Enhanced Transfer Values (“ETVs”) are becoming more and more mainstream, and are a hot topic in the DB pensions world right now.
An ETV exercise involves approaching non-retired members of a defined benefit pension scheme, and offering them a higher transfer value than that which would otherwise be available if they voluntarily requested to transfer. While each set of pension scheme trustees is empowered to choose the appropriate transfer value basis for their scheme, the vast majority have defaulted to the statutory minimum as outlined in Section 34(2) of the Pensions Act. The basis for most ETV exercises in Ireland has therefore been for employers to offer former employees (and sometimes also to current employees no longer actively accruing DB entitlements) an uplift to standard Section 34 transfer values provided the offer is accepted within a certain window.
So why do companies do this?
At a high level the benefits are clear. The company is in control of the amount of the offer and can pitch it at a level that suits their needs. Naturally this is a balancing act – offer too low an uplift and take-up rates will be low; too high and the financial savings may be too small to justify the expense of the exercise. However, given the chasm between statutory transfer values, and the liabilities held on a listed company’s balance sheet, there is ample room to offer a generous uplift and post an accounting gain all at the same time. As transfers are taken, and benefit promises extinguished, the scheme’s risk profile generally reduces.
From a member’s point of view, gaining control of the transfer value can offer flexibility, for example:
- Ability to choose when to retire
- Access to flexible income drawdown facility, for example an Approved Retirement Fund (ARF)
- Choice of pension increases
- Control over allowance for spouse / dependent benefits
Furthermore, there is no overriding legislation in Ireland which compels employers to pay contributions and make good pension scheme deficits. Members of DB pension schemes may therefore view the ETV offer as an opportunity to crystallise the value of their benefit and remove the risk of subsequent benefit reductions if the employer is unwilling or unable to fund the scheme in future.
You could be forgiven, therefore, if you concluded that companies were running little or no risk in undertaking an ETV offer exercise. On the contrary, there are a number of aspects to be managed to ensure the process runs smoothly and no issues crop up many years hence. These include:
Size and format of the enhancement: While a sponsoring employer will likely have a budget in mind to spend on enhancing transfer values, it is worth assessing what an ETV might be expected to provide on a reasonable set of assumptions. If the level of enhancement is unlikely to come close to replicating benefits, then you run the risk of either low take-up rates, or unhappy former members who return with complaints when they retire on a materially lower benefit than that given up.
Clear communication: Perhaps the most important of all project streams, the clarity of ETV communications can make or break the exercise. It is incumbent on those running the exercise (usually the sponsoring employer) to outline all of the details around the size of the enhancement, benefits being given up, and the risks of staying in DB versus transferring out to DC. However, it is equally important that the tone of the communication is not seen to imply one option is preferable to the other as it is really for each member to decide themselves.
Allowing adequate time to consider the offer: While it is reasonable for a company to put an end-date on ETV offers, it is important that members have ample time to consider the offer fully. A clear and balanced communication is likely to run to many pages, potentially with a glossary and even the pension scheme booklet attached, so it may well take several readings for the average member to grasp the whole picture. Furthermore, following acceptance of an ETV offer, there should be a cooling off period to allow the member change their mind.
Offering appropriate financial advice: There is a code of best practice in place for ETV exercises in the UK, and it suggests that financial advice should always be made available, free of charge, to those members to whom the ETV is being offered. Such a practice appears to have now been universally adopted in ETV exercises in Ireland, but that’s only the start. In determining ‘appropriate’ advice, there are a number of further considerations:
- Who will provide the advice? (as the market in Ireland is less developed in this space than in the UK)
- How is the advisor being remunerated? In order that the advice be seen as truly independent, fees should be met by the employer, be fixed or time based (rather than commission based) and be completely unaffected by the member’s acceptance or otherwise.
- Where will the advice be provided? At one end of the spectrum you might want the advisor to call to people’s homes to minimise disruption for them; at the other the member may have to travel to an advisor’s office which will suit some better than others.
- How deep will the advice go – focus on pension alone, the member’s wider income and investments, or a full independent financial review of the member (and spouse, if applicable)?
- Will the advice result in a clear recommendation (i.e. that the member should or should not transfer), or will it be a higher level education exercise, providing enough information for the member to draw their own conclusion?
Associated with this, if the advice is a clear recommendation, what should the Trustees do when a member opts to accept the ETV even when the financial advice is that they should not?
Default investment vehicle: DC pension provision is becoming the norm, and many employees are now somewhat familiar with taking responsibility for managing their own retirement account. However, in ETV exercises there are often members who have never had DC benefits and who are now assuming all of the risks with what could be their main or only source of pension savings. It is therefore important to consider a default product and strategy for them to transfer into.
The above list is not exhaustive, nor intended to caution people against running ETV exercises. Rather, it highlights some of the key pain points and shows the numerous areas to which due consideration should be given. With proper governance from the outset, an ETV exercise can be beneficial to all parties and reflect positively on the sponsoring employer. However, without adequate attention being paid to all of the potential pitfalls, it may transpire many years later that by offering ETVs, the company has done anything but reduce its risk.
Bryan O'Higgins is a Principal and Global Lead for Mercer's Pension Risk Exchange and a member of the SAI's Enterprise Risk Management Committee.
The views of this article do not necessarily reflect the views of the Society of Actuaries in Ireland, the Enterprise Risk Management Committee, or the author’s employer. The article was edited by the Communications Subgroup of the Enterprise Risk Management Committee.