In November 2011, Steve Webb, the Pensions Minister, confirmed his intention to "crack down" on bad practice in relation to incentive exercises ("IEs"). To achieve this, he tasked an industry working group with improving the standard of such exercises, "while preserving [them] as a legitimate tool for sponsors to help manage the liabilities in their [DB] pension schemes".
The result, a non-statutory code of "good practice" (the "Code")
, was published on 8 June 2012.
In this Alert:
- Although described as a voluntary code of good (as opposed to "best") practice, somewhat confusingly much of the language used in the Code is more consistent with its being compulsory.
- For example, the Code states that the authors "anticipate that all future [IEs] will follow the spirit and principles of the Code" and that they "do not expect employers, trustees or their advisers to look for creative ways to work around the Code".
- TPR will review its current guidance on IEs with a view to supporting the Code.
What is an IE?
The Code defines an IE as "an invitation or inducement…provided to a member to change the form of their accrued [DB] rights":
- with the objective of reducing risk or cost for the pension scheme or sponsor(s); and
- where the invitation or inducement is not ordinarily available to members of the pension scheme.
When does the Code apply?
Broadly the Code deals with two types of IE:
- "Transfer Exercises" – for example, involving a transfer out of a DB scheme on an enhanced basis or in return for some other inducement (as distinct from a normal individual transfer request); and
- "Modification Exercises" – for example, a pension increase exchange exercise (involving an enhancement to pension income in return for surrendering all or part of future pension increases).
The Code states that it "applies to all circumstances where an offer is made available to a member after the date of publication of the Code" and that the party initiating the offer (usually the sponsoring employer) "is responsible for following the Code and seeking to ensure that other parties" do likewise.
Comfortingly, introducing new benefit options for (non-pensioner) members does not seem to be caught by the Code. However, employers, trustees and advisers are encouraged to consider "the extent to which it may be appropriate and helpful" to apply some or all of the Code both at the time of introducing a new option into scheme rules, as well as when the option is subsequently offered to a member.
The 7 principles
The Code consists of seven principles. In summary, these are:
- Principle 1 – no cash incentives should be offered that are contingent on the member's decision to accept the offer.
- Principle 2 – For Transfer Exercises, financial advice (including a final written recommendation) should be provided to the member and, for Modification Exercises, either:
- financial advice should be provided; or
- the so-called "Value Requirement"1 should be met and financial guidance provided to the member.
- Principle 3 – communications with members should be fair, clear, unbiased and straightforward.
- Principle 4 – records should be retained so that an audit trail is maintained that can be examined in the future. When providing financial advice, the adviser should record and report on "Insistent Customers"2 to the other parties.
- Principle 5 – members should be given time to make up their minds without any undue pressure.
- Principle 6 – IEs should only be offered to members who are over age 80 on an "opt-in" basis and, when providing financial advice, advisers should adhere to a "Vulnerable Client" policy (namely, recognising that clients who are vulnerable because of their age, health or understanding, may require special treatment).
- Principle 7 – all parties should ensure that they are aware of their roles and responsibilities and act in good faith.
Each principle is supplemented by more detailed information on how it should be applied, including a specific procedure for providing financial advice and guidance.
The Code encourages employers considering an incentive exercise to engage with the scheme's trustees "at an early opportunity" as, amongst other things, trustees "should play a role in ensuring that the Communications principle…is met".
Recognising that the primary duty of trustees is to comply with trust law, the Code's authors acknowledge that trustees are not under a legal duty to follow it. However, they consider trustees are likely to seek advice on the following as a minimum:
- data protection;
- conflicts of interest;
- the trust deed and rules; and
- the extent to which they should satisfy themselves that the offer's design, communication and processes for giving advice are appropriate for members.
The Code suggests trustees might choose not to participate in IEs which do not follow the Code, unless the employer has clear reasons for departing from it and "those departures do not adversely affect the protection of members".
How will compliance be monitored?
The idea is that an (as yet unidentified) independent industry body will own, maintain and monitor the Code. It will use information gathered from the industry and by TPR to assess the extent of compliance. If there is evidence of "significant departures" from the Code, the industry body might recommend that legislation is introduced.
Quite separately, TPR is currently considering whether to require trustees to report basic factual details about IEs in the Scheme Return.
Perhaps unsurprisingly, it is anticipated that the Pensions Ombudsman will have regard to the Code, where appropriate, when dealing with complaints involving IEs. In contrast, given its lack of statutory basis, a court is unlikely to.
Voluntary versus compulsory
Whilst described as a voluntary Code of good practice, as outlined above, the language of the Code is often at odds with its purported voluntary status. It would therefore be sensible for employers (and trustees) considering IEs to seek legal advice on the Code beforehand.
1 Using the framework for actuarial equivalence tests under section 67 of PA95, in aggregate, the membership who are offered the incentive exercise must not be worse off after the IE than they were before
2A member who has received financial advice and chooses to act contrary to the adviser's recommendation in relation to acceptance of the offer