Liability management is a key concern for companies with definedbenefit pension schemes. A transfer incentive exercise can form a useful part of a liability management strategy. Central to a properly conducted exercise will be the role of the member IFA.
How a TIE works
Most TIEs comprise an offer by a scheme employer to members of its DB scheme of an enhanced transfer value from the scheme which is greater than the transfer value a member could request from the scheme’s trustees. Cash payments direct to a member may also sometimes form part of the offer.
The employer’s aim is to incentivise members to transfer their benefits out of the scheme, reducing the scheme’s (and ultimately the employer’s) financial and longevity risks. The cost of such an exercise will usually be lower than the alternative risk management strategy of securing benefits with an insurance company.
The regulatory view
The FSA’s conduct of business rules require IFAs to start from the basis that a transfer will not be suitable. A firm should only consider a transfer to be suitable if it can be clearly shown that it is in a person’s best interests.
The Pensions Regulator has also viewed TIEs with concern for some time. Its current guidance to scheme trustees is that they should start from the presumption that TIEs are not in most members’ interests.
It has particular concerns about direct cash incentives which it considers distort member decisions about long-term retirement planning.
Despite these warnings, taking an ETV may be the correct decision for some members. Reasons for taking an ETV comm-only include:
- A greater need for cash now rather than a guaranteed pension later in life
- Being able to secure a better benefit because of health issues or a lack of dependants
- High-net-worth individuals wishing to have greater flexibility and control over pension benefits
- A wish to remove the risk of benefits being reduced on an employer insolvency
The scheme employer will decide how to structure and communicate an ETV offer. Properly run exercises will involve the employer taking professional advice on these issues and engaging with a scheme’s trustee before putting the offer to members.
The Professional Body for Standards in Transfer Incentive Exercises recommends that IFAs who advise members on the offer are not involved in forming the offer.
Conflicts of interest
The Pensions Regulator and the FSA require IFAs to identify conflicts of interest and take steps to manage them. IFAs should consider carefully any existing links with the scheme employer or anyone else involved in forming the offer. Member communications should disclose details of these matters.
The Pensions Regulator requires any offer to be clear about how an employer has selected an IFA and its fee basis. Both it, the FSA and the Professional Body for Standards in Transfer Incentive Exercises consider fees based on the level of recommended transfers, rate of member take-up or decrease in scheme liabilities as inappropriate. IFAs should ensure that nothing compromises an accurate assessment of the individual client in line with the Cobs rules.
To advise on a TIE, IFAs’ FSA permissions must include advising on pension transfers and opt-outs. In addition, advice can only be given (or must be checked) by a pension transfer specialist who has passed certain exams required by the FSA. Advice given by a firm without permission or by a non-specialist will be a serious breach of the FSA’s rules.
IFAs need to take reasonable steps to ensure that advice on whether a transfer is suitable is based on a proper understanding of the member’s personal and financial circumstances, objectives and attitude towards investment risk. Firms should not make a recommendation where they cannot obtain the necessary information. As mentioned above, IFAs should start from the basis that a transfer is unsuitable. In deciding if a transfer is suitable, IFAs should have regard to the guidance which the FSA issued in March on establishing the risk a customer is willing and able to take and making a suitable investment selection.
To give proper advice, an IFA will need to have a proper understanding of the benefits payable to and in respect of a member which will be foregone on accepting the offer and the type and likely amount of benefits which the ETV will be able to secure. A copy of the comparison must be provided to the member.
The comparison process may be complicated in an ETV exercise where benefits are different for different members, depending on when they left active membership.
Scheme rules may include unusual and complex benefits payable in circumstances such as ill-health and redundancy. More rarely, there may be a continued salary linkage for deferred members while they remain employed by the scheme’s employer.
Additional complications may arise where different normal retirement dates apply to different periods of pen-sionable service or there are fixed commutation or increase factors. To help the smooth and efficient running of an ETV exercise, an IFA may wish to ask an employer to provide a clear description of benefits for each member on which they can rely in providing advice.
To decide whether to accept an ETV offer, a member will probably need to understand several things. This will include whether the ETV represents good value for the benefits foregone.
The FSA has issued a warning that automatically recommending a transfer based on achieving a critical yield will not meet its requirement to assess suitability.
A member may also need to consider the security for benefits under the transfer-ring and receiving scheme, including the role of the Pensions Protection Fund and the Financial Services Compensation Scheme.
Advice should explain clearly the risks of taking a transfer, in particular that the member will bear investment, longevity and annuity risks.
In addition to the stand-ards generally required by the FSA in Cobs for ensur-ing suitability and standards of advice, Chapter 19.1 of Cobs sets out specific requirements for pension transfers and opt-outs, including some relating to the comparison of transferring and receiving scheme benefits and advice on suitability.
IFAs considering advising members on an ETV offer should consider the following points:
- Identify any conflicts of interest. If there is a conflict, take steps to manage the conflict or refuse to act
- Check that you have FSA permission and proper pension transfer specialists to advise on pension transfers
- Check that you have the capacity to advise on the ETV exercise. Where a large number of individuals may require advice, there should be robust processes for dealing with peak work flow
- A proper understanding of the benefits payable to and in respect of a member which will be foregone on accepting the offer is essential. DB scheme benefits will often be different for different members and may include unusual and complex benefits payable in circumstances such as ill-health and redundancy. Consider asking the employer to provide a full and clear description of benefits for each member
- Ensure the member understands the offer and the nature and value of benefits to be given up
- Agree with the member his/her personal and financial circumstances, objectives and attitude to risk. Advice should be clear about the risks of taking a transfer, in particular that the member will bear investment, longevity and annuity risks
- The FSA requires a starting assumption that a transfer is unsuitable use plain language suitable for the general financial awareness of each individual, in a proper format to engage interest and further understanding. Members may lack knowledge of even basic investment issues
- Ensure the member has enough time to consider your advice and make a decision
- Ensure that you keep adequate records to back up any recommendation you make