Northumbrian Water has embarked on a multi-pronged liability management exercise in a bid to control its defined benefit obligations, including a pension increase exchange and employer-funded financial advice.
Pie exercises have seen increased interest from schemes recently. Twenty-seven per cent of respondents to an Aon 2017 survey, including trustees, scheme sponsors and pensions managers, said they were “somewhat likely” to implement a Pie for existing pensioners, with 26 per cent somewhat likely to carry one out for new pensioners.
A non-increasing pension poses less risk to the long-term funding of the scheme, so that’s a big risk reduction
Adam Poulson, Barnett Waddingham
Two new activities to manage Northumbrian Water’s scheme liabilities are being implemented in 2018, according to its latest financial statements.
“A pension increase exchange exercise is being carried out and transfer values are being included in members’ retirement data with the scheme offering to meet the cost of one round of financial advice,” the document states.
It adds that the potential financial impact of these activities was not recognised in the March 31 2018 valuation, but “is expected to be realised in the year to March 2019”.
Who wants a slice?
When a Pie exercise is carried out, members exchange a lower level of pension, which has inflation-linked increases, for a higher level of pension that will not rise in the future.
Northumbrian Water is not the only water company opting for this exercise, and and the evidence suggests it may see a significant windfall. Severn Trent recorded in its 2018 annual report that “an exceptional gain of £8.3m arose… from the net benefit, after implementation costs, of a pension increase exchange arrangement”.
The £954.6m Northumbrian Water Pension Scheme had a deficit of £290.6m and a funding level of 76.7 per cent at December 2016. It has 1,244 active members, 1,145 deferred members and 3,196 pensioners.
Adam Poulson, partner and head of corporate consulting at Barnett Waddingham, said Pie exercises can either be offered at the point of retirement or to pensioner members.
Most Pie exercises are employer-driven, and are typically offered at between 70 and 90 per cent of the value of the pension increase that is given up, according to Poulson. If members take up the offer the funding level is likely to increase.
“A non-increasing pension poses less risk to the long-term funding of the scheme… so that’s a big risk reduction,” he said.
Good communication is crucial
Pie exercises can also be beneficial to members. Stuart Price, partner and actuary at Quantum Advisory, said: “What you find is that many pensioners like the idea of having more money now, when they’re still relatively young in their retirement – healthy and active – and want to go off and spend a bit more.”
He noted that Pie exercises are relatively cheap to implement, but cautioned that communication is one of “the most important parts of the exercise” and "should be kept as simple as possible”.
He also highlighted the importance of guidance, so members can fully understand the offer and can make an informed decision.
Poulson agreed: “Pensions are complex enough anyway, and what these exercises are doing is asking members to make a choice between their already complex pension benefit, which they may not fully understand, and change it to a different form of pension benefit,” he said.
Transfer advice
Northumbrian Water is also offering to cover the cost of one round of financial advice for members with regard to transferring out of the scheme. Material technology group Luxfer recently launched a similar exercise.
Luxfer Group offers IFA to deferred members
Global materials technology company Luxfer Group has launched an exercise offering deferred members of its defined benefit scheme the opportunity to discuss their benefit options with an independent financial adviser.
When members get close to retirement, they will usually be sent a pack explaining their options for when they reach their retirement date. It has become increasingly common for members to be given information, as part of that pack, about their transfer value – in case they wish to switch to a defined contribution scheme to access pension freedoms, for example.
“That’s quite a big decision, switching your income for life from the scheme into something that requires more investment considerations on your own behalf,” said Poulson. The gravity of the decision means for any transfers of more than £30,000, independent financial advice is required by law.
“To help ensure that members are receiving the right… quality of financial advice, a number of companies and trustees are now doing their own research into IFAs, and offering members the chance to meet with an IFA before they retire,” Poulson added.
Martin Hunter, principal at XPS Pensions, said retirement decisions have a huge impact on later life, so “member communications are extremely important”.
Transferring to a DC scheme “gives you more flexibility, but there’s more risk as well, from a member perspective”, he noted.
