Analysis: While many defined benefit schemes have yet to explore ways to provide enhanced flexibility to members, there are three key strategies in this area that could ease the pressure of mounting liabilities in 2016.
New pension freedoms introduced in April apply primarily to defined contribution schemes, but many expect a rise in the number of DB members looking to transfer out to take advantage of the new freedoms.
But flexibility in DB extends well beyond a full statutory transfer. Improving member access and options for partial transfers, additional voluntary contributions and trivial commutation exercises could help schemes trim down portions of their liabilities.
However such moves come with risk warnings.
Establishing a dialogue
Sue Tye, pensions of counsel at law firm Baker & McKenzie, said trustees should focus on having a dialogue with sponsors to establish which flexibilities will bring the best outcomes for the scheme, employer and the workforce.
“Trustees need to be mindful of their duties and what their rules allow,” she said, adding that changes to scheme rules would not typically cause major issues for schemes.
Tye urged trustees to review the industry code on incentive exercises where employers are targeting liability management.
“It’s an interesting time – there is such a broad range of responses to flexibility. For lots of schemes it comes down to a dialogue with employers.”
Partial transfers
Sacrificing DB guarantees for DC flexibility is not a decision to be taken lightly, but demand for partial transfers is likely to rise. It provides members with a halfway house, offering access to new flexibilities while keeping a certain level of secured income from their DB arrangement.
Partial transfers can also help employers and trustees manage down the size of their DB scheme over time by removing small tranches of liabilities.
However, a survey of 35 managers of DB schemes by consultancy Barnett Waddingham showed that less than a third (29 per cent) offer partial transfer of any part of DB.
Nick Griggs, partner and head of corporate consulting at Barnett Waddingham, said fear of an increased administrative burden has held many schemes back from offering these.
“With a partial transfer you have to do a whole load of work but you’ve still got a DB pension you need to administer,” he said, adding that schemes must weigh up the benefits against the burden.
“It may be a burden worth paying given the risk reduction [and] derisking benefits you can get from it.”
But Hugh Nolan, chief actuary at consultancy JLT Employee Benfits, said the potential savings to be made through transfers diminish if members do not take their full benefit.
“You have all the same costs… and all you get rid of is a bit of your liability,” he said.
AVC strategy
Pension freedoms have brought new access options for members with AVC pots:
as a single, taxable lump sum from age 55;
as a series of taxable lump sums from age 55;
on a more flexible drawdown-type basis; and
as a transfer into a separate DC vehicle.
However, there is currently wide discrepancy in what schemes actually offer. While nearly three quarters (73 per cent) of schemes allow members to take their AVC pot as a one-off lump sum, one in five (19 per cent) facilitate access via drawdown or a series of lump sums, according to the Barnett Waddingham survey.
The terms might be slightly more generous... to encourage people to get rid of small pensions that are more trouble than they’re worth on the admin side
Hugh Nolan, JLT Employee Benefits
Griggs said the costs associated with administering a broader range of options “must be significant”.
In addition, fewer than one in five (18 per cent) schemes have reviewed the lifestyling strategy in place for AVCs to accommodate the younger age at which the funds may be accessed.
Trivial commutation
More than three-quarters of schemes surveyed said they routinely offer trivial commutation to members at retirement, and 79 per cent have amended scheme rules since April’s legislative changes reduced the age of eligibility to 55, down from 60.
Nolan said the exercises provide trustees with a good method for “cleaning up” small pots that drag on scheme administration costs but could be more carefully controlled.
“The terms might be slightly more generous than you give elsewhere to encourage people to get rid of small pensions that are more trouble than they’re worth on the admin side,” he said.
“But the key thing here is you can control it better – by definition the amounts are typically quite small.”
