Code finally published on pension incentive exercises

In recent years, due to the rising costs commonly associated with running a defined benefit pension scheme, employers have taken various steps to attempt to reduce those costs. One way in which they have done this is by the use of incentive exercises in which members are given inducements to transfer out or give up certain benefits in exchange for an alternative benefit. The most common methods have been so called enhanced transfer value exercises where members are offered an incentive to transfer their benefits out of a defined benefit scheme into an alternative pension arrangement and pension increase exchange exercises where members are given an incentive in exchange for giving up an entitlement to future non statutory pension increases.

Concern has been expressed by certain sections of the pensions industry that such exercises can have a detrimental effect on members because whilst such incentive offers may be initially ostensibly attractive to members, m may actually be giving up generous defined benefit pension benefits in exchange for what will amount to a less generous pension in the future. In particular, Steve Webb MP, the pensions minister, has been highly critical of such exercises and his concerns led to the setting up of a pension industry wide group to draw up a code of practice for incentive exercises. The minister had floated the idea of legislating to regulate incentive exercises but decided against this (for the time being at least).

The Incentivised Transfers Working Group has now published its code of practice which applies with immediate effect to incentive offers first made on or after 8 June 2012. Incentive exercises which were underway prior to this date are not expressly covered by the code but it states that employers who are running an incentive exercise which began prior to this date should have regard to the code in their dealings with members (according to the stage that their incentive exercise is at). Whilst the code is not strictly legally binding, it sets out the best practice approach to be taken when conducting an incentive exercise and therefore should be followed by employers and trustees whose schemes are carrying out such an exercise.

The code sets out seven principles which apply to incentive exercises and those principles are summarised below:

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• The code states that members should not be offered cash payments which are contingent upon members accepting the offer. However, members can be given offers to encourage them to engage in the incentive exercise process provided that it is made clear to members that they aren’t under any pressure to accept the offer.

• The code recommends that independent financial advice is made available to members from a suitably qualified financial adviser.

• Communications to members should be fair, clear, unbiased and straightforward. Members should be clearly told they are under no obligation to accept the offer and warned of the risks if they do accept it (namely that they may be giving up generous pension benefits in exchange for benefits which may not be commensurate in value to those benefits which are given up).

• The parties to an incentive exercise should keep adequate records of incentive offers which have been made to members, together with a copy of those members’ responses.

• Members should be given sufficient time to decide whether to accept an offer and should not be placed under undue pressure. A two week cooling off period is recommended after members have returned option forms indicating their decision as to the incentive offer.

• Members aged 80 or above should only be included in an incentive exercise on an opt-in basis (i.e. told that the exercise is underway and asked to get in touch with the employer or scheme if they wish to participate in it). Specific procedures should be put in place for any vulnerable members participating in the exercise.

• All parties involved in an incentive exercise should know their roles and act in good faith.

It waits to be seen how effective the code will be in assuaging the concerns of those people who have been critical of incentive exercises. The threat that the government will legislate to regulate (or even prohibit) incentive exercises remains which means that this is very much a watch this space area.