Pension increase exchanges could be making a comeback as schemes look to convert guaranteed minimum pensions, but there can be pitfalls with incentive exercises. When should trustees push back? 

 

Incentive exercises remain part of the pensions landscape, despite the Pensions Regulator’s view that “for members the risk that they will suffer a loss in the long run will usually increase if they accept an offer”, and that “trustees should start from the presumption that IEs are not in most members’ interests”.  

 

Not only should trustees be careful not to influence members, they are also expected to engage with the process; manage conflicts; be aware of and meet data protection duties; and consider the funding impact where employer capital is used to fund such exercises, according to the regulator, who points out that it will hold trustees to the industry’s code of practice. 

 

 

Among the schemes that ran an incentive exercise late last year in the form of a pension increase exchange are UK Power Networks and construction firm Taylor Wimpey.  

 

A PIE offers a higher initial pension in return for a member giving up some discretionary inflation increases, meaning they reduce the inflation risk carried by the scheme. For the same reason they are also generally only beneficial for members who don’t expect to live long and therefore don’t need to rely on inflation increases; in the regulator’s eyes, this will always be a minority or even “a small minority”. 

 

At Taylor Wimpey, 1,000 pensioners accepted the offer after taking financial advice, out of about 8,900 pensioners and 7,400 deferreds. Trustee chair Anna Edgeworth wrote in July that “the option for a higher flat rate pension is also now available to all eligible members at retirement”. 

 

Despite the regulator’s concerns over suitability, Vassos Vassou, a professional trustee at Dalriada Trustees, says trustees don’t tend to push back against PIEs as such because they are giving an additional option to members, but he says there can be tension with the sponsor if the exercise is framed so that there is a financial gain for the sponsor. 

 

He also points to the adviser costs associated with carrying out such exercises, which are sometimes unjustified for the benefit. While PIEs had become “quite popular for a while some years ago”, interest then dropped off because of low member take-up and high adviser costs, he says. 

 

However, more recently, corporate sponsors have shown more interest again, he says, partly because they are “scratching around a bit more” for savings, and partly because corporate advisers are “chipping away at them saying you can save money”, whilst arguing that their costs would be more than covered by any potential future saving on a buyout premium. 

 

 

The vexed issue of guaranteed minimum pension equalisation that schemes are obliged to carry out is also serving as a discussion starter on PIEs, suggests Vassou. Advisers are now sometimes proposing to join the two exercises and save some administration cost by putting both communications out at the same time, despite the risk of ‘overloading’ members with technical information, he says. 

 

But he warns that employer expectations about take-up could be too high, citing a sponsor who was disappointed with the level of take-up from members. Take-up ranges from around 15% to about 25%, he says but that advisers sometimes suggest a 50% take-up to employers. 

 

PIEs are a very bespoke exercise, he notes, and adds: “I would say it’s a good thing to do if the employer is paying for advice and the share of the saving isn’t balanced towards the employer.” 

 

Jonathan Sharp, a partner at law firm Baker & McKenzie, agrees there has been a recent up-tick in PIEs after an initial flurry and then a drop-off. He also says that some schemes are considering these as part of GMP conversion, “as it enables the PIE to apply to a greater portion of the pension”. A PIE “will often be in the context of other discussions that are ongoing”, such as an actuarial valuation or preparations for a buy-in or buyout, he adds. A scheme can usually expect to pay a lower buyout premium following a PIE. 

 

Like Taylor Wimpey, employers sometimes offer PIEs on a rolling basis after an initial PIE, but while financial advice is generally offered as part of a one-off exercise, this is not normally the case if it is ongoing – potentially placing extra risk on trustees. 

 

Sharp says trustees need to ensure the PIE is in line with the code of practice particularly when it comes to member communications. These need to be “clear and unbiased and enable members to make a decision”, he says.  

 

“There will also need to be consideration of HMRC tax issues, and this should be considered as part of the IFA advice that’s provided,” as taking an earlier initial pension could push some members into a higher tax bracket. 

 

Vassos Vassou

Jonathan Sharp

Chantal Thompson