Simmons & Simmons partner Monica Ma introduces this month's legal panel
The Pensions Regulator has issued draft guidance on employer-instigated transfer incentive and other benefit modification exercises, for consultation. These exercises, whereby employers seeking to remove or limit their defined benefit scheme’s liabilities using financial incentives to persuade the members to transfer out or agree to modification of their benefits (e.g. giving up non-statutory pension increases), have become increasingly frequent.
The draft guidance follows concerns expressed by the regulator that members may be misled in the process – trustees should therefore start with the presumption that such exercises are not in members’ interests. The guidance is not, however, intended to apply to schemes closing for future accrual.
The consultation document states that any incentive offer from an employer should adhere to five key principles, ensuring the highest standard of fairness, transparency and ensuring active and full trustee involvement.
The principles are, broadly: to be clear, fair and not misleading so that members understand the implications and make the right decisions for them; to be open and transparent so that all parties involved are made aware of the reasons for the exercise and the interests of the other parties; to identify and manage any conflicts of interest; to consult and engage trustees right from the start of the process; and to ensure that fully independent and impartial advice is made available to members.
Monica Ma (Simmons & Simmons): The regulator particularly warns that cash incentives are suspect as they distort the members’ decision-making process. What circumstances and in what form are financial inducements more likely to be acceptable?
Lucy Dunbar (Sackers): Non-cash incentives could be enhanced transfer values or, in the case of pensioner members, provide a greater starting value of pension (in return for giving up non-statutory increases, for example).
Assuming the guidance is adopted, any incentive exercise may only be acceptable if personal illustrations are given to each member, comparing the value of the benefits the member is asked to give up with the value of the incentive and the replacement cost of securing equivalent benefits with an insurance company. The financial information must be presented in a clear and comprehensive manner, so that members can make a free and fully informed choice. The draft guidance sets out a process it expects employers to follow in order to achieve transparency and fairness.
Vicky Massarano (DLA Piper): As long as the member is offered the full cash equivalent transfer value of his benefits for payment to another scheme, there is no particular reason why any additional amount should not be offered as cash. Clearly, this is an inducement to transfer and it is essential that the member has access to independent financial advice, but if that is taken then it is for the member ultimately to decide whether he wishes to take up the offer. Transferring may be the best option for some members, allowing them greater control over their investment than would otherwise be the case, or allowing them to change the form of their benefits, for example, if they are a single person who does not require dependants’ benefits.
Despite the existence of the PPF and The Pensions Regulator, there are still risks for a member in saving through a defined benefit occupational scheme and consequently it seems draconian to start from the presumption that a transfer offer is not in members’ interests or that a cash element is inappropriate.
Monica Ma: Is the requirement for very strong openness, transparency and trustee consultation from the start of the process something that in practice may jeopardise the confidentiality of corporate planning from a stage earlier than would otherwise be the case, and would it lead to a greater potential for conflict of interest on the part of either the company or the trustees?
Lucy Dunbar: In practice, employers will need to engage with the trustees at an early stage, to obtain member data and assess the viability of the exercise. Employers should consider putting in place confidentiality agreements with trustees, enabling the employer and trustees to work together from the start, without risking early disclosure to members of plans that may never come to fruition.
With the regulator being clear that trustees should assume any incentive exercise is not in members’ best interests, any trustee who is involved on the employer’s side of the exercise is highly likely to be conflicted. Such conflicts should be dealt with in line with the scheme’s conflicts of interest policy, perhaps with any conflicted trustee abstaining from further involvement.
Vicky Massarano: Conflicts of interest need to be dealt with, but few trustees can be under any illusions as to an employer’s motivations for such an exercise. Many employers will conduct a feasibility study before an ETV exercise, which requires information held by the trustees, so trustees could expect to be involved at an early stage anyway. If the employer is providing an appropriate proposal with risks spelt out, the scope for conflicts will be limited.
Monica Ma: The draft guidance emphasises the importance of the members receiving independent financial advice. A joint statement with the Financial Services Authority stresses the importance of the adviser obtaining sufficient information from the member as is necessary to be able to understand the member’s personal and financial circumstances.
If the employer has any concerns about the scheme members’ ability to understand the structure and implications of the offer, then the onus is on it to pay for the independent financial advice and require that members take advantage of it before making a decision. How can the employer best comply with these requirements in a scheme that has a very broad social and educational spread of membership, given any possible data protection restrictions, and how should it deal with any members who refuse to take advice?
Lucy Dunbar: Employers could consider retaining IFAs from a range of firms, so that the advice, and the advisers, are impartial. It remains to be seen whether the IFA market has the capacity to provide such advice on a large scale.
To avoid any conflicts, advisors should be paid a flat fee, irrespective of take-up of the offer. Employers should consider facilitating IFA access at the workplace – telephone lines, individual IFA appointments and member briefing sessions could all be appropriate depending on the particular circumstances.
The key for employers is to promote and encourage the availability of IFAs and clearly document this in all communications. Wording should be included in any consent forms to confirm that access to independent financial advice has been made available and that members have considered taking that advice when giving their consent.
Vicky Massarano: The employer should meet all the costs of the exercise, including the provision of independent financial advice. Individual members may wish to consult another adviser so the employer could consider meeting costs up to a certain level to avoid any suggestion of bias in an adviser appointed by him.
Really it is for the adviser to ensure he presents his advice to the member in a form the member understands. If a member refuses advice, the employer and trustees should get written confirmation from the member that he does not wish to take advice despite it being available to him and that he understands the implications of his decision.
Monica Ma: If the draft guidance is implemented in its current form, employers are likely to find it more difficult to manage their scheme liabilities by way of incentives, and there is likely to be an additional cost burden of compliance. What will employers and trustees need to consider and what procedures can they put into place to mitigate costs for the future?
Lucy Dunbar: Some argue that employers should always have been taking the steps set out in the draft guidance when carrying out incentive exercises. On this view, the new guidance itself may not increase the cost burden.
An incentive exercise may still be worthwhile despite the cost if the aim is to reduce investment and longevity risks. Otherwise, employers may need to consider other ways of controlling these risks, for example via investment hedging arrangements, or proceeding to buyout.
A word of warning here though. If the proposals to abolish DC contracting-out are implemented, members may not be able in the future to transfer any contracted-out DB benefits to DC schemes. This may well remove the incentive option from the table for many employers.
Vicky Massarano: Employers have to factor in the costs when deciding whether to carry out an incentive exercise. Costs will be significant in a well-run exercise and the regulator’s guidance does not change that. There is a danger, however, that the regulator’s apparent aversion to such exercises may not result in it achieving its aim of protecting members’ benefits. In schemes still open to accrual, employers may seek to limit their liability by increasing member contributions or reducing accrual, and in some schemes it may become questionable as to whether members are getting value for money but without the same requirements for independent advice as on an ETV exercise.
