Matt Ritchie asks if ETVs have had their day or whether efforts to improve their reputation can save them

The funding position of defined benefit schemes continues to be a hot-button topic in the world of pensions, and it is difficult to see the issue going away any time soon. Scheme sponsors continue to look for new and innovative ways to resolve their deficit positions, and incentivised transfer exercises are among the tools in the kit.

In simple terms, Enhanced Transfer Values (ETVs) offer members a payment above the value of the underlying cash equivalent transfer value, as an incentive to transfer out of a DB arrangement.

Pensionary increase exercises would commonly see members offered higher pension payments in exchange for foregoing non-statutory pension increases or other benefits.

Such projects can offer a ready means for sponsors to cost-effectively reduce their ongoing liabilities, but their popularity is far from universal. Recent comments from the Minister of State for Pensions Steve Webb have once again thrust incentive exercises into the spotlight.

In May, the Minister raised concerns about poor practice on incentive exercises, in which scheme members were being offered "superficially attractive" deals which would see them achieve lower retirement income further down the track.

While specific examples are thin on the ground, common stories about poor practice include members being placed under excessive pressure to accept offers, or being offered large cash sums in times of financial stress.

"I am sure that the concerns we have raised are being heard and that many employers are having second thoughts about this. But we do still hear of cases. One example is individuals being offered lump sum cash offers just before Christmas. If that is being done deliberately, it cannot be right," Webb says.

Concerns over outcomes from incentive exercises are nothing new. The issue received significant attention late last year, when The Pensions Regulator (TPR) published guidance setting out the best practice expected of those involved in incentive projects.

In the guidance, the Regulator said trustees should approach transfer exercises from the presumption that they will not be in members' best interests in the majority of cases.

While acknowledging that under some circumstances a transfer exercise would be appropriate, the Regulator's view was that these cases were likely to be the minority, very possibly, a small minority.

The guidance sets out five key principles employers must adhere to should they proceed with a transfer exercise. TPR said transfers must manage conflicts of interest; be clear and fair; be open and transparent; trustees should be consulted and engaged from the outset; and all members should be given access to independent financial advice. This advice, it said, should be promoted in the "strongest possible terms".

Policy lead at the Regulator Carl Davey says that although it has seen "good indications" that the market is responding to the guidance, identifying trends will be a long-term process as there is no legal obligation to report transfer exercises.

"We are concerned with the standard of exercises we have observed to date, and the propensity for these to lead to poor outcomes for members. We believe the risks to running these exercises are considerable to all parties involved," a spokesperson said.

Of the points raised in the guidance, the one about advice is critical. Pension consultant at Aon Hewitt Alan Howard says that access to IFA advice is crucial to the success of transfers, and he would support a move to ensure provision of such advice was made compulsory.

"I see advice as key, and the crucial thing there is that the IFA is working on behalf of the member, so they are going to recommend a 'yes' or a 'no' to that member taking into account their full circumstances," Howard says.

Whilst advice provides a degree of protection against members making decisions that run contrary to their best long-term interests, it is not a guarantee that outcomes from incentive exercises will always be ideal.
Indeed, announcing the meeting over ETVs in May, the Minister said he was aware of situations in which members proceeded with transfer exercises despite being advised against it.

Pensions consultant at JLT Jonathon Webb says that the risk of "insistent clients" acting against advice increases dramatically in offers involving large cash incentives.

JLT's oversight committee looks carefully at any transfer exercises the business is involved in, and will turn down projects in which the risk of members being tempted to act against advice – and their own long-term best interests – is too high.

In the end, there is no practical way to completely remove the risk from transfers and other incentive exercises, short of banning them outright.
With the majority of commentary around transfers seemingly revolving around their potential to result in negative outcomes, one could be tempted to suggest that legislating against the measures could be a reasonable move.

However, such an approach would ignore the benefits to sponsors, members and schemes that incentive exercises can offer.

In a speech to the National Association of Pension Funds trustee conference in London last year, then-chair of The Pensions Regulator David Norgrove outlined a number of scenarios in which ETVs could be considered beneficial.

These were where a member has a "limited" life expectancy, those in single life circumstances, where the member is a sophisticated investor looking to balance the risks in a portfolio of retirement benefits, or where the level of benefit is significantly higher than the Pension Protection Fund cap.

JLT’s Webb acknowledges that the projects are only beneficial in a minority of cases, but that in cases where they are appropriate their value can be significant.

Examples could include where an individual has a significant amount of unsecured debt on which they are paying high interest, and pension savings would be more efficiently deployed to pay down that debt and avoid ongoing interest charges.

The relative value of incentive exercises depends entirely on the subject's individual circumstances. Webb cites one particular case in which a scheme member who had been unemployed for an extended period of time accessed their pension savings to retrain, and re-enter the job market.

Aon Hewitt's Howard says that there is a legal requirement for trustees to provide a transfer value, and an ETV is essentially an exercise which provides more than the statutory minimum.

"I do struggle to see how providing something more than the legal minimum can be a bad thing to do – subject to controls around good comm-unication and independent advice."

So, at a time when schemes are searching high and low for means to tackle their deficits, and in doing so ensure they can continue to provide members with retirement incomes, making these incentive exercises work is surely a worthy cause.

If those in charge of regulating the market remain concerned at behaviour around transfer exercises, it is logical to turn to what they intend to do about it. The Minister says the government is committed to working through all the issues before any further decisions are made, though further regulation is "certainly an option".

"We now need to take a measured view and explore options.
"We are also looking at the role of financial advice, because in some of these cases people don't get advice at all to make very complicated financial judgements," Webb says.

In order to root out bad practice, Howard supports enshrining TPR's guidance in regulation, in order to provide the "teeth" necessary to crack down on unscrupulous operators bringing ETVs into disrepute.
Further, looking at the Financial Services Authority's handbook, specifically how it frames the role of IFA advice, is also viewed as a positive potential step.

Stamping out poor practice is in everyone's best interest. In order to achieve this, Jonathon Webb says that some definitive examples of where incentive projects are going wrong would be very helpful.

"What we're desperately keen for is for the bad practice to be outed. We don't want to get involved in projects that are going to have bad fallout for our reputation or for the reputation of the corporates we're working with.
"It's all about being very transparent, trying to adhere to the five principles the Regulator has given us. But further anecdotal evidence of bad practice would be really helpful because that could help frame our approach. If someone would come out and say; 'we've seen these examples of poor practice and we don't like it', that would be great."

Written by Matt Ritchie

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