HELLO
Following the introduction of ‘Freedom and Choice’ for defined contribution (DC) pensions in April 2015, we have seen increasing numbers of members transfer out of defined benefit (DB) schemes to access these new freedoms.
While these options could be attractive for some members, they represent important considerations for both trustees and companies alike:
BEN ROE
MEMBER OPTIONS
2019
Guide to
Our insights are underpinned by the results of Aon’s 2019 Member Options Survey covering 320 defined benefit schemes, as well as our experience advising on more member options exercises than any other consultancy in recent years.
For trustees, considerations include how to support members to fully understand the options available, whether to increase the range of options available in the DB scheme itself and implications for a scheme’s investment strategy; and
For corporate sponsors, a consideration may be using the new flexibilities as a way to manage risks in a scheme, reduce costs and bridge the gap to a possible future buyout.
Whether you are a trustee or a corporate sponsor, there is a range of issues to consider in relation to the new pensions freedoms.
How trustees are supporting members in their decision making at retirement
In our 2019 review, we take a look at:
The latest on bulk member options exercises and the IFA market
Examples of schemes which have used member options exercises to bridge the gap to buyout
Trends in relation to partial transfer options
Investment considerations of carrying out member options exercises
Senior Partner and Head of Aon’s Member Options Team
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If you would like to see Aon’s Guide to Member Options inits entirety, please email the Member Options team andwe will be in touch.
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DRIVING BETTER MEMBER OUTCOMES
1
CHAPTER
Often the decision to retire is one of the biggest financial decisions we make, bigger than changing jobs or buying a house. Yet, the support we receive to make this decision often consists of 30 to 40 pages of incomprehensible block text and numbers. Most of the time this leads to members taking the default scheme pension with little or no consideration of any pensions freedom options.
Members may not be aware of their options if they are not communicated effectively
In this fast-changing world, we are using new channels to get the information and support that we need in life. We use technology to turn the lights on, do the shopping, have a virtual GP appointment, manage our personal finances and even to buy or sell houses. Why should pensions be any different?
One of the biggest financial decisions
Aon’s 2019 Member Options Survey
BUT WHAT DOES SUPPORT LOOK LIKE?
At Aon we do not think that ‘one size fits all’ and we see our clients taking a range of approaches to support members while still complying with statutory requirements, some of these include:
• Communications to members at ‘key ages’ to warm them up to their different options well ahead of retirement • More engaging paper communications – such as engaging covers for retirement packs, with key information highlighted up front • Online modellers for members to explore and contrast scheme retirement options with pension freedom options • Provision of paid-for IFA advice from a qualified, reputable and vetted IFA to help members avoid the costs and pitfalls of the high street IFA market • Short videos explaining member options in a simple and engaging way • Phone apps which enable trustees to send push notifications to members at key decision points
We must not forget that members are people, and people are individual.
Online models seem to be one of the biggest areas of growth in the market. Since its launch in 2016, 50 schemes are now live or in the process of setting up Aon Retirement Options Model (AROM), which will provide access for over 12,500 members. This can be used to help members explore and compare the immediate income they can receive in retirement, based on taking their scheme pension or via exploring pensions freedoms.
Members have more options than ever before as to how they draw their pension, so at Steve Southern Trustees Limited, we strongly believe they need more support to ensure the best possible member outcomes. Aon and I have been working on a mutual client to help improve the member retirement experience. As a trustee, it’s about helping members to be able to make an informed decision, and achieve the right outcome for them.
The guaranteed income of the scheme pension is likely to be the right option for the majority of members. Some members however, could benefit from the flexibility offered by pensions freedom options (for example, those in poor health, the unmarried, or those with a desire to pass on pension as an inheritance), and these members may not be aware of these options if they are not communicated effectively. Perhaps that is why we are starting to see change.
“
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Kelly Hurren
Principal Consultant
Proportion of schemes offering different levels of support at retirement
The chart above shows the results from Aon’s 2019 Member Options Survey – almost one in five schemes are now providing additional support to members at retirement. This is expected to increase to almost one in three schemes within the next 12–18 months.
We are all different. We like our information and support in different ways – and in varying levels of detail. As such, often a combination of different media are required to cater for multiple preferences.
AROM
2016
Launched
50
Live schemes
Interestingly, when AROM was first designed, it was anticipated that members would use it ‘out of hours’ for support at times when IFAs were unavailable.
In fact, our data suggests that members use it most during working hours – perhaps when a quick check online is acceptable at the office but a lengthy call to an IFA is not. The heatmap to the right shows when AROM is being used the most – with 11am to 1pm the most popular time of day.
But members use the modeller at times that suit them. Some members have logged in on a Friday night, some at anti-social times in the morning, and some even on Christmas Day! Further evidence that one size doesn’t necessarily fit all.
Fortunately, technology can help trustees to be flexible and is usually a cost-effective way to meet the needs of many different members.
Usage of Aon’s Retirement Options Model (AROM)
Showing users by time of day
Increasing use of technology
The new Aon Retirement App is able to store key documents and send push notifications when new materials are released. Trustees are increasingly using app-based technology to increase member engagement with their pensions.
The process starts with educational communications, long before members are even eligible to take their pension. We then seek to engage with them using a number of different communication channels, paper communications, an online retirement modeller (AROM), and paid-for IFA support. We hope this leads to something for everyone and enables our members to make informed decisions.
If you would like to see Aon’s Guide to Member Options in its entirety, please email the Member Options team andwe will be in touch.
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Rebecca Wood
Steve Southern Trustees Limited
OUR PEOPLE
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About Aon
Aon plc (NYSE:AON) is a leading global professional services firm providing a broad range of risk, retirement and health solutions. Our 50,000 colleagues in 120 countries empower results for clients by using proprietary data and analytics to deliver insights that reduce volatility and improve performance.
© 2019 Aon plc. All rights reserved. The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
Ben Roe
Senior Partner and Head of member Options
David Bunkle
Partner
Louise Tucker
consultant
Jamil Merali
Principal consultant
Andrew Fryer
Satnam Rai
Gemma Cowan
Lauren Ramsey
Senior consultant
Paul Estruch
Andrew Gaskell
Tom Clarke
Richard Cook
Oliver Cowan
Thomas Williams
Read next...
An update on bulk exercises
2
Offer terms, the IFA market and GMP equalisation should be considered when running a bulk exercise
During 2018, Aon advised on a new bulk transfer value exercise or Pension Increase Exchange (PIE) exercise roughly every other week, covering a wide range of schemes from £100m to over £7bn in size. We continue to see extensive activity in the markets this year. So, what kinds of offerings are we seeing?
Typical offer terms
IFA MARKET
What bulk exercises are schemes planning?
GMP EQUALISATION: A POTENTIAL BANANA SKIN?
Click on the photos to reveal their details
New rules
GMP CONVERSION: A POTENTIAL WAY FORWARD?
What is GMP conversion?
Prior to conversion and PIE:
Post GMP conversion and PIE:
A NATURAL STEP AHEAD OF THE ENDGAME?
2018 saw more full pension scheme buyouts over £500m than there had been in the previous three years combined, and a definite trend to move directly to full buyout rather than opting for a series of buy-ins first. For many schemes, the path to full buyout can seem a long way off. But what if there was a faster way to get there?
3
Buyout specific considerations
Alternatives to buyout
Throughout this article we have focused on buyout as the ultimate long-term destination, but it would be wrong not to comment on the alternatives to buyout at this stage.
IN THE FUTURE
Scheme terms v insurer terms
On the face of it, the structure of these exercises was similar to any other member options exercise; however, the key difference here is the proximity to buyout. If members took no action, they would end up with an insurance policy at the point of buyout. This means there are several special considerations for these projects compared to a regular member options exercise.
After buyout, members will still be able to take a transfer value from the insurer, but this means that the transfer terms available in the scheme will need to be compared with the transfer terms that the insurers would offer members following the transaction. The trustees in the two cases mentioned above were able to offer members terms that were more generous than the terms of the insurer, yet still provided savings on the buyout premium.
Following the PLSA’s document ‘The case for consolidation’ in 2017, 2018 saw the launch of two superfunds, ‘The Pension SuperFund’ and ‘Clara’. Both have very different business models, and understanding the differences would be crucial for any scheme considering these as an option. What their propositions have in common is that they both involve taking on financial responsibility for the scheme, providing strong security for members and doing so at a cost that is expected to be cheaper than passing liabilities on to an insurer. The DWP has published a consultation document covering the consolidation of DB schemes and new regulation is expected in 2019. Although this will not be right for everyone, it could still be an exciting development for some. So watch this space!
responsibility for the scheme, providing strong security for members and doing so at a cost that is expected to be cheaper than passing liabilities on to an insurer. The DWP has published a consultation document covering the consolidation of DB schemes and new regulation is expected in 2019. Although this will not be right for everyone, it could still be an exciting development for some. So watch this space!
As more schemes look to the insurance market as a way of reducing risk, we see it becoming increasingly common for member options exercises to be carried out alongside the insurance broking process. For those schemes that are moving towards full funding, there is now a lot of merit in giving serious consideration to whether that buyout target is closer than previously thought.
process. For those schemes that are moving towards full funding, there is now a lot of merit in giving serious consideration to whether that buyout target is closer than previously thought.
Insurer liaison
If the timing of the exercises means they can be concluded before the final round of insurer pricing, the impact can be captured in this pricing. For one scheme, the buyout happened on accelerated timescales and, in this case, the insurer agreed to underwrite the risks associated with the transfer exercise as part of the final round of pricing. This was a first in the market and allowed the trustees and company to lock into the transaction more quickly than would otherwise have been the case.
COMMUNICATION WITH MEMBERS
Communication material will need to be carefully drafted to explain the offer being made, the potential buyout transaction and that the IFA advice is being provided to help members decide whether or not to transfer ahead of buyout. High quality advice is crucial in these circumstances, so it will also be necessary to fully brief the IFA so that they understand the process. In one of our case studies, 85% of the members contacted the IFA for advice, which shows the importance of providing access to good quality advice in such projects.
This project has achieved the outcome we really wanted. By a collaborative approach from all parties, we have been able to secure a deal which no-one imagined possible at the outset.
Kully Janjuah
PA Consulting
Both schemes actually ended up with a surplus – a better outcome than envisaged at the start of the project. Members were given the option to reshape or transfer their benefits out of the schemes – and these exercises were carried out alongside the insurance broking process. Running the processes alongside each other in this way was a first in the market in 2018.
When insurance pricing improved towards the end of 2016, a buyout started to look more affordable, so the schemes started to consider the possibility of carrying out member options exercises to help bridge the gap. At this point, neither scheme would have believed that what they went on to achieve with Aon in the next two years would have been possible.
RESULTS
Schemes integrating member options with full buyout
CASE STUDIES
During 2018, Aon advised on fully-funded buyouts for Rentokil and PA Consulting, which were two of the largest exercises that we have ever seen. Both of these exercises integrated member options into the buyout process.
Expected evolution of the buyout deficit at the start of the project.
SENIOR Consultant
During 2018, Aon advised on fully-funded buyouts for Rentokill and PA Consulting, which were two of the largest exercises that we have ever seen. Both of these exercises integrated member options into the buyout process.
Although the parent companies of the two schemes were very different, a few years ago they both shared a common goal – to secure member benefits and free their businesses from their large pension scheme obligations. They were both keen on reducing risk, but their buyout targets were a long way off without a large cash injection.
In recent years we have seen member options exercises being successfully carried out in advance of approaching the insurance market to bring down the cost of the buyout premium. What if we were able to integrate these exercises and carry them out at the same time, rather than treating them as separate projects?
PARTIAL TRANSFERS
4
IT SOUNDS LIKE A WIN-WIN, SO ARE THERE ANY PITFALLS?
Complexity
Administration
Offering partial transfers is seen as an extension to the full transfer process
Member decision by size of transfer
Following the introduction of pensions freedoms, most schemes have experienced an increase in members transferring out to take advantage of pensions flexibilities. However, for members, the transfer decision leads to a ‘binary’ choice between long-term security from the regular income of a defined benefit pension, versus greater flexibility from transferring to the defined contribution world.
RICHARD COOK
THE BEST OF BOTH WORLDS?
Currently around 1 in 10 schemes offer a partial transfer option alongside full transfer values - it's likely more schemes will be considering this option going forwards
SO, HOW POPULAR IS THIS OPTION?
Schemes offering a partial transfer option alongside a transfer value at retirement
Partial transfers will not be right for all schemes and they need to be carefully structured to reduce complexity. Given the benefits, we think more schemes will be considering this option going forwards.
We have talked about the potential advantages of offering members a partial transfer option, but there are some potential pitfalls to consider when setting up such an option.
First off, although it may be a valuable option for a wide range of members, it has the danger of leading to member disengagement if not communicated properly. Clear and engaging communications that do not overwhelm members are therefore vital to realise the benefits.
Secondly, there will be administration considerations when the option is first set up to ensure the administrators can calculate the correct portion of benefits to transfer and the correct portion to put into payment at retirement. Administrative challenges can be reduced if the option is well designed – administrators are used to processing a cash lump sum option on behalf of most members at retirement; a partial transfer option would work in a similar way. Options to reduce the administration burden include limiting the availability of the option to ‘at retirement’ only and to limit the offer to fixed proportions, such as 25%, 50% or 75% of pension.
COMPANY EXTENDING OPTIONS FOR ITS EMPLOYEES
CASE STUDY
Ford Motor Company Limited recently put in place a standard partial transfer option for its 8,000 active employees to consider at the point of retirement. The Company, Trustees and Union were concerned that only offering the option of a full transfer was too much of a binary choice for members between an income from the Ford Pension Funds or transferring all their benefits to an alternative arrangement. The view was this could lead to significant risks for some employees and so they worked closely via a joint working group to address these concerns.
task
solution
A partial transfer was one of the solutions decided upon, along with increased communications and an online and paper-based service to help educate employees. Members are offered the option to transfer 50% of their pension at retirement and retain the rest in the fund, with those deciding to take up the option benefiting from defined benefit pension, defined contribution flexibility and retaining an ongoing link with the group.
The option was made simpler to administer and for employees to understand by providing one partial transfer option of 50% at retirement, along with the full transfer option. The more complicated GMP slice of pension is transferred out first, leaving the scheme with a simpler set of benefits in respect of partially transferring members.
It is early days, but Aon’s 2019 Member Options Survey showed that, where a scheme provides members with the transfer option at retirement, slightly more than one in ten schemes offer a partial transfer option – with the flexibility more likely to be found in larger schemes. Given the advantages, why are more schemes not doing this?
The most likely reason is that schemes have only recently started considering the support they provide around full transfers – such as communications, online tools and IFA support. Offering partial transfers is seen as an extension to the full transfer process and this is only just starting to make it onto the agenda for most schemes.
what are the investment considerations?
5
Poor cashflow management can lead to:
Trustees should be mindful of the impact on a scheme’s investment strategy before, during and after member options exercises. Investment considerations include:
Caroline Allensby-Green
Cashflow management
The most appropriate approach will depend on the size of the scheme, the level of hedging in place and the popularity of any member options exercise. For example:
These strategies have merits and d rawbacks, depending on scheme circumstances. Nevertheless, we welcome the increased focus on managing cashflow risks, which is a key consideration for all schemes. It is important that trustees have a robust plan in place for managing both expected and unpredictable cash outflows. Because member options exercises can lead to increased (and less predictable) cash outflows from schemes in the short term, cashflow management can become of even greater importance. The key is to have a well-documented plan in place, a robust process to reduce operational risks and sufficiently liquid assets that can be sold at short notice and at limited transaction cost. The nature of the asset to be sold can also be important, because a more stable asset is less likely to be sold at a temporarily depressed price.
In this chapter, we focus on the interaction between member options and these considerations, identifying practical steps trustees can take to plan for and manage the investment impact.
Impact on required return
There has been a growing interest in recent years in cashflow driven investment strategies which aim to match some or all of a scheme’s regular cash outgoings.
• A need to sell assets at short notice, when prices may be temporarily depressed • Higher transaction costs from asset redemptions • A greater governance burden for trustees
Have a well-documented plan in place
Impact on pricing of bulk annuity investments
Interest rate and inflation hedging
cashflow management
LDI design
Member options have an impact on the liabilities, which in turn affects liability hedging design. For example:
A PIE exercise will reduce the inflation sensitivity of some of the scheme’s liabilities. If this is not reflected in the LDI solution, and all else being equal, the scheme will become over-hedged to inflation relative to the trustees’ target
Transfers reduce the value of the remaining liabilities in the scheme, which can result in the scheme becoming over-hedged relative to the target hedge ratio if the LDI solution is not adjusted
Three ways of updating a liability cashflow benchmark:
Re-doing
Re-casting
Re-scaling
In our 2019 Member Options Survey, 8% of schemes had seen their liabilities reduced by more than 5% as a result of transfer values being paid out. This was broadly matched by around 10% of schemes updating their liability hedge by a ‘re-scale’ or ‘re-cast’ approach. The importance of maintaining an accurate hedge will depend on the circumstances of the scheme. For example, better-funded schemes with high levels of hedging are more likely to place a greater emphasis on maintaining an accurate LDI hedge, because an inaccurate hedge may become one of the largest remaining risks in the scheme.
Note: example only for a large scheme with a high hedge ratio. Clients should seek specific advice in relation to their schemes
Why does this matter?
If the inflation sensitivity of the liability benchmark differs from the underlying liability by 10%, then for a scheme with assets of £100m, a 0.5% shift in inflation could result in a £1m difference between where the asset value is expected to be and its actual position.If there is a mismatch in the present value of a liability benchmark versus the target liabilities of a similar magnitude, then there will be a similar financial impact from interest rate yield movements.
Required return
It is possible that funding improvements resulting from member options exercises could reduce the required return on the scheme’s investments. In other cases, significant cash outflows can exacerbate the consequences of under-funding, because a smaller asset base needs to ‘work harder’ to close the scheme’s deficit.
Funding gains from member options exercises may make bulk annuities more affordable
For example
A scheme with £100m liabilities and £90m assets requires c.1% p.a. asset outperformance to become fully funded in 10 years (assuming no deficit contributions are made). To illustrate the principle with an extreme example, if £50m of benefits are transferred out, the scheme will have £50m liabilities and £40m assets, and will require c.2% p.a. outperformance from the residual assets to meet the same goal.
Bulk annuity investments
Planning for member options exercises
Funding gains from member options exercises may make bulk annuities more affordable. By reducing uncertainty (for example, a reduction in inflation risks following a Pension Increase Exchange exercise), insurance premiums may also fall.
In our view, the best way to plan for the investment impact of member options exercises is to analyse the expected cashflows from a scheme over time, with different member options outcomes. Various stresses can then be applied to test the resilience of potential investment strategies.
For example, we can address questions such as ‘if there is a 20% take-up rate in an ETV exercise, and an LDI collateral call occurs around the same time, are the scheme’s assets sufficiently liquid to meet these payments? And what will be the impact on remaining asset liquidity?’
Example cashflow analysis
This type of analysis can help trustees move forwards with a member options exercise with greater knowledge of the possible investment impact and the steps required to mitigate cashflow risks.
Re-do
Re-cast
Re-scale
