The IBM Pension Trust has updated its cash commutation factors, offering transferring members across its schemes higher lump sums when exchanging part of their defined benefit entitlements.
As DB schemes attempt to reduce liabilities, some have started offering more attractive commutation factors. The Rexam pension scheme recently reduced its membership through a trivial commutation exercise; last year, the Mineworkers Pension Scheme and the BT Pension Scheme also took to trivial commutation.
But unlike trivial commutation, where members with small benefits can take out their entire pot in return for giving up all pension entitlements, cash commutation allows a member to take part of their pension as a tax-free lump sum in exchange for a reduced pension.
It’s not enough to make these decisions simple, we have to make them real
Vincent Franklin, Quietroom
IBM, whose largest scheme, the IBM Pension Plan, managed £6.75bn in assets at the start of this year, said its decision to increase the lump sums on offer was driven by consideration of life expectancy updates as well as current and future market expectations.
“Members who take their DB benefits from 6 January 2017 and choose to convert some of their DB pension into a cash lump sum will receive a larger cash lump sum and residual pension when compared to using the current factors,” said Adrian Spann, pensions trust manager at the tech giant, in a member newsletter.
Rules determine if schemes can change factors
The options available to trustees considering changing commutation factors vary depending on the wording of scheme rules.
As such, trustees should be aware of the flexibility available on commutation factors, and be clear who has the authority to make changes, according to Mark Smith, pensions partner at law firm Taylor Wessing.
“Where the trustees have discretion, they need to think about matters like how long members are expected to live, does the pension increase and does it come with an attaching spouse’s benefit, in deciding – with the help of the scheme actuary – how much each pound of future pension that is exchanged for cash now is worth,” he said.
A fair deal for members
While factors used vary from scheme to scheme, anecdotal evidence suggests that current market conditions are prompting actuaries to recommend increasing the lump sums on offer.
Having members take a tax-free lump sum at retirement does derisk a scheme by shrinking its overall liabilities. But Vassos Vassou, trustee representative at Dalriada Trustees, said that liability management would not be a key driver for reviewing commutation factors.
“You wouldn’t be thinking about derisking, you would be thinking about what’s fair for members,” he said.
He said reviewing the factors every few years constituted “good governance”, but cautioned trustees to bear in mind the impact that a change in factors might have on the funding level of the scheme.
Phil Cuddeford, head of LCP’s corporate consulting practice, agreed that derisking would not be a major driver and pointed out that the benefit to a scheme of regularly reviewing factors would be largely dictated by the direction of travel of interest rates and yields.
Instead, he said trustees would normally bring factors in line with market norms because “they were concerned from a reputational side of things”.
Take-up rates of cash commutation were reportedly between 90 per cent and 100 per cent anyway, owing to the tax advantages of taking the sum outweighing what Cuddeford called an “actuarially mean” calculation process.
Base comms on everyday outcomes, not calculations
Part of the increased focus on factors has been brought about by freedom and choice, which removed restrictive tax measures on members transferring out of a scheme.
“One of the actual drivers for trustees or companies reviewing their cash commutation factors is just this increased awareness of how it stacks up against transfer valuations,” said Cuddeford.
Rexam reduces membership through commutation exercise
The Rexam Pension Plan has carried out a trivial commutation exercise, contributing towards a reduction in total membership as defined benefit schemes are trying to reduce costs.
Explaining the differences between the two will therefore be a key challenge to trustees communicating changes in factors.
Vincent Franklin, co-founder of communications consultancy Quietroom, said schemes should base communications in everyday language and everyday outcomes, rather than explaining calculation methodologies.
“It’s to help people see these figures in the context of their lives – as the money that will buy them cans of beans, car insurance, a turkey at Christmas,” he said.
“So it’s not enough to make these decisions simple, we have to make them real. Only then can people properly make their choice.”
