Planning your best route
Regardless of the chosen endgame strategy, trustees and sponsors often have the common aim of getting there as quickly as possible and at the lowest cost. While investing in higher expected return assets may close the gap, the sun does not always shine and most schemes discount this option as being too risky. Investment strategy aside, there are a number of tools available to smooth the terrain enroute:
- The sponsor pays in more cash to reduce any deficit and accelerate the process
- 'Sit and wait' while the scheme matures (non-pensioners become pensioners) and take advantage of better pricing for pensioners
- Negotiating with the insurer/superfund for better terms
- Actively finding ways to reduce the cost of what is being secured, via member option exercises
While all of these may be possible, option 4 is seen by many as the most beneficial to all scheme stakeholders - including the members - as it offers increased flexibility and certainty over the price of insurance.
What are member options exercises?
In simple terms, they provide members with options about the way they draw their pension benefits. The ‘standard' option routinely offered to members allows them to exchange a portion of their pension at retirement for a tax-free cash lump sum. However, there are other options which can be provided to pensioner or non-pensioner members either at retirement or as part of bulk exercises. These allow members to change the format of their benefits to suit their personal circumstances more effectively.
- Pension Increase Exchange (PIE) - members exchange future pension increases for a higher initial pension with lower increases in the future
- Bridging Pension Option (BPO) - at the point of retirement, members exchange a proportion of their lifetime pension to receive a higher initial pension from the scheme, which reduces when the member reaches state pension age. From a member's perspective, they receive a 'smoother' income in retirement across the scheme and state pension.
- Transfer value - exchange pension from the scheme for a lump sum payable to another arrangement
Some options are available to deferred members whereas others are available to pensioners. These new options can be structured to lead to liability savings. For options at retirement, savings are generated over time, as and when people retire and exercise the option. In contrast, savings are generated immediately when a bulk exercise is carried out. These exercises can be more effective for schemes looking to accelerate their journey to settlement.
To maximise the impact of any such exercise, it is often better to consider implementation sooner rather than later, as the savings that can be achieved from member options reduces every year you delay implementation. For example, for every year a PIE is delayed, the savings are reduced by around 2.5 percent.
But savings are not the only benefit. Member options are also an important governance tool that should be considered by trustees. Some options which are ordinarily available in the pension scheme may not exist post-buyout or may only exist on worse terms (e.g., a transfer value pre-buyout may be higher than what the member can get from the insurer post-buyout).
When is the right time to introduce these options?
It is very important to consider how member options fit into the overall endgame strategy. We recommend discussing this at the outset to ensure any exercises (and preparatory work) are carried out in the right order, at the right time, efficiently and as planned.
If your scheme is sufficiently funded to reach buyout within the next few years, a bulk transfer and retirement exercise will be the best route to achieve immediate savings and could speed up the progression of deferreds to pensioners. However, if your endgame is further in the future, a new option at retirement will lead to lower up-front cost and allow savings to be achieved over time.
Planning your route carefully will allow a more streamlined approach by avoiding duplication of work. For example, the benefit specification for insurers can incorporate the member options at the outset, rather than requiring re-work after implementation. Additionally, and critically, it will ensure resources such as admin or IFA support are available when required.
Member options exercises are not only beneficial for members, trustees, sponsors and insurers, it can help turn the proverbial mountain into a molehill.
If you are interested in learning more on member options, our 2022 Member Options Survey has collated the views of over 300 pension schemes, focusing on the level of support available to members at retirement and the changes that schemes plan to make over the next year. Read here.
This post is funded by Aon