Incentive Code applies to commutation exercises

The Incentive Exercises Monitoring Board has confirmed that the Code of Good Practice on incentive exercises applies to one-off trivial and small pension commutation exercises.

19 January 2015

In 2012, the pensions industry responded to concerns about poor practices being adopted in pension incentive exercises by issuing a Code of Practice for Incentive Exercises (“the Code”). See here for more details.

The Incentive Exercises Monitoring Board (“the Board”) has recently issued guidance confirming that the Code does apply to one-off trivial and small pension commutation exercises.

These commutation exercises would be incentive exercises (and  therefore within the scope of the Code) if the “offer” to members meets the following test:

  • one objective of providing the offer is to reduce risk or cost for the pension scheme or sponsor(s); and
  • the offer is not ordinarily available to members of the pension scheme.

One-off commutation exercises would generally be expected to meet the above test and therefore come within the scope of the Code. Although compliance with the Code is voluntary, the Board expects all incentive exercises to follow the spirit and principles of the Code.

The Board’s view is that one-off trivial and small pension commutation exercises should be treated as “Modification” exercises under the Code. The consequences of this are that the party making the offer should:

  • provide “Guidance” to members, provided that the deal is a 100% (or more) “Balanced Deal”; and
  • comply with the Code’s requirements on Vulnerable Customers.

If the Balanced Deal percentage is less than 100%, “Advice” should be provided (instead of “Guidance”).

Where trustees initiate a commutation exercise, as opposed to the employer, this would not affect whether or not the Code applies. However, winding-up lump sums are generally expected to be outside the scope of the Code. Also, where trustees regularly carry out commutation exercises as part of the normal course of scheme business (i.e. not on a one-off basis) this may, depending on the circumstances, also be outside the scope of the Code, although trustees should consider following the Code’s principles as a matter of good practice.

Finally, the Board recognises that the 2014 Budget announcements will have a significant impact on incentive exercises and they are planning to carry out a major review of the Code once the policy, legislation and market positions are clearer. We will keep you updated on this process when further information is available.

If you are considering, or in the process of, completing a commutation exercise, you should speak to your usual Shepherd and Wedderburn contact to discuss how this development may affect you.