The controversial practice of offering members of defined benefit (DB) schemes Enhanced Transfer Values (ETVs) to leave their fund is set to be offered by half of all such schemes over the next decade, claims a recent KPMG report

ETVs are an increasingly established step on the path to completing an insurance-backed buyout, KPMG pensions partner Mike Smedley told Pension Funds Insider. Challenging the Pensions Minister, Steve Webb, who early this year said that there is a risk of mis-selling and bad practice in ETV exercises, Smedley argued that "while there have been bad examples in the past of undue pressure placed on members or ETVs being offered at the same time as redundancy programmes, our experience is that practices are improving significantly."

The KPMG research found that since 2008, every single ETV exercise has been accompanied by sponsor company-funded independent financial advice for those given the option of leaving the DB scheme. Typically, members are offered their full pension pot and a top up, often in the form of cash, to take into a defined contribution (DC) scheme, although occasionally a lump sum is offered to spend at the member's discretion.

Should current take-up rates (averaging 30% since 2008) be mirrored across half of all DB schemes, KPMG estimates that 750,000 members could leave final salary plans and total liabilities could be reduced by as much as 10% in the coming decade. Smedley says "as it is typically younger, 30 to 40 year-old members who transfer out, the reduction in risk will be even greater at some 25%. That will translate to a reduction in buyout costs as well".

Smedley's expectation that up to half of DB schemes will offer some form of ETV over the next decade is based on the age profile of schemes that may have recently closed to new members. He said "to put it simply, if you leave it 10 years you might not have many people left young enough to want to take it."

Younger pension scheme members are typically more likely to agree to take part in ETV exercises as the long period of time before their future retirement makes them more receptive to the higher risk of a DC pension pot.

Smedley also said: "As ETVs are effectively for deferred members they naturally suit schemes with a large proportion of deferred pensioners. Despite its potential to reduce deficits, quite a lot of schemes that are well funded have been looking to use ETVs to reduce risk and get a step closer to a buyout, which isn't really on the horizon for funds with severe deficits".

Wildly varying take up rates were indicated by the KPMG research. In one in seven exercises less than 10% of members accepted the offer, while in one out of every six cases over 50% agreed with the offer. Structuring an ETV generous enough for members and engaging effectively are vital to ensure high take up rates, explains Smedley.

Smedley says: "Funds should be making sure data is clean so they know who you need to be communicating to and carefully deciding the best method and channels to get everyone to listen."

Doubts remain

Malcolm Mclean of Barnett Waddingham cautions that the practice of offering ETVs needs to be scrutinised. He told Pension Funds Insider: "From the point of view of consumers it would not be in the interest of the majority of members to accept an ETV. That clearly depends on how much is being offered though, and there are some people who would definitely gain, for instance somebody with an urgent need for cash or a reduced life expectancy".

Referring to Steve Webb's concerns on offering cash lump sums to sweeten ETVs, Mclean said: "The minister may have had a point in wanting to look into cash incentives, as more people do seem to take up these offers when there is a cash element. Although I would not like to see the practice banned, there have been bad examples of people being misled in the past. Thankfully the KPMG report confirms that practice has got much better."

Mclean also argues that proper financial advice for members is a vital element, saying that: "Providing that employers are paying for proper regulated independent financial advice for their individual members it shouldn't be a problem. People have been lured into these things, however. If 90% of members are accepting an ETV you have to wonder how it has been conducted".

Mclean does not advocate further regulation but appreciates the scrutiny applied to the practices, saying: "The regulator has given quite definitive guidance on this but needs to keep an eye on what's going on to make sure it is all being done properly and people are not being duped into this."

Mike Morrison, head of pensions development at AXA Wealth admitted he shares the concern with the practice of offering a cash enhancement to an ETV, which KPMG found to occur in 87% of cases analysed. Morrison told Pension Funds Insider that "my key concern from the recent KPMG survey was the fact that an exercise was more likely to be successful if there was a cash element along with the idea of immediate spending as being more attractive than saving for a pension. This reflects some of the general apathy that a lot of people have to pension saving."  

Morrison added that rational calculation is key to deciding whether an ETV is a good deal, saying: "There are a number of reasons why a scheme could want to offer ETVs, but it is likely to be caused by the fact that the future cost of the scheme is becoming unsustainable.

"Members need to understand the amount they are being offered and how that relates to the actual value of their entitlement and therefore the value of any enhancement, the critical yield required to match the future benefit and the nature of the investment risk."

Reiterating the view that as ETV practices vary wildly, each offer needs to be considered individually, Morrison says: "There are certainly three parties to consider in an ETV exercise: the employer, the scheme and the scheme member, and all of these parties could suffer positive or negative outcomes."

Improving the practice

Fuat Sami, a Sackers solicitor who specialises in the ETV arena, warned that despite the marked improvement in ETV practices he is "certain that bad practice is still happening at some small employers. A lot of smaller schemes lack the resources to take professional advice and that is where the problems occur, with members offered an ETV still not getting access to IFAs free of charge for instance".

Nonetheless Sami is confident that the guidance issued by the Pensions Regulator on the practice last year has been a positive development. "The guidance has certainly had an impact and when employers are taking advice it's unusual for the guidance not to be given strong consideration at least. It is quite easy for all parties to follow."

Sami stresses that the offering of ETVs by companies in a bid to reduce their pension deficit is difficult for trustees who find themselves needing to avoid direct involvement in the offers in the interests of neutrality. He explained: "Trustees are in a difficult position as the offers are made by employers to members, and depending on the structure of the offer the trustees' role is likely to be very limited and their legal ability to do anything is limited."

That is a sore point for Sami as the Pension Regulator's guidance assumes an important role for trustees in monitoring ETVs.

Sami added that for trustees, "translating a desire to protect members' interests into actual measures is difficult when it comes to ETVs. There are things that trustees can do, however, like ensuring that employers' communications to members are accurate so that they can make informed decisions and making sure independent financial advisers are being provided to members and remunerated appropriately." 

Echoing the general perception that implementation of ETVs is improving, Sami claims there is now more effort taken to synchronise interests between trustees and employers. He says: "There has definitely been an improvement in the dialogue between employers and trustees. This continues to move in the right direction with more employers liaising with trustees at an early stage.

"In the early ETV exercises before the Regulator's guidance came out there was a lot of smoke and mirrors surrounding it with trustees not finding out about ETVs until a later stage. The guidance has proved helpful in providing a set framework and focusing minds on what needs to be done".

First published 25.08.2011

dbillingham@wilmington.co.uk