Consultancy Services - Liability Management

Flexibility at Retirement for members

Flexibility at Retirement for members

Lets Talk - Early Retirement

Lets Talk - Early Retirement


Rob Dales FIA Rob Dales FIA

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:

  • the scheme liabilities are reduced on a one-off basis every time pension is commuted for cash - a smaller scheme is inherently less risky and less volatile in absolute terms 
  • pensioner liabilities are normally priced less conservatively than deferred liabilities, therefore the cost of buying out scheme benefits is likely to reduce following an exercise with a reasonable take-up rate.