By Martin Palmer, Corporate Benefits Marketing at Friends Life
There is a widespread recognition that final salary is a dying proposition and so Trustees and managers of these pension arrangements have had to come up with strategies to deliver something of the promise made by their schemes through alternate routes. The transition towards the cost certainty offered by money purchase schemes is a reasonably simple case to make for future contributions, but in many cases, final salary schemes have to work out what to do with the benefits accrued up to the point of the transition. One route to managing the liability is to remove the promise of benefits from the scheme, to convert the final salary benefits into a cash equivalent transfer value (CETV) and offer to transfer this into a new money purchase scheme. Schemes who wish to encourage their members to make the transfer from final salary to money purchase do so by deciding what could be offered to make the transfer more attractive i.e. by enhancing the transfer in some way, whilst still offering the quid pro quo of a saving and/or future cost certainty for the sponsoring employer.
The starting point has to be that the CETV plus any enhancement represents a fair representation of the value of the final salary promise, and that an investor with a balanced attitude to risk could match or exceed the value of the final salary benefits in a money purchase environment.
In some cases, the additional amount that the employer is required to provide proves to be a stumbling block. For others the next decision is how to structure the offer to meet the often conflicting needs of the employer, the trustees or managers of the scheme, the members’ representatives (the unions) and the individual.
In the past this has sometimes meant offering an enhancement exclusively in the form of a cash sum payment. The cash incentives offered were made as attractive as possible, and were available to individuals who would agree to transfer to a personal pension. The risk with this is that offering someone unexpected cash means that while you are explaining what is happening, they are in another place, working out what they are going to spend it on. Whilst members considering a transfer were offered advice, there was always the fear that a member’s decision making could be distorted by the availability of a cash payment.
Having concern for the some of the practices employed by the ETV market in its earlier years, in 2011 Steve Webb, the Government Minister, established an industry working group to carry out a review and develop a code of good practice. On 12th June 2012, the Industry Working Group on Incentive Exercises published the Code of Good Practice on Incentive Exercises. It is a voluntary code although the Minister has made it clear that non compliance or significant abuse would lead to legislation. The Code has been welcomed by the main ETV stakeholders and various industry bodies are now establishing how best it can be implemented on a consistent basis. The Code contains seven principles. The stand out principle is that any form of non pension enhancement can no longer be offered to members as an inducement to transfer out of a final salary scheme.
The fact that employees will always receive advice and that a full Transfer Value Assessment Summary (TVAS) is carried out and considered alongside specific member information around attitude to risk and wider financial requirements provides everyone in the industry with comfort that members are making informed decisions. They may not be the decisions that you or I might take but then each member’s personal financial needs are different, which is why the advice is needed.
In delivering advice member outcomes must be the highest priority otherwise CETVs have the potential to cast a shadow over the image of the industry and what may be seen as a short term gain for the employer could become a long term cost in terms of reputational damage.
In summary, CETVs are a way for an employer to generate cost certainty by transferring away the risk inherent in the delivery of their final salary promises. Members should receive appropriate financial advice that is specific to their individual circumstances to make sure that they understand what they are giving up, and what they are receiving in return. The advice should include a clear description of the level of risk they are taking in terms of the returns on their investment needed to deliver the value of benefit they have transferred away from their final salary scheme.
The industry must ensure that financial incentives to transfer are proportionate and readily explained, and that governance has been put in place to ensure that a member’s lack of knowledge cannot be open to accusations of exploitation. It is hoped that the publication of the Code of Good Practice will ensure that this will always be the case going forward.
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