Consultancy Services - Liability Management
Early Retirements
Running a defined benefit pension
scheme is not becoming any easier in the current economic and
regulatory environment. Pension scheme sponsors have been paying
increasing amounts into their schemes in order to get them to a
satisfactory funding level. However this remains a moving target
for most schemes, due for the most part to falling markets and
increasing longevity.
Sponsors who can afford to secure
their scheme's liabilities in the market, via a buyout or buy in
policy, have increasingly followed this route in order to de-risk
their schemes. But such sponsors are in a minority. For the
remainder of schemes, the necessity to de-risk is just as important
if not more. However solutions need to be pursued which will not
require a significant upfront outlay of funds from the sponsor.
One de-risking strategy which can
assist trustees and sponsors to manage their scheme's liabilities,
while providing an increased amount of choice to scheme members, is
the implementation of an early retirement exercise. The exercise
would involve all members aged 55 or over, who are proactively
offered the option to start drawing early retirement benefits from
the scheme. The benefit payable on early retirement would be
reduced, using the scheme's current early retirement factors, to
allow for the longer period over which the benefit is expected to
be paid. Members would also be invited to commute part of their
pension for tax free cash, in accordance with scheme rules and
pension legislation.
How does an early retirement
help in managing liabilities?
Schemes are generally funded on a
conservative basis, so that there is a very high likelihood that
there will be sufficient assets held to pay members' benefits in
full. This is a specific requirement following the introduction of
the Statutory Funding Regulations.
On the other hand, early retirement
and commutation factors are generally calculated on a "best
estimate", realistic basis. As a result, a profit will usually
accrue to the scheme, on the funding basis, every time a member
takes early retirement and/or commutes pension for cash.
The amount of funding profit to a
scheme will depend on how the factors used compare to equivalent
factors calculated using the funding basis. Our experience shows
that this can be substantial for some schemes.
Some second order benefits arising
from an early retirement exercise are as follows: