The pensions industry has responded to concerns about poor practices being adopted in pension incentive exercises by issuing a Code of Good Practice. This voluntary code recognises that incentive exercises can remain a valid option for some members but seeks to improve the standard of such exercises to help ensure that members can make informed decisions and better choices.
As defined benefit pension liabilities have continued to rise, many employers have sought to manage their liabilities by undertaking exercises which offer members incentives to give up or reduce their defined benefit pension rights. These incentive exercises generally fall under one of two categories:
- Transfer exercises: where members are offered incentives to transfer out of a defined benefit scheme to a defined contribution arrangement (often through payment of an enhanced transfer value); or
- Modification exercises: where members are offered incentives to reduce their defined benefits (for example by giving up non-statutory pension increases under a pension increase exchange exercise).
Despite the fact that these exercises were already covered by guidance issued by the Pensions Regulator, there was increasing evidence that members were being inappropriately pressured into accepting incentive offers.
The fear that incentive exercises would become the next ‘pension scandal’ led to increased regulatory scrutiny. The FSA recently published new guidance on the assumptions to be used by financial advisers in pension transfer value analyses (which generally means that it is less likely that an adviser will be able to recommend a transfer exercise) and Steve Webb, the Pensions Minister, asked the pensions industry to draw up a code of good practice.
The new code of practice
A Working Group, including representatives from the National Association of Pension Funds, the Association of British Insurers, the Society of Pension Consultants and the Department of Work and Pensions, published the new voluntary code of practice on 8 June 2012.
The new code sets out seven principles which parties undertaking incentive exercises should follow:
- No cash incentives: cash payments that are contingent on the member’s decision to accept the offer are specifically prohibited under the new code. Small payments to encourage members to engage with the process (for example a £100 gift voucher) are permitted provided it is made clear that members are under no pressure to accept the offer.
- Independent advice: independent financial advice must be provided to members. For modification exercises a value requirement can be provided as an alternative – broadly a ‘balanced deal calculation’ must be made and should show that the present value of the additional benefits granted is at least equal to the present value of the benefits being given up.
- Communications: communications with members must be fair, clear, unbiased and straightforward. The initial offer should, amongst other things, explain the reasons why the employer is making the offer and warn members about the potential downsides of accepting the offer.
- Record-keeping: the parties should keep adequate records of incentive offers made to members and members’ responses. Financial advisers should also report when a member chooses to accept an offer contrary to advice.
- No undue pressure: members should have sufficient time to make up their minds about an offer without undue pressure being applied. In particular, they should be provided with at least three months to make a decision and also be given a two week cooling-off period after returning option forms.
- Vulnerable members: incentive exercises should only be offered to members who are over age 80 on an “opt-in” basis and the vulnerable client policy should be followed.
- Good faith requirement: all parties should be aware of their roles and responsibilities and should act in good faith.
Many of the principles outlined in the new code should have already been complied with however there are certain requirements which will have a noticeable impact on current practice. In particular, many incentive exercises have historically included some form of cash incentive and the ban on offering cash payments is likely to reduce the number of members willing to accept incentive offers, and will perhaps ultimately dissuade employers from carrying out these exercises. In addition, whilst independent financial advice has generally been offered as part of enhanced transfer value offers, this has been less common with pension increase exchange exercises. Going forward, the cost of providing independent advice or a value requirement will need to be factored into any decision to make an offer.
Status of new code
Whilst the new code is voluntary, the Government has not ruled out future legislation if it feels that the spirit and principles of the code are not being followed. In addition, whilst the code will not have strict legal effect, the Pensions Ombudsman and the Financial Ombudsman Service will have regard to the code when dealing with any complaints involving an incentive exercise.
The Pensions Regulator has also welcomed the development of the code and stated that it intends to publish new guidance that will rationalise its current publication with the code. It is expected that the new guidance will be issued in the near future and we will update you once this has been released.