 By Alan Collins, Head of Corporate Advisory Services, Spence & Partners
Pensions Minister Steve Webb has said a lot over the last twelve months in relation to employers offering incentives to individuals to give up or exchange their defined pension benefits, using some choice words including “bribes”, “bungs” and “dodgy deals”. The Minister’s views may play to the gallery and reinforce stereotypes of the financial advisory process in the UK but do they give a fair and balanced reflection of the efforts of employers to manage their defined benefit liabilities? I certainly feel that his cross-hairs may be hovering over the wrong targets.
The focus here needs to be on the two main types of liability management exercises – incentivised transfer values and pension increase exchanges.
Prior to retirement, each member of a defined benefit pension scheme has the right to transfer the value of their benefits to an alternative pension arrangement such as a personal pension or the pension arrangement offered by their current employer. This value is calculated based on assumptions set by the scheme’s trustees. In these so-called incentivised exercises, the sponsoring employer of a scheme offers members a transfer value which is normally considerably in excess of that offered by the trustees.
The incentive may be made up partly of a direct cash payment, and it is this aspect which has drawn the particular ire of Mr Webb and indeed the Pensions Regulator. I find it difficult to argue against choice and think it could set an unwelcome precedent if the Government starts telling people what they can or can’t do with what is essentially their own money. However, there is no doubt that cash incentives skew the members’ decision making process and may therefore lead to wrong decisions being taken. It is clear that Mr Webb wants to find a way of banning such offers and if he succeeds, I think this may cut off an avenue for sharp practices and so is likely to better protect most members in the long-run.
This does not, however, mean that transfer offers should be done away with entirely. There are many cases where it may be in the members’ interest to transfer – for example, if they are unmarried, if they have impaired life expectancy or if they simply wish to take greater control over their own financial affairs. Indeed, it seems somewhat odd that incentivised exercises get such a bad press when the value on offer is in excess of what is normally offered by scheme trustees. Should the spotlight not turn on whether or not sufficient value is offered as standard?
Members also have a choice to exchange pension for cash at retirement. This offer is made without any regulation or oversight and the exchange terms can often provide very poor value to the member. Again, should the focus of regulation not be on the decisions made on a day to day basis, rather than focusing on chasing pockets of bad practice which would arguably be dealt with under existing legislation by the FSA?
Pension increase exchanges are individual agreements where the member of a scheme gives up his or her right to future pension increases – either fixed increases or ones linked to inflation - in exchange for a higher immediate pension which will not subsequently increase.
I suspect Mr Webb must have been perched in his greenhouse when he chucked a stone at employers who offer pension increase exchanges. Mr Webb and his government gifted some employers the best liability management present of all time when he switched the measure of inflation from the Retail Price Index to the Consumer Price Index which overnight slashed up to 25 per cent off the value of some defined benefit pensions. Time, and the High Court, will tell if this change will stick.
In any case, many individuals would prefer a higher income now rather than waiting for future inflationary increases. Where these offers are constructed fairly, the member may have to wait until their mid 80s or beyond until the inflation linked pension provides greater overall value.
The most important thing to get right is providing members with clear communication and paid-for access to good quality financial advice. Members are currently taking many pension decisions without access to any advice at all. Further, they are presented with very few options at retirement when exploring other options which may be in their best interests. I would therefore encourage trustees and employers alike to learn from the best practice in the liability management process and extend the offer of paid-for advice to members at important milestones throughout their scheme membership (eg – when they’re leaving the scheme or at retirement).
I would finally ask you to consider two of Mr Webb’s less well known quotes on this issue: “Firms have every right to talk to their workers and ex-workers about getting their pension rights in a different way” and “I have no problem with firms managing their liabilities responsibly.”
On these points, to paraphrase a well known Lib-Dem catchphrase, “I agree with Steve”.
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