David Adams explores the current level of pension transfer exercises, now they have been in the regulator’s spotlight for the past couple of years

In the right circumstances enhanced transfer value (ETV) and other risk transfer exercises can be good news for pension schemes, sponsoring employers and members. Yet they have been out of favour for the past couple of years. As Aon Hewitt principal consultant Matthew Arends noted in a piece for Pensions Age earlier this year, Aon Hewitt’s 2011 Global Pension Risk Survey suggested that 25 per cent of schemes were likely or very likely to implement a liability management exercise between then and now – yet in 2013 it is clear that very few of them actually did so.

Arends suggested two main reasons: criticism of ETVs, based on them offering members poor value, and poor market conditions. Back in 2010 The Pensions Regulator’s David Norgrove advised trustees to view any proposed ETV exercise with suspicion. In June 2012 an industry working group published a Code of Practice for ETVs and other incentive exercises that prohibited the use of cash incentives. Many planned ETV exercises put on hold while the code was being drawn up were then shelved once it was published.

“Data is hard to come by,” says Buck Consultants senior corporate actuary Colin Richardson, “but what we [at Buck] have seen is a much lower number of transfers than before the code was passed. It was already slowing, but it’s slowed down much more since the code came in. We’re talking about the number of cases being 25 per cent of what it was.

“But the biggest driver reducing the number of transfers has been financial conditions,” he continues. “This exercise may be about the long term, but a lot of companies will pull away from it if they’re going to make a pensions accounting loss that will impact profit and loss in the short term.”

But are we about to see a revival in the use of ETVs? “When gilt yields change you move into profitable accounting territory again,” says Richardson. “Then the only downside for the employer would be if being unable to offer cash meant only a small number of people took up the offer. And the code has erased some fears: the controversy and reputational issues have significantly reduced. Trustees who may have been a bit concerned will now have more confidence that this is being done properly.”

“Most people have put ETVs to one side, but there’s still quite strong underlying demand,” says Aon Hewitt head of liability management Ben Roe. “Our [2013] Global Pension Risk Survey showed 6 per cent of companies had done ETVs in the past, 5 per cent were ‘likely’ to do them in future and 21 per cent ‘somewhat likely’.”

Broadstone director, actuarial services, Richard Nobbs also sees growing interest. “They’re back on the agenda for a variety of organisations,” he says. “We’re also seeing interest within smaller schemes, but obviously for them the savings have to be compared to the administrative costs.”

“The challenge is the cost and where to pitch the transfer value, so that you still get people taking it up,” says JLT Pension Capital Strategies managing director Charles Cowling. “Those members who are likely to take it tend to be a slightly different cohort – they tend to be more financially savvy. We’re seeing increased activity targeting those with larger pension pots. For those aged over 55 we’re seeing regular offers to members whereby they might be able to take advantage of an impaired life annuity to get a better deal.”

Roe says many employers and trustees are looking at liability management in broader terms, including pension increase exchange (PIE) exercises, where pensioners and both active and deferred members reaching retirement are offered an immediate increase in their pension in return for giving up all or some of future annual pension increases (provided these would have been higher than the statutory minimum); as well as promotion of transfer values to people at retirement.

Aon Hewitt’s 2013 Global Pensions Risk Survey shows a growing appetite for PIE, with implementations having taken place for 5 per cent of new pensioners and 4 per cent of existing pensioners (in comparison to the 6 per cent of schemes to have implemented ETVs), while 29 per cent of schemes were ‘very’ or ‘somewhat’ likely to implement PIEs for new pensioners – the figure is 25 per cent for existing pensioners. It’s notable that BT is offering PIE to around 120,000 pensioners this year. Such exercises can benefit employers, schemes and members, but the latter will need to make a fairly sophisticated calculation about life expectancy and long-term inflation risks when deciding whether or not to accept the offer.

“If we return to more, what we could call ‘normal’ market conditions we’ll see more of these things,” says Barnett Waddingham head of corporate consulting Nick Griggs. “That wouldn’t automatically lead to increased activity, but it makes these things look more attractive. Some clients have got these things on hold at the moment but would like to revisit them at some point, while acknowledging that take-up rates aren’t going to be as high as when cash incentives were being freely paid.”

But how do trustees feel about transfer exercises? “Quite rightly, trustees are nervous,” says Nobbs. “Trustees have to look at whether it is an appropriate and fair offer. If that’s not the case, trustees have a duty to challenge the company and make sure that members are fully informed that it’s not in their interests. Trustees and companies need to be careful around pitching an offer at a sensible level. Our experience is, providing you pitch it at a sensible level and provide good quality advice, you can still get a decent take-up.”

“I’ve been in meetings where you see trustees sitting uneasily in these meetings when people start talking about ETVs,” says BDO director, pensions advisory, John Hubbleday. “But they are an option. Any member can say ‘thanks, but no thanks’. All a company is doing is offering them an improvement. But communication is absolutely key: it has to be clear, concise and appropriate.”

He also highlights the possibility of using some form of equity incentive for some members. “That may not be a viable route for smaller companies, but it could be a good, innovative step forward for larger companies.”

There is also some evidence of ETVs being used as a kind of bridging mechanism to help prepare a scheme for full buyout at some point in the future. “Planning for buyout is something that a lot of companies are doing,” says Hubbleday. “Conditions may not be conducive for buyout now, but who knows where we’ll be in five, 10, 15 years’ time? We’re working with two clients at the moment where they’re using these exercises to facilitate that buyout. They just want to make it as efficient as possible and give members an option to shape their benefits.”

“Companies may do it piece by piece,” says Nobbs. “So one year maybe you offer a PIE, then a year later you look at ETV. Then they may go back to some of these options every now and then, depending on budget, experience with previous exercises and their view of the pension scheme, because at some point it’s going to be wound up.”

Hubbleday says he thinks offering transfer options to members is something employers and trustees should consider. “A member is entitled to an option if you’re going to improve an existing offer,” he says. “I’m sure the regulator will continue to see some instances of bad practice, but hopefully the regulatory guidance will manage those risks. It wouldn’t surprise me if there continues to be a tightening up of regulation around this, but I believe these exercises will remain a viable option.”

“As yields rise in the future we’ll see ETVs coming back, because there is demand out there,” says Ben Roe. “Once financial conditions improve ETVs should look more attractive. I would expect interest and activity to increase, primarily in the retirement space; and that will lead to more bulk exercises over the next five years.”

David Adams is a freelance journalist

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