When it comes to endgame planning, many schemes focus on an insurance buyout as a means of insuring members' core accrued benefits.
But, in reality, some benefits are likely to need simplification or adjustment to make them insurable and allow an insurance transaction to take place. This is perhaps most noticeable when it comes to benefit options at retirement. Many schemes have added a range of member options to give their members flexibility and the chance to reshape their pension into one that better fits their personal financial needs. However, insurers typically prefer standardised, streamlined administration, and are highly unlikely to continue to offer members these choices after transaction. Some large schemes may have the leverage to agree that member options continue to be offered but, for many, the benefit will cease once the scheme is insured. For those members, who would otherwise benefit from taking up these options, the impact on their retirement can be considerable.
Our data suggests around 30 percent of schemes currently offer options or support at retirement that is typically not available after buyout. So, what other strategies to improve outcomes for members should schemes be considering as part of their endgame planning?
Simply running on for a period can give members the opportunity to benefit from member options. One approach which offers the opportunity to go further and provide additional benefits is ‘Active' run-on. Active run-on strategies deliberately aim to build up a material surplus in the scheme. For example, Aon's ASTRO framework aims to generate 20-30 percent surplus over time. The expectation is that much of this surplus will be available to the scheme sponsor. However, a material surplus can allow additional member benefits to be funded, such as discretionary pension increases, or benefit uplifts at the point of a future buyout. For example, sharing one-third of the surplus generated under ASTRO would allow members to receive pensions around 10 percent higher on average than their guaranteed benefits. This can be a win-win for all, as the prospect of future surplus can encourage the employer to consider additional discretionary benefits, even where those might not have been favoured in the past.
Below, Aon's Gerard McKenna shares insights to the benefits that a well-constructed run-on strategy can offer members, bringing choice and potentially significantly better retirement outcomes as a result.
Pension Increase Exchange (PIE)
PIE offers current pensioners and dependants an opportunity to exchange some (or all) of their future annual pension increases (typically linked to inflation) for a larger one-off immediate increase in pension and lower (or no) pension increases in the future. These are not currently favoured by insurers, especially for schemes that are not considered large, (£1 Billion+).
Bridging Pension Option (BPO)
A BPO supports members who wish to retire ahead of their State Pension Age (SPA) by smoothing their income so that their total income (from the scheme and the state) is broadly equal before and after their SPA. Without a BPO in place, a member is likely to experience a significant increase in their total annual income at SPA and may not be able to afford to retire before this. Once you have transacted with an insurer, it is extremely unlikely that members will be able to elect for a BPO.
Retaining access to support
It's not just the availability of options that is potentially reduced post buyout. Insurers are also unlikely to offer improved member support going forward, such as fully paid-for IFA advice. This form of support is greatly valued by members to enable them to make informed retirement decisions.
Better option terms?
The relative value of options to members broadly depends on the factors used to calculate the option terms. For example, with cash commutation (where members give up part of their pension payable from retirement in exchange for an up-front lump sum), a higher factor will leave members with the potential for both more tax-free cash and a higher residual pension after taking a pension commencement lump sum. Better transfer terms lead directly to higher payments to members when they transfer.
Transfer values are typically lower in an insurance regime, reflecting the greater return seeking investment strategies employed by an insurance company relative to the typical pension scheme in run-on.
For similar reasons, cash commutation terms could also be less generous for members. This could be more impactful on members' benefits because commutation is such a popular option within schemes.
Wider discretionary benefits
As outlined above, discretionary pension increase can be a very immediate and valuable benefit for members if exercised. However, many schemes have a much broader range of discretions available to members, for example in relation to early retirement terms (in both normal and ill-health), payment of dependants' pensions and sometimes simply long-standing administration practices that are not documented in the rules. These discretions often will not apply to all members, but codifying them, or even removing them, in order to enable insurance can have a real impact for some individuals.
Multiple benefits
Running schemes on can have multiple benefits for scheme members as well as the sponsoring employer. Active run-on should therefore be considered as part of robust endgame planning.
In situations where members benefits are not at risk and active run-on can be implemented with confidence, the impact on benefits may become a factor when choosing an endgame that is in members' best interests. If you would like to discuss the opportunities for your scheme to run-on in greater detail, then please do get in touch. More detail about Aon's ASTRO framework can be found here.
More detail about navigating the options for supporting members can be found in our AIMS framework here.
