Pension Increase Exchange
JLT Employee Benefits
Against the backdrop of the economic turmoil of the last few years, many trustees and sponsors
are looking at ways to manage the liabilities in their defined benefit pension schemes.
One solution is to give members the option of exchanging some of their future pension
increases for a higher non-increasing benefit.
Liability Management
Ultimately a buyout lies ahead for most defined benefit
pension schemes. However, with current strained funding
levels, this may not be a realistic proposition for a number
of years. This does not mean inaction – rather action and
innovation.
De-risking exercises can be undertaken to improve
scheme funding levels and remove risk before insurers are
approached for bulk annuity quotations.
Bulk exercise - Pensioners are offered a one-off opportunity
to exchange some of their increasing pension for a higher
non-increasing pension. This exercise can be repeated at
periodic intervals to give members opportunity to take
advantage of this option as their circumstances change.
Why provide this option?
The principal reasons for making this option available to
members are:
❯❯ Risk within the scheme is reduced
Increasing Member Choice
❯❯ Generally there is a reduction in deficit
If the strategy is right, de-risking can add choice and value
for members along the way.
❯❯ Sponsor incentive payment is not required
Scheme members can already choose the amount of taxfree cash they take at retirement. The additional option of
a pension with lower increases is an extension of the same
theme.
Why would members agree?
What is Pension Increase Exchange (PIE)?
❯❯ Ultimate buyout costs are relatively lower
There are a number of reasons why members would
exchange future pension increases even if informed that the
value of the alternative benefits is lower.
Pension legislation sets out the minimum levels of pension
increases that defined benefit schemes must provide. Many
schemes provide increases above these minimum levels –
typically on pensions accrued before 6 April 1997.
❯❯ A higher level pension better suits their personal
circumstances
Under PIE members may exchange some of these nonstatutory increases for a higher non-increasing benefit
either at retirement or as part of a bulk exercise.
❯❯ Many members see the offer as good value
Retirement option - Members are offered a further option
on retirement in addition to the usual options of full pension
or reduced pension plus tax-free lump sum. This further
option is typically a higher tax-free lump sum and higher
initial pension (but with lower increases).
❯❯ A higher initial pension generally leads to a higher tax-free
cash sum at retirement.
❯❯ Many members want the highest income when they are
most active
JLT Employee Benefits
Pension Increase Exchange
Member Example
Case Study
The member’s pension under the scheme is £20,000 per
annum at retirement, half of this was accrued before 6 April
1997 and increases at 5% p.a. The other half increases in line
with the Consumer Price Index (CPI) subject to a maximum
increase of 5% p.a. Part of this pension may be commuted for
a tax-free lump sum.
Our client operates a £50 million closed defined benefit
scheme with deferred pensioner liabilities of £30 million and
current pensioner liabilities of £20 million.
The member, after receiving information on his option and
taking advice, decides to take the PIE option. His retirement
position relative to what it would have been had the PIE
service not been available is shown in the following table.
His post April 1997 benefits are unaffected as they are already
in line with statutory increases.
Member’s pre
Member’s pre
April 1997 benefits April 1997 benefits
Scheme pension
Tax-free cash
Residual pension
(Post exchange)
(Scheme benefits)
£14,000 p.a.
£10,000 p.a.
£57,500
£46,000
£8,600 p.a.
£6,900 p.a.
Pension increase
in payment
Nil
5% p.a.
Spouse’s pension
50% of pension
that would have
been payable pre
exchange at date
of death
50% at date of
death
In this example, 60% of increases are passed to the member.
The member gains through higher pension and the company
and scheme gain through lower technical provisions.
We designed and implemented a bulk PIE exercise for
pensioner members. Under the offer, 60% of future increases
were used to fund higher pensions with the remainder used to
reduce the deficit. Over 40% of members accepted the offer
and consequently the pensioner liabilities reduced by £1 million.
At the same time, the retirement process was amended to
allow retiring deferred members the option to exchange
future pension increases. This choice proved very popular and
the trustees agreed to make allowance for the exchange in
the next actuarial valuation. This could reduce the deferred
pensioner liabilities by around £2 million.
Design and Implementation
Communications need to be clear, transparent, balanced and
adequately equip members to reach an informed decision
that is right for them. Trustees and sponsors need to be aware
of their roles and responsibilities to members. In particular,
they need to fully understand the structure of the PIE offer
and give due consideration to the Code of Good Practice for
Incentive Exercises.
We have significant experience of working with trustees
and employer in designing and implementing PIE exercises,
with robust processes and procedures to ensure regulatory
requirements are met.
Next steps
We provide advice, guidance and assistance to sponsors and
trustees. We are structured to support both sponsors and
trustees in a way that helps manage potential conflicts of
interest yet maximises the outcome in terms of the trustees’
and sponsor’s joint strategy for the scheme.
For more information please contact your JLT consultant
or Charles Cowling on 0161 242 5388, Rob Dales on
0113 203 5883 or John Breedon on 0161 253 1110.
Charles Cowling
John Breedon
Managing Director
t: +44 (0)161 242 5388
e: [email protected]
Director
t: +44 (0)161 253 1110
e: [email protected]
Rob Dales
Director
t: +44 (0)113 203 5883
e: [email protected]
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