(October 15, 2013) — Concerns are rising about a controversial piece of pension legislation which is leading to undue pressure being put on actuaries to sign off on compulsory pension increase exchanges (PIEs).
PIEs started to gain traction in 2009 as a way of simplifying benefits. They work by replacing the existing pension arrangements, including any underpins for inflation increases, with an alternative arrangement.
The exercises were particularly popular with employers who had acquired multiple pension schemes with different benefits structures as a way of simplifying their benefits package across the whole of the work force.
A secondary benefit was to make it easier for insurers to price their pension book for a buyout or a buy-in, and it is this particular advantage that employers are now pushing actuaries to consider compulsory PIEs for.
Several actuaries from different companies have told aiCIO they are concerned about how Section 67 of the Pensions Act is being used by employers. Under the legislation, employers can make PIEs compulsory for their pension beneficiaries, provided an actuary signs off to say that the deal is “fair value”.
In 2010, the Department for Work and Pensions (DWP) after pensions minister Steve Webb announced he would be cracking down on cash-enhanced transfer valuations and other exercises to encourage members to leave their existing pension arrangement for another workplace pension. PIEs also came under the industry spotlight.
Then, as now, there are concerns about whether the member is getting the best deal. The biggest problem revolves around how to calculate what a “fair value” deal is, according to several actuaries aiCIO spoke to.
There are no standardised calculations for defining a fair value deal, as Hugh Nolan, a regional director at JLT Employee Benefits, explained.
“It’s difficult to standardise “fair value” as there are several options for calculating it. Some look at the buyout costs, others look at the lowest common denominator or transfer values without any guarantees, but there’s little consensus between actuaries,” he said.
“There is an accepted wisdom in the Incentive Code that says you should use the transfer value basis, and that as long as it’s more than 100% of the scheme value you don’t need to offer financial advice.”
Richard Murphy, partner at actuary LCP, told aiCIO he had been involved with a compulsory PIE, although he stressed he did so without undue pressure from his client employer.
In that instance, the trustees and the company sought to simplify pension increases across the board. It wasn’t about saving the employer any money, but about preparing the pension scheme for a buyout.
“I can see how people would be put under pressure from sponsors,” he said. “The key thing for the client is it has to be a ‘fair value’ PIE for the actuary to sign off on it.
“With some schemes a compulsory PIE can be helpful, for example, where there have been takeovers or acquisitions, and there are underpins on individual members’ benefits, some of which have underpins on underpins—those underpins can make it difficult to move towards a buyout.”
In Murphy’s case, the trustees found it difficult to agree to a compulsory PIE, so they decided to give their members the option to convert back to the old system, which some of them did.
There is another example where compulsory PIEs could be an effective tool, Murphy continued: guaranteed minimum pensions (GMP) equalisation.
Legislation to be introduced next year will require pension funds to equalise any unfair improvements members may receive to their benefits derived from their sex.
Administratively, updating pension funds to reflect this change will be extremely challenging. Murphy believes the simpler answer would be for compulsory PIEs to be adopted, and for DWP to publicly support their use for this purpose.
“I understand there is a lot going on in the background at DWP, particularly as it hadn’t realised that to convert GMPs was so painful,” he said.
“There is a stigma around PIEs, although now there is a code of practice with a path people can go through which gives a choice over whether they keep existing benefits or choose the PIE.”
But there would still need to be something done to deal with any undue pressure from the employer, Murphy concluded, as well as more definite terms on how to calculate “fair value”.
Patrick Bloomfield, partner at Hymans Robertson, also warned that no matter how well-intentioned compulsory PIEs and Section 67 as a method of simplifying benefits may be, they would be judged in hindsight.
“Offsetting GMP equalisation with compulsory PIEs and Section 67 carries substantial risks that two wrongs won’t make a right for members,” he warned.
“In my experience, trustees want to comply with the law and sponsors want to deal with the funding consequences with as little cost and interruption as possible. Nobody is happy about the impending mess of GMP equalisation, but we need to find ways of dealing with it as pragmatically and cost effectively as possible.”
In response to an aiCIO request, DWP said that it was worth remembering that for PIEs, only non-statutory indexation can be exchanged for a higher starting pension.
It added that it would not be appropriate for DWP to prescribe further rules on actuarial equivalence or fair value as “it is for the scheme sponsor to agree with the trustees, supported as necessary by the actuary”.
The spokesman added: “DWP is working with stakeholders to develop GMP conversion guidance, including guidance in respect of equalisation for the effect of the GMP. The issues being considered are complex, and we continue to work towards a resolution.”