Introduction

The Incentive Exercises Monitoring Board (IEMB) has issued an updated code of practice (the Code) and several “boundary examples” which illustrate when and how the Code does (or does not) apply to incentive exercises. 

The changes provide useful clarifications as to how the Code applies to modifications and transfers of accrued defined benefit (DB) rights – particularly concerning how its principles apply to trustees and where an incentive exercise is below a certain threshold value. 

They will be of interest to employers, trustees and advisers who are planning or implementing any measures that could be treated as incentive exercises. These include changes to their retirement processes, offering pension increase exchanges (PIEs) or options to transfer DB rights to defined contribution arrangements. The changes reflect that the Code has become increasingly relevant to transfer exercises intended to allow DB members to benefit from the new pensions flexibilities introduced last year.

Recap on the Code of Good Practice

In general terms, the Code applies to offers to change the form of accrued DB rights in UK registered pension schemes which are:

  • intended to reduce the risk or cost of their pension scheme (or their employer sponsor); and
  • are not ordinarily available to members of that scheme.

These types of offer include both:

  • modification exercises” which change the terms of accrued DB rights – eg PIE exercises; and
  • transfer exercises” where the member transfers DB rights out of the scheme – eg enhanced transfer value (ETV) exercises, total pension increase exchange exercises (also known as flexible retirement offers), or conversions of DB to DC rights.

The Code consists of the following seven principles and explanations of how they should be applied:

  • No cash incentives should be offered that are contingent on the member accepting the offer;
  • Independent financial “Advice” should be provided to the member at the employer’s expense (or guidance, in the case of modification exercises which meet a value requirement);
  • Communications with members should be fair, clear, unbiased and straightforward;
  • Parties need to retain their records and maintain an audit trail for future reference;
  • Members need sufficient time to make up their minds without undue pressure (eg at least three months from the date of receiving final information and communications on the offer and a two-week cooling off period);
  • Incentives should only be offered to members over age 80 on an "opt-in" basis and member advisers need to comply with a "vulnerable client policy"; and
  • All parties need to be aware of their roles and responsibilities and act in good faith.

Overview of changes

The updated Code:

  • Places greater emphasis on circumstances when the Code will apply to trustees and advisers (eg it contemplates that trustees may have a central role in communicating incentive exercise offers to members);
  • Confirms that the Code applies to full commutation and conversions of defined benefit to defined contribution pensions – which may become increasingly common as trustees and employers seek to allow DB members to benefit from the new “pensions flexibilities”;
  • Includes a comparison between Advice provided by an Independent Financial Adviser (IFA) and the DC Guidance Guarantee (ie the requirement that DC members be offered free, independent advice on the options available to them);
  • Introduces a proportionality threshold, which removes the requirement to provide Advice on incentive exercises for smaller pensions and modifies the requirement to provide guidance. This will affect how the Code applies to: 
     
    • Transfer exercises where a member is being offered a transfer value of £10,000 or less - although, the boundary examples note that it “may be difficult to justify” distinguishing between members with transfers of more / less than £10,000;
    • Full commutation exercises where a member is being offered a cash commutation payment of £10,000 or less; and
    • PIE exercises where the pension that can be modified under the offer for a particular member is a pension of £500 per annum or less;
  • Requires that the Advice considers the implications of the offer for other parties, eg the spouse and other beneficiaries of the member, and advise the member (and as appropriate the other parties) on those implications. This could affect the willingness of employers and trustees to seek to bind contingent beneficiaries based on a member’s acceptance of offers for incentive exercises; and
  • Confirms that the Code is not intended to apply to exercises associated with winding-up, on the basis that trustees can be expected to set terms for all options appropriately in the context of the wind-up.

Boundary examples

The IEMB has issued ten examples, illustrating how the Code might apply in practice. These broadly cover:

  • how the following situations may fall within or outside the Code, depending on the facts:
    • changing retirement processes;
    • retirement catch-up (or launch) exercises;
    • PIE catch-up exercises; and
    • trivial commutation reminder to pensioner group
  • reminders of the Code’s requirements on PIE backdating and IFA costs; and
  • how the proportionality threshold applies to transfers in the current environment.

A key feature of these examples is that the Code is more likely to apply where offers are time-limited rather than being provided on an ongoing basis – eg where an employer agrees to fund the cost of financial advice, offer preferential transfer value or commutation terms, or issue personalised option letters, but only for a certain period. 

The IEMB notes that even where the Code does not strictly apply, they would expect employers and trustees to adopt most of its principles – with the possible exception of not paying fully for financial advice. 

The examples also offer a useful clarification that backdating of higher pensions on PIE exercises should only be offered where this will be administratively easier. Backdating of 3 months may be consistent with the Code, but backdating of 12 months or more is likely to be viewed as a breach.

Next steps

The updated Code applies where an offer is made to a member after its publication date (ie after 1 February 2016). 

We can help you to assess whether you need to take action in response to the updated Code, including if you:

  • are planning an incentive exercise that has not yet taken place and need advice on whether, and/or how, the Code will apply; or
  • have already established a practice of offering incentive exercises to members (eg as part of your retirement processes) and need advice on whether this offer is affected by the changes made to the Code.