Fiona Matthews explores the impact the code of good practice for incentive exercises will have on ETVs and PIEs

On 8 June an industry working group, chaired by Margaret Snowdon, OBE, published a code of good practice for incentive exercises which includes enhanced transfer values (ETVs) and pension increase exchanges (PIEs). Many employers have been waiting with baited breath to see whether there was any future for liability management exercises. Now that the results are out, will there be a sudden rush of activity or will companies put away their plans?

Work on the code has sparked a healthy debate between many interested groups, including the government, employers, advisers and various industry bodies. The result is a set of seven principles that everyone felt would improve the standard of incentive exercises, help members to make informed decisions whilst still preserving these exercises as a legitimate tool for employers looking to manage their ever-increasing defined benefit liabilities.

Much of the new code reflects what well-designed and well-run exercises already looked like. The most significant points are:

• Cash incentives to transfer or change benefits have been ruled out
• Clarification that PIE options offered to members retiring are not incentive exercises
• Introduction of a more standard way of comparing the value of the new uplifted pension with the future increases given up for PIE offers to pensioners
• Definition of what financial advice or guidance should be given to pensioners faced with a PIE offer

Nearly all ETV offers to date have permitted members to take some of the enhancement as cash, though several which Towers Watson have been involved with have required much of the enhancement to be paid into the member’s new pension scheme. Whilst the working group did investigate ways in which cash might be retained, on balance they concluded that the added complexity needed in the code to ensure that cash was used responsibly was outweighed by the simplicity of banning it.

With no cash on offer the big unknown for ETVs is how take-up rates might be affected. ETVs without cash payments may still be attractive to some members if the amount on offer is more than sufficient for a financial adviser to recommend a transfer; especially if the member values the extra flexibility available through DC pensions.

If an employer wants to make a PIE offer to pensioners within its pension scheme, there are now two different ways in which this could be done. One approach is to set the terms of the offer so that they meet a ‘value requirement’. Essentially the value of the initial pension uplift is compared with the value of the pension increases given up using assumptions consistent with those used to calculate cash equivalent transfer values for pensioners to arrive at a ‘balanced deal percentage’. If the balanced deal percentage is more than 100 per cent then the pensioner should receive independent guidance from a suitably qualified and experienced individual. If the percentage is less than 100 per cent then the pensioner should receive full financial advice including a recommendation on whether to accept the offer. So employers must weigh up whether they should give a lower uplift and full financial advice or a bigger uplift (which meets the value requirement) and less expensive guidance.

PIE options routinely available to members as they approach retirement are not directly covered by the code. Such options have much in common with one-off offers to pensioners (which are in scope) and with the option to commute pension for a tax-free lump sum (out of scope). Thus whichever way at-retirement PIE was treated was going to create some anomalies. Where the line has been drawn could mean a member retiring receives quite a different option to that made available to an older pensioner, although employers offering an at-retirement PIE are ‘encouraged to consider’ applying some or all of the principles within the code.

Whilst the code does place new restrictions on incentive exercises and may mean that companies need to adjust the design of the offer, its publication provides a helpful framework for constructing and implementing an exercise in a way that is widely acceptable.

Written by Fiona Matthews, senior consultant at Towers Watson

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