New code firms up boundaries on incentive exercises

The introduction of freedom and choice has led to a rise in the number of defined benefit members exploring transfers, but a report from the Pensions and Lifetime Savings Association last week showed just 5 per cent of DB savers eligible to take advantage of new pension freedoms have actually transferred their savings into a defined contribution arrangement since April last year.

One of the typical things we get asked is, if an employer issues a retirement letter that has a transfer value in it, does that mean it becomes an incentive exercise?

Margaret Snowdon, IEMB, PASA

However, many schemes have seen the reforms as an opportunity to reduce their liabilities by facilitating a range of incentive exercises for members – a trend that could grow further in an era of low yields and rising longevity.

In December, adhesive tape manufacturer Scapa Group saved around £600,000 by offering flexible retirement options to some deferred members of its DB scheme, clearing more than £10m of liabilities.

New code

In June 2012 the Incentive Exercises Monitoring Board introduced a voluntary good practice code, both to protect members from being disadvantaged or mislead by poorly executed exercises and to help trustees and employers navigate a complex regulatory arena.

The new code does not depart from the original principles, but provides a number of key changes in response to recent regulatory developments:

• Introduction of a proportionality test, with a threshold of £10,000 for transfers and commutation, and £500 for pension modifications

• Clarification on the definition of guidance to show that IE Guidance differs from other types

• Provision of 'boundary' examples to help practitioners understand how the code applies

Current guidance on winding-up lump sums remains under review ahead of anticipated growth in this area; the board has announced plans to consult with the industry on WULS in 2016.

Margaret Snowdon, chair of the IEMB and PASA, said updates to the code’s practical guidance, which distinguishes incentive exercises from 'business as usual' practices, will help trustees and employers in what she termed the “new world”.

She said: “One of the typical things we get asked is, if an employer issues a retirement letter that has a transfer value in it, does that mean it becomes an incentive exercise?”

“We’re clarifying the point to say: no, by itself that doesn’t make it an incentive exercise.”

"Minor tweaks"

Benjamin Roe, head of member options at consultancy Aon Hewitt, said the existing code has been widely accepted by trustees and scheme sponsors.

“It’s doing what it’s supposed to do in terms of trying to improve member outcomes,” he said. “The fact it’s only had to have minor tweaks given the new freedom and choice regime is very positive.”

Roe said clarification on what constitutes advice for incentive exercises, included in the boundary examples, is particularly useful for the industry.

“In the new freedom and choice world we’ve seen quite… a wide range of different practices in the marketplace in terms of what’s actually meant by advice,” he said.

“This clarification – that advice in these circumstances is not just [what] the right course of action for somebody [is], but actually getting them into a place where they can get into that vehicle… is really important.”

Matthew Demwell, head of member options at consultancy Mercer, said member options exercises are increasingly being integrated into broader derisking plans, including partial or total member buy-ins and buyouts.

A key element in the feasibility of incentive exercises is the transfer value basis, Demwell said; trustees should target a “sweet spot” – exceeding the statutory minimums for members but lower than the long-term funding and administration cost – alongside providing good support for members assessing their options.

“Be prepared to do some groundwork… it’s really important that trustees and employers provide support for members.”