Previous articles in this series have looked at the range of options available to members in Defined Benefit (DB) schemes, the support available at retirement and the importance of engagement and communications.
In this final article in the series following our in-depth research across 50 trustees and over 1,000 members of DB schemes, we look at how trustees set the terms for the options provided to members - something that's on the agenda for all schemes at the moment given the recent extreme changes to market conditions and interest rates.
As expected, value to members (84%) and fairness to members (76%) came across as fairly important, as did impact on the funding position (80%) and agreement with the sponsor (76%). Surprisingly though the terms being used by insurers was seen as the most important factor, with 90% of trustees rating this factor as important.
Many schemes now have an endgame in sight and having regard to the terms being used by insurers avoids significant changes to terms and a cliff edge for members further down the line.
In general, terms for member options, such as commutation and early retirement, are set for a period to time to keep the administration simple and enable members to plan for their retirement. Terms are usually set at such a level that they can cope with fluctuations in market conditions and still strike a reasonable balance between giving fair value to members and protecting the funding position.
Interestingly the recent significant shift in market conditions means terms for some options are perhaps now too generous to members. A review of commutation terms being used by our clients has shown that, based on 30 September 2022 market conditions, around 50% of schemes may have commutation factors which are more generous than the terms typically offered by an insurance company. At the start of the year this figure would have been less than 5%. Many trustees will now be looking to review their terms and may be facing some difficult decisions.
Reassuringly, 88% of trustees felt the impact on a scheme's long-term objective is an important factor to consider when setting terms for member options, and a huge 92% of trustees recognise that member options impact a scheme's journey plan.
Most member options are provided at retirement and this gradual activity adds up over time, with its impact becoming more important as schemes advance along their journey plans. Conversely, targeted exercises offering options to members in bulk - such as transfer values, early retirement, pension increase exchange, bridging pension or a combination of these - can help a scheme progress its journey. They can also be used effectively shortly before buy-out as a last chance to offer members flexibility that won't be offered by the insurer.
Importantly any exercise should be designed first and foremost around the members, providing them with welcome choice and offering good value. Trustees need to be wary about the overall terms when combining options like bridging pensions, pension increase exchange and commutation. Although the terms for each individual option may be reasonable, when combining a member could be selecting a benefit which, perhaps unintentionally, offers pretty poor value. Our approach to designing any exercise is to focus on the member perspective and so avoids this.
Thankfully, it is usually possible to set terms that are fair value to members, cover the costs of undertaking the exercise and result in a significant saving against the scheme's long-term objective and therefore help accelerate the journey.
The research we carried out into member options provided us with a mixture of reassuring and surprising results, interesting insights into how members view their options and highlighted a clear gender divide. We hope you have enjoyed the series and please get in touch to see how we could help you and your scheme get the balance right.
Debra Logan
Partner, Actuarial Consulting
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