Liam Mayne, Associate, corporate consulting at Barnett Waddingham
The decision to relax rules relating to the purchase of an annuity at retirement has revolutionised the defined contribution (DC) landscape. The measure has been popular with members – HMRC has estimated that since April 2015, around £9 billion of retirement savings has been accessed by over 500,000 members.
The measures do not extend directly to defined benefit (DB) members – however, it is now apparent that the second-order impact of these changes on DB schemes could be substantial indeed.
Previously, not much attention was typically paid to a member's statutory option to transfer their benefits to an alternative arrangement. Now, many non-pensioner members are exploring opportunities to transfer their final-salary benefits and avail of the flexibilities in a DC scheme.
Opportunities for sponsors – de-risking and cost reduction.
Around 60% of DB members in the UK are not yet retired – covering assets of approximately £800 billion; this highlights the potential for large transfers to occur from DB to DC in the future.
This presents opportunities for sponsors to manage the financing of DB schemes. For each member transferring, the financial obligation and associated risk is removed. This will be expected to reduce cash funding, in effect, the prudent reserve which schemes must fund for is released. In addition, it will be cheaper than securing benefits with an insurance company, which is the end game for many schemes.
For those sponsors approaching this in a pro-active manner, liability management exercises are likely to include actions such as subsidising the cost of members' financial advice. However, the upshot for these companies would be a plausible scenario of 20% to 30% of non-pensioner members aged 55 and over transferring out.
Incentive exercises – potential pitfalls
In addition to technical matters such as the relationship between the scheme's funding and transfer bases, a key component of a successful strategy includes adequate member protection. A minority of historic cases have led to some reputational damage for incentive exercises – however, such projects are now subject to a voluntary but universally-adopted code of practice supported by the industry.
It is also necessary for companies to involvei independent financial advisers (IFAs) to represent members' interests – indeed, new legislation compels companies to pay the cost of financial advice if the company is incentivising members to take a transfer.
Maximising the opportunities
Taking advantage of the pension flexibilities regime represents one of a number of tools available to companies. Ideally, it will form part of a wider strategic framework that is scheme-specific - for example, a transfer incentive exercise is unlikely to be optimal for a mature scheme with a small proportion of non-pensioners. We recommend a collaborative approach with scheme trustees. This will facilitate better understanding of any potential roadblocks e.g. quality issues with member data.
The appropriate use of IFAs presents an important line of defence for members – we recommend adequate due diligence is performed to understand processes, capacity and preferences. We believe in keeping the big picture in mind at all times - if done in a sensible way, companies can reduce costs and better control their risks.
Meeting members' needs in the longer term
The long-term success of incentive exercises will depend on protecting members from poor decision-making. The prevalence of pension scams and the tendency for individuals to underestimate their own life expectancy means there are significant risks to negotiate.
Here employers can play a leading role in providing access to financial education programmes. It is crucial this is done before individuals leave the workforce – it is much more difficult to engage after this point.
Good outcomes will require good quality advice – in a positive step, the government has recently announced an increase in the tax relief available for employer-led advice whilst also setting out plans for members to be able to fund advice from their pension pots on a tax-free basis.