Is there too much focus on discretionary pension increases? 

Discretionary pension increases are in the headlines!

A sharp rise in inflation, coupled with improved funding positions have led to debates between trustees and sponsors: whether to award discretionary increases, and if so, how much. 

Awarding annual (or periodic) discretionary pension increases is not uncommon but a lot of governance time can be spent on the decision. This is, perhaps, understandable given the implications for members’ benefits, funding, and the sponsor’s accounting position, but is the focus fair and proportionate given not all members will benefit?

Pension increases are only one of the many forms of discretionary benefit that a pension scheme can offer. Just as awarding a discretionary pension increase can boost a pensioner’s income, improving option terms, such as the exchange of pension for cash, can do so for those yet to retire.

Is it not too much of a stretch to widen the net?   Why not include early and late retirement and cash equivalent transfer values in the discussion? 

The members of the Boots pension scheme might argue in favour of doing so: those not yet retired saw their early retirement terms change for the worse following a transaction with an insurer in late 2023.

Are we treating non-pensioners “fairly”?

In the midst of the recent high inflationary environment many trustees considered what discretionary pension increase to seek from sponsors. At the same time, UK government bond prices, and with them the value of commutation terms and cash equivalent transfer values, were falling.  Conversely, funding positions were improving. 

So, what is “fair”?

Whether or not surplus should be used for members will be vary from scheme to scheme; the funding position and covenant strength will be key considerations, as will the balance of powers in the rules. 

A further issue is the sponsor’s accounting treatment – a discretionary pension increase will go through P&L. But improvements to member “options” don’t.    

Knowing very little of members’ wider financial positions, it is impossible for trustees to determine which members “need” or even “expect” a discretionary pension increase.  Assessing a member’s “need” is particularly difficult as trustees will not have an idea of their income or resources outside the pension they govern.  A small pension could belong to a short-serving former CEO!

A starting point might be to aim to benefit all members equally, not just the pensioners.  There is an argument for younger members needing a boost: they, after all have felt the pinch of the decline of DB pension provision more acutely, and the Pension Protection Fund’s safety net is poorer the younger you are.

Why is it that most trustees set cash equivalent transfer values based on the legislative minimum when taking a transfer value, having sought individual advice, will be in some members’ financial interests? What about surplus sharing and distribution on wind up – should those taking transfers share in some of the upside from a strong funding position? 

There is no right answer: views will differ.  But surely focusing solely on discretionary pension increases for retired members just doesn’t fit the bill.

A better path

Trustees often need to overcome a series of hurdles to grant a discretionary increase: they require sponsor consent, increase liabilities and risk and impact sponsors’ accounts.

I am not arguing against the granting of discretionary increases but want to highlight that there are other ways to improve member outcomes, and some, depending on the scheme’s rules, may be provided by trustees unilaterally.  

This could mean better commutation terms, reduced (or waived) early retirement factors, better cash equivalent transfer values that reflect a surplus position. 

And don’t forget the possibility of providing financial advice and support to members through the retirement process, or even years in advance as part of a retirement planning process. 

All of these options would align trustees with their members’ interests, come with less risk than a discretionary increase and, importantly, might be easier to deliver and avoid difficult accounting implications for the sponsor. 

In summary, trustees have an obligation to act in the interests of all members, not just pensioners.  

Not all discretionary spend needs to be focused on pensioners.  

With inflation returning to levels below many pension increase caps and funding levels remaining buoyant, it is now time for a rethink.

Matt Smith

- Partner

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