A revised version of the voluntary Code of Good Practice on Incentive Exercises (the Code) was issued on 1 February 2016. Whilst the core principles remain unchanged, it has been updated to reflect the changing pensions landscape. Changes include the introduction of a “proportionality threshold”, an obligation for advice to cover the implications on other parties such as spouses and dependants and confirmation that the Code will apply to “full commutation exercises”.
The Code, which consists of 7 principles, was originally launched in June 2012 due to concerns that incentive exercises were being conducted in a way that was detrimental to pension scheme members. It sets out (voluntary) good practice for incentive exercises. Incentive exercises are one-off “offers” (either an invitation or an inducement) to members to change the form of their defined benefit pension rights with the objective of reducing risk for the employer/pension scheme. Broadly, there are two categories of incentive exercise:
- transfer exercises – where a member’s defined benefits are transferred out of the scheme (for example, enhanced transfer value exercises and total pension increase exchange exercises), and
- modification exercises – where a member’s defined benefits are changed (for example, full commutation exercises or pension increase exchange exercises).
The Code does not apply to new benefit options that are introduced and which will be made “ordinarily available” to members – for example, as part of a member’s usual retirement options.
Background to the revised Code
Following the introduction of the Code, the Incentive Exercises Monitoring Board (the Board) was set up to monitor the effectiveness of the Code over a three-year period and decide whether the Code should be amended (but still remain voluntary) or whether the Code should instead be placed on a statutory footing.
A strong theme of the forewords to the revised Code (from Baroness Altmann, Pensions Minister, and Margaret Snowdon, Chair of the Board) was the importance of updating the Code to reflect the changes to the pensions landscape since 2012 – most significantly, the introduction of freedom and choice – as well as recognising that the good practice guidance has generally been embraced by those carrying out incentive exercises (without a need to legislate to achieve the Code’s objectives).
What has changed?
Although the original principles which were set down in 2012 remain the same, the key changes are as follows:
- Proportionality threshold introduced – where an “offer” made to a member relates to a transfer value / cash commutation lump sum of £10,000 or less (for transfer exercises or full commutation exercises) or where the member’s yearly pension is £500 or less (for pension increase exchange exercises) then the “proportionality threshold” is not met. This means that there is no requirement to provide advice or for the member to take guidance before the “offer” can be accepted. However, guidance should be “available and readily accessible” to any member who wants it.
- Full commutation exercises fall within the Code – the “offer” of a cash lump sum in place of a pension under the scheme will fall within the Code. Where the “offer” first includes conversion of safeguarded defined benefit rights to flexible defined contribution benefits, this should be treated as a transfer exercise.
- Boundary examples introduced – various examples (which do not form part of the Code itself) have been published. They are designed to give guidance on when the Code will apply. Other examples are also included. These provide further guidance on the application of the Code to the backdating of pension increase exchange exercises, independent financial adviser fee structures and the application of the “proportionality threshold” to transfer exercises are also included.
- Practitioners’ notes discontinued – the practitioners’ notes (providing additional commentary and examples) which accompanied the original Code will not be maintained in future.
- Advice requirements updated – advice provided to the member should consider the implications of the “offer” on other parties such as the member’s spouse and other beneficiaries.
- Guidance – for modification exercises where guidance is provided, the revised Code sets out how this differs from the DC guidance guarantee comparison provided by Pension Wise.
- Party initiating the offer may be trustees/other third party – the revised Code recognises that the party initiating an “offer” (and who should therefore comply with the Code) may be the trustees or another party as well as (more typically) the employer.
- Winding-up lump sums outside scope of Code – the revised Code is not intended to apply generally to winding-up lump sums (WULS) because “trustees can be expected to set terms for all options appropriately in the context of [a] wind-up”. However, it goes on to say that parties should be mindful of the principles of the Code in the context of winding-up to ensure members’ interests are protected. Margaret Snowdon also notes in her foreword, that the Board can “foresee the growth of WULS being used as Incentive Exercises” and given this, it will be consulting the industry during 2016 on whether WULS (or certain types of WULS) should in fact fall within the Code.
Who does it apply to?
Where an “offer” has already been made in writing to a member before 1 February 2016 (the publication date of the revised Code), the 2012 version of the Code will apply. For all “offers” made after this date, the revised Code will apply.
This is a welcome update to the Code to bring it up to speed with recent developments such as freedom and choice in the defined contribution environment. It is encouraging that the general sense is that those carrying out incentive exercises do adhere to the good practice required in the Code – without the need for it to be underpinned by legislation – and this has resulted in “better behaviours, better run exercises and less risk of members being disadvantaged”.
One point to watch for the future is the promised consultation on WULS. The Code states that it is “not intended to apply generally to exercises associated with winding-up”. However, it is not entirely clear what this means in practice given that it also goes on to say that “all parties should be mindful of the principles of the Code in such circumstances”. We are of the view that this probably does not, for example, mean that advice or guidance needs to be provided to a member being offered a WULS payment or that a two-week cooling off period should be included. However, we do believe it is prudent to bear in mind the spirit of the principles set out in the Code when carrying out WULS exercises in future.