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the value of providing options for DB scheme members and helping them to choose the right one
Better pension choices:
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Contents
05
06
04
03
02
01
Foreword
What Next?
Contact us
Conclusion
Making the case
Expanding the toolbox
Options: what's on the table
Many people will be counting down the time to the day they can retire, put their feet up and do all the things they have dreamed of doing. But before that they have some important choices to make about their pension.
Giving members some choice has long been a part of the DB pensions system. The opportunity to take a tax-free lump sum at retirement or, prior to retirement, take a cash equivalent transfer value are both long established options which are available to all. However, over a number of years we have seen more and more pension schemes add new options to the menu such as pension increase exchange (PIE), bridging pension options and partial transfer options.
More choice is great for members as it allows them the most flexibility to shape their retirement benefits to best fit their individual needs. And one thing our “Making decisions that last a lifetime” research shows is that everyone’s needs are different. However, with choice comes the need to help members choose because these decisions are complicated, have significant financial implications and really do last a lifetime in many cases.
The direction of travel for a number of years has been for trustees and scheme sponsors to introduce more support around retirement decision making – from better communication of the options through to online modelling tools and independent financial advice for members. This goes hand in hand with the new and existing member options which are made available.
Member options are positive for trustees and scheme sponsors too, beyond the obvious benefits of giving members choices they value, many options have the effect of accelerating payments, reducing risks such as inflation risk or removing the financial risk of meeting the liability completely in the case of a transfer value. This helps those running the scheme to plan because the scheme’s finances are more predictable. Increasingly, member options are therefore an integral part of schemes’ journey plans whether these end in buy-out or the scheme intends to run on for many years.
David Bunkle Partner & Member Options Specialist, Aon
While longevity risk is one of the top concerns among schemes, particularly for medium and large schemes…
… Longevity swaps are rarely seen as accessible by smaller schemes due to their perceived complexity and cost
Smaller pension schemes perceive their size to be a barrier to accessing the insurance market: 27% of small schemes believe a buy-in is a viable option, compared to 62% of large schemes
Yet growing evidence shows insurance companies are both willing and able to consider smaller transactions
With almost half of schemes considering risk settlement in stages, it is important that schemes have a de-risking plan, to maximise insurer engagement and benefit from opportunities
There are several measures trustee boards can and should take to improve their scheme’s readiness for an insurance transfer
This report is based on the findings of a quantitative survey of over 100 pension scheme representatives, including trustees and pension scheme managers, and five in-depth interviews with professional trustees. All references to ‘small schemes’ mean those with assets of less than £100 million; ‘mid-sized schemes’ have assets between £100 million and £750 million; and ‘large schemes’ mean those with assets of £750 million and over.
About the research
Executive Summary
'There is currently a wide range of de-risking options available to schemes of all sizes'
In 2019, more than £43 billion worth of defined benefit scheme liabilities were transferred to insurance companies.
£43bn
+ See Chapter 01
Chapter 01: Options
As member options continues to be an important area of pensions strategy and pension scheme management, we wanted to understand how the market is evolving. We have worked with the team at Professional Pensions to find out, starting with a series of interviews with five professional trustees to fully understand their viewpoint, and moving onto a survey of 100 of their peers working with defined benefit schemes ranging from under £100m AUM to those with £750m+. The findings from this research is presented across the coming pages.
What options are on the table? PIE is well-established, partial transfers have been gaining traction and we have also seen an explosion of interest in bridging pension options over the last couple of years.
What do trustees want most? The clear answer seems to be more support for members and we expect the number schemes sourcing advice and guidance for their members from independent financial advisers to continue to rise.
What are the main barriers to schemes introducing more options and providing more support? It seems like those we surveyed are largely sold on the benefits and it is the cost and complexity of introducing more choice that most concerns them. But the market is adapting. Lessons from those who have already introduced options and support are shared with later movers, effective project management makes implementation smoother and outsourced administrators can now implement the common options like PIE and bridging pension options in a cost efficient way.
We hope you enjoy this report!
The vast majority of schemes of all sizes offer members a tax-free lump sum of up to 25% of the member’s total pot at retirement and transfer values are a statutory right. We now see over half of schemes proactively provide members with details of the transfer options from the scheme.
Both of these options have significant benefits for both members and the pension scheme. By taking a cash lump sum at retirement, members can pay down debts or put money towards activities such as holidays or moving home as their lifestyle changes.
A PIE offers a one-off uplift to annual pension payments to replace future inflation-linked increases. Members benefit from a higher income at the start of their retirement, while schemes can lower their long-term inflation-linked liabilities.
1
Pension Increase Exchange
A ‘bridging pension option’, where a member gets a supplementary income if they retire and start drawing their occupational pot before reaching state pension age. The member would receive a reduction in pension at state pension age, broadly equivalent to the state pension they start to receive. Therefore, their overall level of income remains consistent. A bridging pension option offers the option of early retirement with a guaranteed income for members and higher lump sums at retirement, while not increasing the cost for the scheme as it can be offset from reduced later payments post state pension age. This makes early retirement possible where it might not be otherwise.
Bridging Pension Option
A partial transfer option allows members to transfer some of their pension out of the scheme and retain a DB pension with the rest. For the member, it stops it being an ‘all or nothing’ choice and provides a number of new possibilities.
Partial Transfers
Pension Increase Exchange (PIE) options have increased in popularity in recent years with 31% of mid-sized schemes and 24% of large schemes offering these to their membership. In contrast, only 14% of small schemes currently offer their members a PIE at retirement but with medium and larger schemes leading the way, this may be something that will increase in future.
2
Similarly, the research showed that of those surveyed it was only the mid-sized and large schemes that offered their members a bridging pension option at retirement.
Note : Small schemes were defined as those with under £100m AUM, medium as between £100m and £750m and large as those with greater than £750m. Trustees were able to answer for all the schemes they were involved with.
Chapter One Options:
Chapter 02: Expanding the toolbox
what’s on the
table for DB members?
Similarly, transferring out of a DB scheme altogether can give members full access to the flexibilities of DC (defined contribution) pensions – for example, flexible drawdown or self-investing options. For the scheme, the entirety of the liability associated with that member is then taken off the balance sheet altogether.
The chart below shows two of the other member options we see being offered to members at retirement.
Pension Transfer
Tax free cash lump sum
Small schemes
Mid-sized schemes
Large schemes
88%
86%
83%
94%
90%
97%
Does your scheme(s) offer any of the following options to its members?
What’s on the table? (1)
Bridging pension options have gained increased focus over the last year, especially amongst larger schemes. The research showed no small schemes in the survey currently offering bridging pensions but, as with PIE, we expect this will change in future as they benefit from the learning experiences of the larger schemes. The findings on PIE and bridging pension options are similar to our 2021/22 Global Pension Risk Survey which showed increasing traction for partial transfers. These can be a good halfway house option for members, by allowing them to transfer a certain amount to a DC pot, which they can access flexibly, and keep the rest to take as a guaranteed income. Being faced with the binary option to transfer all their pension is a very challenging decision for members – especially if they lack support and guidance. This is particularly true for long serving members who have one main DB pension but who may be reluctant to manage large sums of money if they transferred their entire pension to a DC arrangement.
Aon viewpoint
These options can benefit retirees and pension schemes – particularly where members wish to access flexibility but also retain the certainty of a guaranteed income. Furthermore, as schemes implement GMP equalisation solutions we are starting to see many schemes combine such projects with member options. For example, combining GMP conversion with PIE or a bridging pension option means a complicated communication about a legislative necessity can become a positive story about member choice. It also brings about many project efficiencies ultimately leading to cost savings.
PIEs and bridging pension options can smooth the allocation of funds to members across their retirement, allowing them to take more of their pension in the early stages when they may wish to have more money for certain lifestyle choices.
However, the downside is that, without the benefit of inflation protection or with the scheme pension reducing in the future, members need to ensure they have enough for later life. It is important schemes provide members with good support to be able to understand how the option would work with their personal circumstances.
These options can also bring great advantages for the employer as they reduce ongoing pension liabilities. Trustees are also keen to offer members choice since they can make early retirement a more accessible choice.
Aon’s research “Making decisions that last a lifetime” gives great insights into a member’s decision making process about whether to transfer or not.
A happy balance
“I would love to be able to offer these because particularly with the state pension age going up, people who are retiring at 65 and taking their pension from a DB scheme, for the first couple of years they’re just living on their scheme pension. They’re really strapped for cash at a time when they’re trying to adjust to retirement, and perhaps have more energy to do the things that they could do if they weren’t working for the rest of the lives: go on a cruise or settle into retirement life gradually rather than be suddenly cut off with no income.”
Hugh Nolan, of Dalriada Trustees
Not all trustees that we spoke to were in favour of bridging pensions as they perceived them as being complex to administer, most notably with concerns were these were typically set on the member’s state pension age, which is now usually different to the scheme retirement age.
Bridging pensions do require the administrators to ensure the necessary reduction in pension is implemented when the member reaches State Pension Age. We have seen the industry evolve so that Third Party Administrators have robust processes in place to ensure this change is done accurately and communicated with members. As these are becoming more prevalent across schemes, administrators become more experienced in dealing with these benefits and increased automation means there is less scope for any human error.
It is worth remembering that some members might want to access their pots to meet specific needs, e.g. helping children with house deposits, paying for a family wedding, unexpected house repairs – any number of reasons. If schemes offered partial transfers to members, then it will prompt more members to consider this option as it would free up cash while maintaining a level of guaranteed income. Our research showed this is in line with what most members want – a core level of guaranteed income topped up with money which can be accessed flexibly.
“A combination of partial DB and partial DC would be hugely advantageous for members, as I do believe it would give them the best of both worlds.”. Wesbroom explained that such an arrangement could give a member a split between a guaranteed sum to cover day-to-day living expenses alongside a flexible pot of money for additional spending. “I think [this] would be really powerful for members but also financially advantageous for the scheme.”
Kevin Wesbroom, of Capital Cranfield
Some schemes have offered bridging pension options during the pandemic to help members who have been financially affected amid the slew of corporate insolvencies and restructuring activity and support them in being able to retire earlier than they may have previously planned.
The Covid-19 pandemic created a wave of workers being put on furlough, which has in turn triggered redundancies. Some members will go on to work elsewhere, but many older workers will not and a study by the IFS showed that one in eight older workers changed their retirement plans as a result of the pandemic. In our research, 24% of DB Trustees said that their sponsor had made redundancies because of the pandemic. A further 21% believe they may yet have to.
Pandemic impact
Source : Office for National Statistics Source : ifs.org.uk
3
of DB Trustees said that their sponsor had made redundancies because of the pandemic.
24%
believe they may yet have to.
21%
Even outside of crisis situations, these can be attractive options for pensioners to reshape their retirement savings to better suit their personal circumstances, if they have good advice or guidance. Additionally, by making early retirement more affordable for members, they help employers with workforce planning and in many cases can also help reduce pension liabilities.
A significant number of Trustees – 39% - believe that members would take up options like PIE – should they be offered. A clear majority of Trustees – some 71% - believe employers would benefit from the de-risking offered by retirement options.
0%
20%
40%
60%
80%
100%
Pension increase exchange at retirement
Bridging pension at retirement
16%
17%
31%
14%
Click icons for case studies
Sam is 64 and is expecting £12,000 a year from his DB pension when he retires next year, index linked with inflation. Sam is in good health and is keen to spend the early years of his retirement travelling. By taking the PIE option, he is able to boost his initial income to £15,000 a year. In doing this, Sam has sacrificed any future inflation-linked increases on benefits built up prior to 1997. However, he has a higher income earlier in retirement to support his retirement goals.
CASE STUDY: Sam
Charlotte is 55 with a deferred pension of £20,000 a year in her DB pension scheme. She would like to reduce her hours but intends to continue working for a good few years. She takes a partial transfer of half of her DB pension. This gives her a significant DC pot to invest and spend as she needs to bridge the gap when she reduces her working hours. She can also draw a lump sum from her new DC pot to pay for a new kitchen! When she reaches her normal retirement age she still has £10,000 a year of DB pension left to provide the essentials.
CASE STUDY: Charlotte
Carla is 60 and wants to retire earlier than her state pension age of 66. However, she is worried that her £11,000 a year DB pension will not be enough. Her scheme offers the option of a bridging pension to increase the initial annual payment to £16,000. In return, Carla’s future benefits when she reaches age 66 are reduced to coincide with the start of her state pension allowing her to maintain broadly the same overall income.
CASE STUDY: Carla
Nearly two thirds of respondents to our survey – 61% – said they would like to be able to provide a larger suite of support and guidance. Almost nine in 10 believe members would benefit from a greater understanding of the choices available to them. The chart below shows the popularity of some of the types of support that schemes can provide to their members.
Source : https://bit.ly/3maCLo6.
In the wake of the British Steel Pension Scheme scandal – which saw many members advised by unscrupulous individuals to transfer into high-cost, complex, or otherwise inappropriate pension arrangements – trustees are increasingly concerned about the standard of advice given to members around retirement or other major decision points. Members are at risk of being targeted by pensions fraud and scams, and these have become more common during the pandemic.
Given the risks of doing nothing, it is essential to educate DB members about their retirement options. Trustees recognise this, with more than three quarters of respondents (77%) saying they felt a lack of understanding increased the likelihood of members getting scammed.
Trustees discussed several stories about members who would have potentially lost out on large sums of money owed to them at retirement because they simply did not understand their entitlements.
The types of support that trustees would like to offer vary according to the prevailing demographics of scheme members, but certain options came up more regularly than others.
Generally, trustees want a better range of engagement and educational options to be offered to DB scheme members and for these to also be provided in a consistent way to DC members.
Chapter 02 Expanding the toolbox:
Chapter 03: Making the case
of respondents saying they felt a lack of understanding increased the likelihood of members getting scammed.
77%
4
Trustees want more support for DB members
10%
30%
50%
Interactive modeller
A selected IFA or panel of IFAs for member to obtain guidance
Annual newsletters with more information on what a member can do with their pension
Explanatory videos tailored to the member
41%
49%
52%
56%
57%
6%
A selected IFA or panel of IFA's for member to obtain full advice
Transfers provided in retirement quotes
Other
5
Source : https://bit.ly/3EaWmuH
“The problem we’ve got is actually getting members to understand what their choices mean,” said Michael Clark of CBC Pension Services, adding that members tend to “grossly underestimate” how long they will live in retirement.”
Michael Clark, of CBC Pension Services
Some Trustees have concerns about the costs associated with appointing a financial adviser to the scheme– particularly amongst smaller schemes.
Featuring strongly in our table of options that Trustees would like to provide is access to independent financial advice or guidance. “For most Trustees their real fear is people taking their advice from the man in the pub who knows nothing about it” says Alan Pickering of BESTrustees.
Providing financial advice and guidance
“I can appreciate concerns that trustees might have when considering whether to appoint a financial adviser to support members at retirement. Not only is there nervousness around potential criticism if advice given to members is later challenged but there can also be concerns about the costs involved in appointing an adviser especially for schemes with limited budgets”
Harus Rai, of Capital Cranfield
But failing to provide an easy route to financial advice can carry an alternate risk – as the British Steel debacle aptly illustrates – as Pickering put it.
“if the newspapers carry stories that British Steel pensioners got bad advice, then the only words that resonate are British Steel and bad advice. It’s not that XYZ IFA gave bad advice – its British Steel whose name hits the headlines”
Alan Pickering, of BESTrustees
Where the appointed IFA is educated on the scheme benefits and all of the necessary set-up work is done in advance, our experience is that the typical cost of advice is around £1,000 per member for support at retirement. Our Member Options survey showed that 68% of schemes pay for those costs on behalf of members. However, around one-in-five schemes pay for the set-up costs and then ask members to pay for the ongoing advice costs themselves. This option still gives members huge advantages in that they are able to approach a reputable firm that knows the scheme benefits and the costs which are negotiated by the trustees will be a fraction of the costs they would pay on the ‘high street’.
The results also demonstrate that many trustees are eager to improve the options available, and members’ access to advice and guidance. So what stands in the way of making change?
Sources small print and graph copy
The Pensions Regulator is putting greater emphasis on DB schemes to be certain of their end-game planning. In its provisional revamped DB scheme funding code, the regulator wants schemes to set a long-term objective, encompassing its funding and investment strategy and with the aim of reaching a “position of low dependency” on their sponsors. For many closed DB schemes, this is expected to involve an end game – transfer to an insurer, or another route to removing the scheme from the sponsor’s balance sheet and securing member benefits.
Source : ‘Quick guide to our defined benefit funding consultation’, The Pensions Regulator, March 2020.
Achieving the end game
Of the 100 schemes we surveyed, nearly three quarters (74%) expect to reach their end game objective within the next 10 years.
70% 60% 50% 40% 30% 20% 10% 0%
27%
62%
32%
37%
36%
Buy-in (liberties partically insured)
Buyout (liberties completely insured)
Medium schemes
Our survey has shown clearly that there are multiple options for DB scheme members when they reach retirement.
Chapter 03
confirmed it was a key part of their strategy
indicated they had not yet dismissed this opportunity
"
Chapter 04: Conclusion
6
already have a fairly full range of options in play, the single largest barrier is cost and complexity.
Setting aside the 27% who already have a fairly full range of options in play, the single largest barrier is cost and complexity.
There are clear benefits for scheme members, trustee boards and sponsoring employers from increased options at retirement and support. As outlined in the previous sections, each of the main at-retirement tools for members can give flexibilities or benefits to people in the appropriate circumstances as well as giving schemes and their sponsors greater certainty over future payments.
There is also a moral duty consideration. It is increasingly recognised that there is a moral duty to help members make good retirement decisions and highlight the risks of falling prey to scammers or bad external advice. These risks rebound on the trustees and sponsor, and don’t just affect the member.
Additionally, a high standard of member service can increase member and employee satisfaction, as well as demonstrating that the company cares about its loyal staff into retirement and not just while they are working.
There is a perception that smaller schemes can’t offer the same options as larger schemes because it is not economical to do so. However, we think that this is no longer the case. We’ve invested in developing streamlined approaches across all of the key aspects of members options – PIE, bridging pensions, selecting an IFA, online modellers – and this means that schemes of all sizes can benefit from giving their members more choice and support. Third-party administrators are getting increasingly familiar with such options too, although it is vital to ensure robust processes are put in place to ensure the new options can be administered correctly. Before carrying out member option exercises, trustees and employers carry out a cost vs benefit analysis and, in purely financial terms, the numbers commonly stack up. There are lots of other non-financial benefits as well which means that overall the business case is very good
Making the case for improving member options
What is your time horizon for reaching your end-game?
13%
25%
38%
We are there now
0-2 years
3-5 years
6-10 years
Over 10 years
Don't know
26%
43%
2%
Almost two thirds (71%) of trustees believed employers would benefit from the opportunity to de-risk their pension scheme by offering alternative retirement options. When asked if they see member options being a key part of the journey to reaching their schemes’ end game, 31% confirmed it was a key part of their strategy, a further 52% indicating they had not yet dismissed this opportunity and just 14% of respondents indicating that they do not envisage utilising member options.
Many trustees and sponsors find providing member options to be a useful tool to accelerate the time to reach buyout. Bulk exercises can be used to simplify schemes and liability can be discharged at a much lower cost than securing the benefits with an insurer.
Furthermore, given that the options available to members and support to understand those options may change irrevocably after buyout, trustees see the importance of fully communicating with members about their options ahead of buyout as being part of good governance. Schemes are increasingly developing formal “member journey plans” to document the plans for their members’ experience alongside funding and investment plans ahead of buyout.
Better pension choices: the value of providing options for DB scheme members and helping them to choose the right one
Chapter 04 Conclusion
Offering more support at retirement around options such as PIEs, bridging pensions and other options can be a win-win scenario for both members and sponsoring employers. Coupled with paid-for advice or guidance services, companies can help their current and former employees have better retirement outcomes and meet their personal financial needs, while also reducing risks to the business from pension liabilities and reputational damage. Trustees should use their influence to encourage and empower employers to do the right thing for members while also helping their schemes get closer to their endgame goals. At a time when redundancies and business uncertainty have increased during the pandemic, this is a perfect opportunity for trustees and sponsoring employers to go above and beyond for their members. The business case is good and the market has developed to enable options to be offered in a cost effective way to schemes of all sizes.
Get in Touch
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David Bunkle Partner david.bunkle.2@aon.com
Polly Cripps Senior consultant polly.berdinner@aon.com
This article is intended for professional clients and is for informational purposes only and should not be construed as a specific recommendation. Aon Solutions UK Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No - 04396810. Registered Office - The Aon Centre, The Leadenhall Building, 122 Leadenhall Street, London EC3V 4AN
