Inflation has never been higher. At least not in my lifetime, as I desperately cling onto my twenties. The UK’s Retail Price Index (RPI) rose to 7.5% in the 12 months to December 2021. This is potentially bad news for Defined Benefit (DB) pension schemes, as benefits are typically inflation-linked, albeit often capped at a certain level. High inflation can therefore significantly increase scheme liabilities.
So how can trustees and sponsors of DB schemes reduce their inflation risk? One option is to take advantage of high inflation levels, which makes now an excellent time for schemes to consider implementing a Pension Increase Exchange (PIE) exercise. PIE exercises reduce inflation risk, provide members with more choice and saves money (and who doesn’t like pie, right?).
A PIE exercise usually provides members of DB pension schemes with the opportunity to receive a higher pension today, in exchange for forgoing future pension increases. While PIE is generally offered to current pensioners only, deferred members can also be offered a PIE as part of a flexible retirement package. The option is popular with members, who usually prefer a higher pension in the short term when they need it most. A typical exercise can see 1 in 2 members engage with a financial adviser, and around 1 in 3 members then accept an offer. When designing a PIE offer, pension scheme sponsors often aim to find the ‘sweet spot’ of maximising member take-up and overall savings to the scheme, by varying the amount of the future forgone pension increases that is passed back to the member as a higher initial pension.
High inflation increases the value of the potential inflation-linked increases that members can forgo, which means that schemes can currently offer members a larger uplift to their current pensions. Naturally, this leads to higher engagement and take-up from members.
A successful PIE exercise can save schemes millions of £s, but the main driver is to reduce a scheme’s inflation and longevity risk. With many schemes now agreeing journey plans to de-risk, with the aim to secure their liabilities with an insurance company in the future, a PIE can help support this objective. A PIE can be used as a key lever to significantly improve insurer pricing and accelerate timescales to buy-out.
Some schemes have held back from undertaking a PIE recently, due to the uncertainties arising from RPI reform and GMP equalisation. However, following the November 2020 announcement that RPI will be aligned with CPIH from February 2030, together with the GMP conversion guidance released by PASA in 2021 and now the trend of high inflation, there is sufficient guidance available to take these projects forward.
We are increasingly seeing schemes combining a PIE with GMP conversion, to further increase the amount of pension that can be exchanged as part of an exercise. Combining the two exercises also leads to increased member engagement, better member outcomes and cost savings that more than offset the costs of GMP equalisation. Over 25% of typical PIE costs could be saved by running these two projects alongside each other. Stages such as data cleanse, calculations, member communications and implementation can all be made more efficient by running together.
For those reasons, sponsors and trustees should now review whether a PIE is appropriate for their scheme and whether synergies can be achieved by building it into their GMP equalisation project. Now is the perfect time to act to maximise benefits, particularly as those new year diets will soon be coming to an end – with both schemes and members being keen for a piece of the pie…