Managing Liabilities

Traditionally, sponsors and trustees have concentrated on de-risking the scheme investments and given little thought to the bigger problem of the liabilities. Contributions continue to be paid and the scheme continues to grow, thereby increasing the risks. JLT’s approach is to consider both assets and liabilities in an integrated way. Rather than pay contributions to increase the assets, our solutions use these contributions to reduce the liabilities, risk and future cash requirements.

By reducing the liabilities in your Defined Benefit pension scheme, you can reduce the inherent risks of the scheme, improve its funding position, offer your scheme members greater flexibility and improve the security for those who remain.

Communication and financial advice play a crucial role in any member option exercise. Your communications need to be clear, transparent and unbiased and enable your members to make an informed decision that is right for them. You and your Trustees need to be aware of your responsibilities to your members and should appoint a financial adviser (independent of you and your Trustees) to provide advice to your members about their options.

We will provide advice, guidance and assistance to you and your Trustees. If you agree they are the right option for you and your members, member option exercises could form an integral part of your endgame strategy.

We are structured to support you and your Trustees in a way that helps manage potential conflicts of interest and maximises the outcome in terms of your joint strategy for your scheme.

Click on one of the tabs below to find out more about the options available to you.

WHAT WE DO

  • Enhanced Transfer Value
  • Pension Increase Exchange
  • Flexibility at Retirement
  • Trivial commutation
  • What is an Enhanced Transfer Value (ETV)?

    Members of your pension scheme can already elect to transfer the value of their benefits out of your scheme and into another arrangement. An enhanced transfer value involves your offering an incentive, in the form of a transfer value higher than would be available to your members, as part of a bulk exercise.

    The introduction of ‘Freedom and Choice’ in 2015 gave members of Defined Contribution (DC) schemes far greater flexibility in how they receive their benefits at retirement. The members of your Defined Benefit (DB) pension scheme do not have access to those same options. So, in addition to having the potential to provide you with a cost-effective means of reducing the risk in your scheme and potentially improving its funding position, it could also give your members greater flexibility and choice.

    Why would a member accept an ETV?

    • Access to pensions freedom flexibilities
    • Possibility of a higher initial pension
    • A potentially larger tax-free cash sum
    • Chance of improved death benefits
    • Security of benefits
    • Consolidation of legacy pension benefits.

    Why might a member not accept an ETV?

    • Does not want or need additional flexibility
    • Can’t secure a higher initial pension than scheme pension
    • Prefers security of pension backed by sponsor
    • Only has one pension fund so will not gain by consolidation
    • Terms offered by insurer are not attractive
    • Not comfortable taking risks.

    Design

    The level of enhancement is crucial for any ETV exercise to ensure it is cost effective for you and of value to your scheme members.

  • What is a Pension Increase Exchange (PIE)?

    Pension legislation sets out the minimum levels of pension increases that your Defined Benefit (DB) pension scheme must provide. However, if, like many schemes, you provide increases above these minimum levels, a PIE, exercise may form part of your endgame strategy.

    Under PIE, your members may elect not to receive any non-statutory pension increases in exchange for a higher level pension.

    The graph illustrates a PIE offer that could be made to a pensioner in a scheme with increases on the initial pension in line with inflation.

    What is a Pension Increase Exchange

    Why would you offer a PIE?

    • Balance Sheet gain
    • Profit and Loss gain
    • No incentive payment needed
    • Lower buyout costs
    • Reduced deficit

    Why would your trustees offer a PIE?

    • Choice for members
    • Increased member satisfaction
    • Reduce lifetime of scheme
    • Lower liabilities
    • Reduced risk

    Design

    In the chart above an increase to the Year 1 pension of around 40% is offered in exchange for the member’s future pension increases. In practice, the actual increase would depend on your scheme’s pension increases and the structure of the offer agreed between you and your Trustees.

    Timescale

    A typical PIE exercise can be implemented in 3-6 months, depending on the quality of the scheme’s data and the speed of the decision-making between the company and Trustees.

  • What is Flexibility at Retirement (FaR)?

    If the strategy is right, your endgame strategy can add choice and value for your scheme members along the way.

    Not all your scheme members will want an increasing pension together with a spouse’s pension payable on death. However, Defined Benefit (DB) schemes are very inflexible in the benefit provision they offer members. Meanwhile, members of Defined Contribution (DC) schemes have greater flexibility in how they take their retirement income.

    Since the introduction of ‘freedom and choice’ in 2015, FaR exercises have gained significant traction. DB pension scheme members aged 55 or over are given the option of accessing the full range of flexibilities available to DC scheme members. This gives members a real choice in the shape of their retirement income.

    Figure 1: Potential benefit from a FaR option

     

    Initial pension (pa)

    Tax-free cash

    Pension Increases
    Scheme pension £4,600 £31,000 RPI max 5%

    Alternative options

         
    Normal health £7,100 £47,000 Nil
    Smoker/impairment £8,200 £47,000 Nil
        Tax-free cash Taxable cash
    Cash/Drawdown option Nil £47,000 £142,000
    NOTES: The table in Figure 1 shows how a typical member of a typical scheme might benefit from a FaR option. The figures assume that the member chooses to buy an annuity that provides a contingent spouse’s pension equal to half the member’s pension, as would be provided by the scheme (although, in the case of the scheme pension, a spouse’s pension is based on the pre-commutation pension).

    How does it work?

    Members are provided with a statement of their scheme pension options as well as a transfer value quotation, which may be enhanced (see Enhanced Transfer Values), and illustrations of the benefits they could secure if they were to take the transfer offered and immediately retire.

    Along with the statement of options, members are offered the chance to receive financial advice, at no cost to them, to decide whether a transfer or early scheme retirement is right for them.

    Why would a member choose FaR?

    • Provides access to pensions freedom flexibilities
    • Possibility of a higher initial pension
    • Potentially a larger tax-free cash sum
    • Chance of improved death benefits
    • Security of benefits
    • Consolidation of legacy pension benefits

    Why would you and your Trustees offer FaR?

    • Security of benefits
    • Post-retirement scheme risk reduced
    • Offers members more choice
    • Increased member satisfaction
    • Scheme deficit reduces
    • Scheme liability reduces
    • Reduction in the lifetime of the scheme
    • Company sees real benefit from contributions paid

    Design

    The design of the offer is crucial to the potential success of any Flexibility at Retirement exercise. You will need to consider whether or not an enhancement should be provided to the Scheme transfer value to improve the take up rate.

    Example Exercises

    The table below illustrates results of three FaR exercises we have managed and demonstrates that the exercises can be appropriate for schemes of all sizes.

     

    Example 1

    Example 2

    Example 3
    Number of members in scope for exercise 1,004 28 42
    Total transfer values for members in scope £126m £6.4m £3.7m
    Percentage of members who sought financial advice 61% 86% 79%
    Total transfer values paid out £25m £1.8m £1.8m
    Percentage take-up rate 20% 28% 48%
    Saving against current buyout deficit £24.9m £0.7m £1.1m
  • What is trivial commutation?

    The costs of administering small pension payments can be disproportionately high. Subject to eligibility criteria being met, if a member’s benefit has a value of less than £30,000, Defined Benefit (DB) pension schemes can commute it into a one-off lump sum.

    So, if the liabilities in your DB pension scheme include a large number of small pensions payable to members who are aged 55 or over, a bulk trivial commutation exercise may form part of your end game strategy.

    What are the benefits of a trivial commutation exercise?

    • Reduces scheme liabilities
    • Reduces ongoing administration costs
    • No incentive payment needed
    • Balance sheet gain
    • Profit and Loss gain.

    Design

    The design and implementation of a trivial commutation exercise, including how the lump sums are calculated, is crucial to its success. You will also need to ensure any exercise complies with the Incentive Code of Practice for member options.

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