Over the last few years there has been a trend for employers to try to reduce the financial and longevity risks associated with DB benefits by offering alternative benefits to members through incentive exercises. These have commonly involved offering members an enhanced transfer value to a personal pension plan or a higher, flat-rate, pension in exchange for giving up rights to future pension increases.
The Government has become increasingly concerned that members have not properly understood the implications of taking up offers and in some cases have clearly been tempted into making poor investment decisions.
Following clear signals of possible legislative intervention, an industry working group has issued an incentives exercise code of practice. This is aimed at ensuring that offers are fair and transparent and that members are able to make an informed choice about whether to accept an offer.
The code lays down seven principles with which all incentive exercises should comply.
- No cash incentives for accepting an offer. Small incentives to encourage engagement with the offer process are allowed.
- Free, independent, advice on enhanced transfer value offers with a recommendation on whether to accept the offer. For benefit modification offers (typically giving up pension increases for a higher flat-rate pension) members may be given guidance rather than advice, but only if the value of old and new benefits is at least the same for most members to whom the offer is made. Advisers should operate a vulnerable client policy.
- Communications must be fair, clear, unbiased and straightforward.
- Proper records must be kept and advisers must highlight members who insist on accepting an offer despite being advised it is not in their interests.
- Members should have enough time to consider an offer – three months from receiving final information and two weeks from receiving final advice/guidance. Members should be given a two week cooling-off period.
- Members aged 80+ should only be told that an offer is being made, with the onus on them to ask for further details.
- All parties must be aware of their roles and responsibilities and act in good faith.
The full code can be found at http://www.incentiveexercises.org.uk/.
The Code's Status
While the code is a voluntary one, there is an expectation that employers and industry professionals will comply with the code for all incentive exercises. The Pensions Ombudsman and the Financial Ombudsman Service are likely to take account of whether the code was followed in dealing with member complaints.
Clearly much work has gone into the code. We believe it should ensure that more members make considered and suitable decisions about their pensions.
For transfer-out offers, members will now have to receive an independent recommendation about whether they should accept the offer. For other types of offer, involving re-shaping benefits, there will be a minimum requirement for clear guidance and a check that old and new benefits for most members are equal in value. Given the complexity of assessing the suitability of these offers and the general low level of member knowledge, we believe there is a strong argument that advice should be required for all offers. Many employers may see advice as a good long-term protection against future claims from employees who feel they have lost out by accepting an offer.
We welcome the ban on cash incentives. In the current economic environment cash to help deal with immediate financial difficulties at the expense of valuable pension rights is likely to be too tempting for many members.
The effect of the code is likely to be that incentive exercises will become less common as code compliance will result in fewer exercises being cost effective – exercise costs will increase and take-up rates will be lower. Offers may become unviable for smaller employers and schemes.