, would be to increase the pension age for future service beyond 65;
• It is likely that the rate of increase in stipends will slow sharply from 2010. It would also be open for the Archbishops’ Council (as the stipends authority, and after consultation with ‘employers’) to make a commitment to hold back the growth rate of the national minimum stipend whilst the deficit in the pensions fund is being reduced. This would hold back the increase in the level of pensions paid at the point of retirement in the future since they are linked to the minimum stipend and not to the stipend actually received at the date of retirement. The commitment might also have an immediate effect to reduce the contribution rate;
• The stipends actually paid are not rigidly linked to the national minimum, but a large increase in the pension contribution rate has obvious implications for the simultaneous affordability of increases in stipends over the next few years;
• To the extent that the Church Commissioners were asked to be part of the solution to the problem it would need to be recognised that money that the Commissioners made available for one purpose would no longer be available for another. Thus, additional money distributed to help dioceses meet additional pension contributions would inevitably involve reductions in one or more of the other categories of distribution that the Commissioners and Archbishops’ Council make from the money made available by the Assets Committee. Moreover, depending on the form in which help was given, there could be a need for legislation to give them fresh powers;
• To the extent that the Pensions Board concluded that it could soften some of the assumptions built into its funding plan – and these could not go beyond what the Pensions Board and the Pensions Regulator regarded as prudent – the Church would have to accept that the increased risk thereby incurred had potential consequences for the future funding of the scheme. Thus, for example, if the Pensions Board concluded that it could responsibly allow for a somewhat increased assumption about the returns from equity investments over the longer term or if, on the strength of the covenant from the Church Commissioners, it concluded that it could stretch any new deficit recovery period somewhat further than 15 years, dioceses and other funding bodies would have to acknowledge that, for the sake of some relief in the contribution rate now, they were running a greater risk of further increases later in the event that these assumptions proved optimistic. It is, of course, only the Pensions Board trustees who can ultimately decide what it is prepared to put to the Pensions Regulator as a responsible plan.

Next Steps

30.  While the present financial crisis runs its course and the markets remain subject to much volatility there are obvious dangers in rushing to irrevocable conclusions. It is still too soon to know how long the present turbulence will continue and whether the situation at the end of 2009 (when the next full valuation of the fund is due) will be as serious as now, or less or more so. Against this uncertain background we intend, therefore, to use the next few months to explore a range of possibilities in more detail before we issue a consultation paper with more worked up options and perhaps some recommendations. We are acutely aware that decisions may need to be taken over the next 12 months or so to ensure that, when the Pensions Board comes to set the contribution rate following the next formal valuation of the fund, it is at a level which the Church can afford.

31.  Our task is not to come up with what we see as the right answer but to help the Church come to a mind on what the right answer might be, given its view of the priority that clergy pensions should command compared with other core items of Church expenditure. We shall, therefore, be listening carefully, between now and June, to the various conversations which we expect this scene-setting paper to trigger within the various national bodies, at the Inter-Diocesan Finance Forum, at the Consultative Group of DBF Chairs and within dioceses and elsewhere.

32.  We are not, at this stage, seeking formal submissions to the Task Group but are very happy to receive any comments that anyone wishes to send us at pensionstaskgroup@c-of-e.org.uk . Our expectation is that the more extended consultation document which we will issue no later than the end of June will ask some specific questions of bishops’ councils to which we will need an answer by the end of October.

Andrew Britton                     Jonathan Spencer                Andreas Whittam Smith

March 2009

Technical Annex

The overall contribution rate payable by participating employers is made up of two elements:-

(a)            Future service funding rate

This is the amount that needs to be paid for pension benefits that will be earned in the future up to the point members retire. The calculation takes into account a range of factors, including the age profile of the scheme members. The value of this type of liability (sometimes referred to as a scheme’s “technical provisions”) is normally calculated by reference to the returns available on gilt-edged securities (Government bonds) which is the investment type which most closely matches the liabilities. Allowance is then made for the some of the additional returns that are expected from investing in “riskier” asset classes (particularly equities – stocks and shares) which would be expected to produce a higher rate of return. This is known as the “equity premium”. The assumption adopted by the Board at the last valuation was an equity premium of 1.5% above the return on gilts.

The future service contribution rate set at the last financial valuation was 34.5% p.a. of the pensionable stipend.

(b)            Deficit recovery payments

At each triennial valuation of a pension fund the actuary calculates the amount of money which needs to be in the fund to pay for pensions already in payment and pension benefits earned by clergy who are still in active ministry, along with statutory increases in those benefits. An allowance is also made for expected future increases in the national minimum stipend on which pensions, on retirement, are based.

This calculation results in a past service liability figure which is then compared with the market value of the assets in the fund at the valuation date. The difference between the two figures shows whether the scheme is in deficit or surplus.

Where a deficit is revealed the trustees of the scheme (the Pensions Board) must agree a recovery plan to ensure that the additional sum comes into the fund over an agreed period. The trustees are required to submit this recovery plan to the Pensions Regulator which has the power to reject the plan and impose a different plan if it is not satisfied that the deficit is being recovered quickly enough.

At the last triennial valuation the Pensions Board submitted a recovery plan based on eliminating the deficit (then £141m) over a 15 year period, which was accepted by the Regulator. For the purposes of deficit recovery the Board assumed an equity premium of 2% (ie 0.5% higher than used for determining the future service rate).

The deficit recovery contribution set at the last triennial valuation was 5.2% of the pensionable stipend.

Total contribution                               39.7%

ends