An industry working group has published a long-awaited Code of Practice on enhanced transfer value (ETV) exercises. The Code, entitled Incentive Exercises for Pensions, was drafted by representatives of the Association of British Insurers, the National Association of Pension Funds, pension providers, pension schemes and benefit consultants.
An ETV exercise typically involves an employer asking members of its defined benefit (DB) pension scheme to give up their defined benefits in favour of a cash transfer into a defined contribution (DC) pension arrangement. Members are offered either a larger transfer sum than they would otherwise be entitled to or a separate cash payment alongside the transfer. This is the "enhancement" offered as an incentive to agree to the employer's proposal.
Whether or not accepting a particular ETV offer is in a scheme member's interests will depend on the size of the enhancement provided, as well as the member's individual circumstances. The Pensions Minister, Steve Webb, has expressed concerns in the past that the enhancement may be insufficient in many cases to compensate for the loss of the member's valuable DB rights. It is these concerns that have led to the introduction of the Code.
As well as covering ETV exercises, the Code extends to "modification exercises". These are exercises in which members of a DB scheme are asked to accept variations to their pension rights while remaining within the DB scheme. A notable example of a modification exercise is a "pension increase exchange" exercise. This involves a member being offered an increase in the basic amount of their pension (or some other inducement) in return for giving up some or all of their rights to future pension increases.
The Code is built around 7 principles:
1. No cash incentives should be offered that are contingent on the member's decision to accept the offer. This includes "anything which has a value to the member that is not a pension benefit". This would seem to mean that the enhancement offered to members must take the form of an increase to their transfer sum rather than a side payment. Employers can, however, offer members small payments to encourage them to engage in the process; the Code gives the example of retail vouchers to the value of £100.
2. For transfer exercises, advice should be provided to the member. This entails impartial financial advice provided by an adviser who is independent from the employer and is suitably qualified, and it will include a written recommendation tailored to the member's own situation. The employer must pay for the advice, and the fee structure must not include commission or be linked to take-up rates. The requirements are less onerous for modification exercises.
3. Communications with members should be fair, clear, unbiased and straightforward. Certain specific requirements for the employer's initial communication with the members are set out.
4. Records should be retained by the various parties involved in an exercise so that an audit trail is maintained that can be examined in future. When providing advice, the member adviser should record and report on insistent customers to the other parties. An "insistent customer" is a member who chooses to act against the adviser's recommendation.
5. Exercises should allow sufficient time for members to make up their mind with no undue pressure applied. For example, members should have at least 2 weeks from receiving their final advice before they have to make a decision, and a further 2 weeks as a cooling-off period if they choose to accept an ETV.
6. Incentive exercises should only be offered to members who are over age 80 on an "opt-in" basis. Member advisers should adhere to a "vulnerable client policy" when providing advice.
7. All parties involved in an incentive exercise should ensure that they are aware of their roles and responsibilities and act in good faith in the areas over which they have direct control. This means, amongst other things, that the employer must engage with the scheme trustees and confirm to them that it intends to follow the Code. In addition, any insurance company that is providing the DC transfer vehicle should seek sufficient information to be assured that the Code has been complied with.
These principles have been publicly endorsed by a number of leading industry groups, including the Association of Consulting Actuaries, the Society of Pension Consultants and the CBI.
The Code does not have any legal force in itself, but it has been confirmed that the Pensions Ombudsman will have regard to its provisions when considering complaints about ETV exercises. In addition, both the Pensions Regulator and the FSA have endorsed the principles in the Code. The Regulator will be drawing on the Code when it publishes its own updated guidance on ETV exercises.
Clyde & Co Comment
The publication of the Code puts an end to a period of uncertainty regarding the future of ETV exercises. There has been some speculation in the industry that the Code will reduce the number of ETV exercises and we suspect that will be the case longer term. However, it is understood that a number of planned exercises have been suspended pending the publication of the Code, so the coming months may see an increase in ETV activity in the short term. The Government has been warning in particular about cash incentives for some time and we suspect they are already rarely used.
While the Code is in principle a voluntary document, Steve Webb is taking a very robust line on compliance, stating: "This new code of practice must be adopted as the standard for all transfer exercises in the future, without exception." Future legislation in this area has not been ruled out.
It should be noted that compliance with the spirit as well as the letter of the Code is expected: "The authors of the Code do not expect employers, trustees or their advisers to look for creative ways to work around the Code."
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