Alan Collins, head of corporate advisory services at Spence & Partners, highlights what impact the code of practice will have
June 2012 saw final publication of a government-led code of practice on pension scheme incentive exercises (where members of defined benefit schemes are given rewards for giving up future pension rights).
There had been some initial consideration within the working group, made up of some formidable names within the UK industry, that they might ban the practice of encouraging members to opt out of their pension scheme. This prospect would have given rise to more than a few chills among those companies who see incentivise exercises as an effective means of managing their pension schemes. Fortunately for them, no such arbitrary measures were taken.
The new guidelines – all of which are voluntary but leave open the possibility of full-on regulation being implemented if the code is not complied with – allow employers to continue offering incentives to the members of their company pension scheme. However, with the publication of the code of practice, the government will feel it has made progress in tightening up one aspect of the current pensions market which was potentially open to abuse – cash incentives.
The element most of interest to the IFA community is the requirement for proposed incentives to be to be accompanied with appropriate regulated and qualified independent financial advice, paid for by the employer.
What do the guidelines entail?
Firstly, no cash incentives (so-called plasma TV offers) should be offered to any members as a means of enticing them to transfer out of their pension scheme. In my own experience, as an adviser on a number of these exercises, most firms tend to recognise the skewed nature of any offer involving cash and very few were comfortable to participate in such exercises.
The use of cash incentives was the major bone of contention for government and oversight bodies. They also presented a big risk to advisers – the use of cash incentives made it much more likely that a member could raise a complaint in future that they were mis-sold on the transfer.
Reducing adviser risk
So the removal of the cash incentive will actually reduce the risk associated with the exercises for advisers and employers. In early incentive exercises, the cash sum was provided free of tax and National Insurance. Once this loophole was closed by HM Revenue & Customs (HMRC), such incentives were significantly less attractive in any case.
As mentioned earlier, advice should also be provided to members on transfer exercises. The same situation applies in getting advice on exchange exercises unless a value requirement is met by the employers. Members should also be given time to consider offers and pressure should not be applied to them in the process of getting them to accept offers.
Bosses need to be realistic
Employers must be realistic about what they can achieve from an incentive exercise which will only generate saving versus the ultimate cost of buyout. If a company is simply wishing to reduce their ongoing funding deficit, they should not proceed.
Indeed, transfer exercises will likely lead to a charge to company profits. However, these exercises will reduce the risk profile of a scheme as a reduction in liabilities makes it less sensitive to changes in future market conditions.
Funding transfer exercises also tends to require a relatively substantial amount of cash. Where this is not feasible, other exercises may be preferable, such as pension increase exchanges or offering early retirement to members.
For these reasons, I don’t see the code as changing the parameters in which we’ve operated in recent years. These exercises continue to be a legitimate tool in the managing of pension risks – for most companies considering a buyout strategy, it is likely that liability management will form part of the strategy.
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