Alan Howard of Aon Hewitt discusses incentive exercises
Incentive exercises such as enhanced transfer values seem to provoke extreme reactions - earlier this month the government suggested they might even be outlawed.
There is no doubt they have gained a bad reputation and it seems to have become commonly believed that if the employer is encouraging this kind of offer, it must be solely in their best interests and against the members'. But, while that view is fundamentally flawed and simply not true, we believe updated and legally enforced guidance may be necessary to restore their reputation.
A well-run exercise can benefit both the member and the sponsoring employer. We completely agree that the offer may not be suitable for all members - but it doesn't need to be. It only needs to be beneficial for some members and their individual circumstances for it to be a valuable option.
There are many well-documented reasons why certain members might benefit from an ETV exercise - those in poor health, those who are single and those worried about the security of the scheme. However, there is a more basic reason - the member simply might be prepared to accept more investment risk in order to boost their retirement savings.
The difference in risk appetite explains how these offers can benefit all parties rather than there needing to be a loser.
Deficits continue and there is no doubt that defined benefit schemes are in decline. With that background and with successive bouts of legislation that have effectively ‘forced' them to de-risk, companies are in real need of pensions liability management options. When implemented properly, ETVs provide an affordable way to help this process. Just banning them makes no sense, especially when they are providing members with more than the legal minimum.
However, it is clear these exercises have been subject to abuse, and we completely agree with the government that there is a need to root out and eliminate bad practices. No-one should be allowed to design offers that mislead or pressurise members. Financial advice is clearly important and it helps members to understand the terms of such offers. But that advice needs to follow Financial Services Authority guidance - and that guidance is now out of date.
Aon Hewitt is working to set industry standards and has suggested areas to the FSA where its handbook needs to be updated, tightening up the advice process and reflecting changing market conditions and practices - making it fit for purpose.
The new guidance needs to cover both ETVs and all types of incentive exercises - including pension increase exchanges, total PIE and flexible drawdown - otherwise those providing the unscrupulous offers will simply change their focus.
Increased policing of these exercises is an obvious solution but given the spending cuts, it is unlikely that regulators will have adequate resources to do that.
However, just banning incentive exercises is not the answer as it will put yet another constraint on both employers and members, and would remove an option that can benefit all parties. Therefore, we believe it should be a legal requirement to follow the updated guidance.
For the majority of incentive exercises, the guidance should require members to offer fully independent financial advice - paid for by the employer - so they can make informed decisions. This is vital - it ensures members are not misled or mis-sold while allowing scheme sponsors to retain the flexibility to deal with one of their most pressing issues.
This week’s top stories include Prudential Retirement urging schemes to insure member benefits, and the Universities Superannuation Scheme submitting its 2018 valuation.
Legal and General (L&G) Retail Retirement has agreed an introducer agreement within its retirement income division to provide annuities to Prudential customers with guaranteed rates.
Incisive Media, the parent company of Professional Pensions, has launched the inaugural Women in Investment Festival.
This week's edition of Professional Pensions is out now.
Nick Greenwood – the former manager of the £2.2bn Berkshire Pension Fund – died earlier this month.