One of our partners, Stuart Price, reveals how carrying out a Pension Increase Exchange (PIE) exercise could save your scheme money and why clear communication is the key to its success.
PIE exercises are a potential way for sponsoring employers to reduce their Defined Benefit pension scheme liabilities without having to commit to paying out large cash sums up front.
If a scheme provides higher increases in payment than the statutory minimum, carrying out a PIE exercise could be of benefit. A PIE exercise can be carried out for all current pensioners and for each non-pensioner when they come up to retirement.
How does PIE work?
Current pensioners are offered the option to exchange future non-statutory increases for lower statutory increases. Some of this saving is then passed to the pensioner so, in return, they receive an additional one-off increase to their pension. The remainder of the savings stay in the scheme and is immediately recognised – so reducing scheme funding liabilities.
Non-pensioners are offered an additional option at retirement to the usual pension or pension plus tax-free lump sum: a higher tax-free lump sum and a higher pension with lower increases once in payment. Although the savings for non-pensioners will only emerge as each member retires, it is possible to build an appropriate assumption into funding calculations so that liabilities can be reduced.
Why will members accept the offer?
Research shows that pensioners prefer more income in the early years of their retirement because this is when they are most active and able to enjoy life.
As part of the PIE offer process, pensioners should be given personalised information showing their pension before and after the offer, and their break-even point – when the total of pension payments is the same regardless as to whether the offer has been accepted or rejected. Given this kind of clear information, many people see the offer of a higher (but lower increasing) pension as good value for money, depending on their perceived life expectancy.
For future retirees, a higher initial pension generally leads to a higher tax-free cash sum payable on retirement. Again, research shows that members prefer to maximise the amount of tax-free cash they can receive and so the PIE offer is attractive.
Compliance and communication
A Code of Good Practice is in force within the pensions industry which provides best practice guidance on how to carry out a PIE exercise. It recommends that existing pensioners speak to an Independent Financial Adviser (IFA) before accepting any offer, although full advice may not be necessary. Non-pensioners are not required to speak to an IFA before coming to their decision.
The key to a successful PIE exercise is clear and concise communication. We strongly recommend that sponsoring employers speak to trustees before carrying out a PIE exercise and ensure their acceptance. The scheme’s rules will also need to be amended, which is a relatively simple task we can help with.
Also, as there is an initial increase to pensions in payment, the scheme’s PPF levy is likely to increase over the shorter term. However, this is more than offset by the savings in funding costs, plus the future buyout costs will also be reduced as non-standard pension increases are replaced with lower statutory increases which are more attractive to the insurance industry and are reflected in their reduced premiums.