Pensions Update - Code of Practice issued for Incentive Exercises
8 June 2012
The Industry Working Group, set up by the Pensions Minister, has today issued its Code of Good Practice relating to pensions incentive exercises. Those involved in enhanced transfer value, pension increase exchange and other similar exercises will now be expected to comply with this Code.
Given that the Code is intended to reflect good practice, much of it is familiar to those of us who have been involved in well run exercises over recent times. The seven principles include things such as a need for communication to be "fair, clear, unbiased and straightforward" and a requirement for members to be given sufficient time to make up their minds.
ETVs get off lightly, but cash is outlawed
As widely expected, the Code says that cash should not be offered to members as part of the incentive under these exercises. Take up of enhanced transfer value exercises (where members are offered an incentive to transfer out of a defined benefit scheme) has tended to be significantly higher where cash has been offered and so this change will reduce take up rates.
However, more damage is likely to have been done to transfer value exercises by the FSA's recently revised transfer value analysis requirements than by this Code of Practice. The revised analysis increases the enhancement that is required in order to obtain a transfer recommendation from a financial adviser and so increases the cost of transfer value exercises to employers.
PIEs hit hardest
The impact of the Code is likely to be much greater on pension increase exchange exercises – where members are offered a higher immediate pension in return for giving up some or all of their non-statutory annual pension increases. The terms of the offers and the financial advice provided under these exercises is much less developed than for transfer value exercises and so much of the detail in the Code, and the supporting Practitioners' Notes, focuses on how pension increase exchange exercises should be run.
One of the big issues with pension increase exchange is how much of the value of the future pension increases which are being given up is converted to higher immediate pension and what actuarial basis is used to calculate that value comparison. Typically between 60% and 100% of the value has been awarded in higher immediate pension, with scheme funding being boosted by any retained amount, but these calculations have been carried out on a variety of different actuarial bases.
The Code will require a calculation on an aggregate member basis of the benefits given up and the replacement benefits using the scheme's standard transfer value basis. If the value of the replacement benefits on this basis is less than 100% of the value of the benefits given up, members must be offered (but need not take) financial advice before they can accept the offer. However, if the value is 100% or more, only financial guidance needs to be given to members. This is likely to be the most controversial aspect of the Code as 100% exchange on this basis does not mean it is a good deal for each individual member; nor does less than 100% represent a bad deal for some members.
Scope of the Code
Interestingly, the Code does not apply to pension increase exchange and other options which are routinely offered to members at the time of retirement. This is presumably because it is unrealistic to expect an employer to have in place procedures to offer financial advice in those circumstances, particularly as advice might then also be required on all the member's other retirement decisions. However, the Code says that those involved with pension schemes should consider applying some or all of the Code when these sort of options are offered to members.
The Code is voluntary rather than having any legal force. However, it suggests that advisers should report concerns about these exercises to the Pensions Regulator. In addition, a Monitoring Body is to be set up which will keep the Code under review. In his foreword to the Code, Steve Webb, the Pensions Minister, repeats his threat to legislate if the industry does not accept voluntary compliance with the Code and one role of the Monitoring Body is to recommend the need for legislation if there is a lack of voluntary compliance.
The Industry Working Group which produced the Code was made up of representatives from across the pensions industry. It was supported by a Steering Group, which included Osborne Clarke pensions partner, Jonathan Hazlett, who represented the Association of Pension Lawyers.
A copy of the Code is available here.
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