Posts Tagged ‘Transfer Values’

Angela Burns

There have been huge increases in the numbers of individuals taking transfer values from their defined benefit pension schemes over recent years. This has been driven by numerous factors, one of which being all time low interest rates, giving us record high transfer values. Individuals have been seeing multiples upwards of 30 times pension in many cases, which when added to the increased flexibility now available, is proving a mixture all too difficult to resist.

With the Bank of England raising interest rates for only the second time in a decade (up 0.25% p.a. from 0.50% p.a. to 0.75% p.a.), having been stuck at 0.5% for over nine years, this change is likely to have an negative impact.

Gilt yields rising results in liabilities falling, all other things being equal, so we are likely to see a reduction in transfer values. At this stage the impact is likely to be relatively modest with a 0.25% p.a. increase in gilt yields reducing a £150,000 transfer for a 45 year old by about £10,000 and for a 60 year old by about £5,000.

Such a change means that the amount transferred needs to return a lot more to be able to match, or improve on the benefits offered by the scheme. This change is likely to see the investment return needed to match or improve on the benefits increase by around 0.5% p.a. for the 45 year old and by 1.0% p.a. for the 60 year old.

The investment return required in the period until retirement (also knows as the critical yield or in recent parlance ‘personalised discount rate’) is often seen as a benchmark which needs to be reached before an adviser can even consider if a wider discussion on transferring benefits is even possible. So lower transfer values, which result in higher critical yields, is likely to mean that fewer people reach the threshold and so many more stay with their existing scheme.

For employers incentivising staff to transfer through the use of enhanced transfer values, lower transfer values will mean that higher top-ups are required to reach an attractive level, placing a greater cash requirement on the employer and therefore making exercises less attractive. Alternatively, retaining the same top-up value may result in a lower take-up.

As the transfer value basis in some schemes may not react immediately to changes in gilt yields this may provide individuals with a short window of time before any changes are made. In addition, individuals who are currently within their transfer guarantee period may be keener to have their transfer value processed within the guarantee window, to ensure they take advantage of a higher value than would be likely to be available post the guarantee, given the gilt yields rise.

Further rate rises may be on the horizon. We don’t have a crystal ball to see what will happen in the future, however, current perceived wisdom seems to be that rates will slowly rise over time on the basis that they can’t possibly stay this low. However, this has been the general belief since around 2009! Some think we have entered a ‘new norm’ where rates are unlikely to rise materially.

Individuals and sponsors should take care when considering transfer values or transfer exercises as gilt yield increases can materially affect the ‘real’ monetary value of any transfer, with timing now increasingly important.

Richard Smith

There have been a plethora of news articles in recent weeks commenting on the sharp increase in the levels of transfer values available from defined benefit pension schemes. Whilst these values have dropped back from their peak, they still remain substantially higher than they had ever been previously to this. The sometimes eye-watering sums on offer are now tempting even the most prudent to consider cashing out their benefits. However, some commentators are warning members against losing the longevity protection provided by a DB scheme and taking on all the investment risk themselves. What are members to do?

Subject to a few exceptions, anyone who is a member of a funded defined benefit pension scheme and has not yet started to draw their benefits, has the right to “transfer out” their pension and pay the cash value into another pension scheme. Doing this gives members much more flexibility in how they take their pension – increasing the cash available (even potentially taking it all as one large cash sum), re-shaping the benefits to release more value in the early years of retirement, and could also lead to significant increases in survivor benefits if the member were to die early. Read more »

Rachel Graham

The result of the EU referendum on 23 June 2016 was a surprise for many of us. It was difficult to predict the detrimental impact on gilt yields which occurred in the weeks following the result! With many UK pension schemes invested in gilts, the historically low gilt yields which resulted has led to pension schemes being faced with significantly higher liabilities. Transfer values for deferred members of DB schemes have also increased. A transfer value is a best estimate of the cost of providing the benefits to the member in the scheme and these too are calculated with reference to gilt yields.

Trustees may be concerned if their scheme experiences an increase in transfer value requests post Brexit. Trustees are ultimately responsible for the security of benefits of ALL members- those who wish to transfer and those who remain in the scheme. Read more »

Laura Cumming

I recently had a need to review the Regulator’s Guidance on Incentive Exercises which was updated in December 2010. While on the face of it the principles are not too different to the original guidance I thought it worth re-iterating a few of the main points.

An Incentive Exercise (formerly known as an Inducement Exercise) is where an offer is made by an employer to a Defined Benefit scheme’s members to transfer out or amend benefits, usually in return for some form of financial incentive, with the intention of reducing liabilities or risk in the scheme.

These exercises remain a viable starting point for any company tackling the funding levels of a Defined Benefit (DB) scheme and, as long as they are dealt with in accordance with the Regulators guidance and with the input of the Scheme’s Trustees, offer an attractive alternative to many members if pitched at the right level.

The Pensions Regulator tells Trustees Read more »

Alan Collins

I came across an interesting panel discussion in the current issue of Engaged Investor Magazine, where a number of industry experts were asked for their views on developments in pension scheme de-risking. My views on the questions addressed are as follows:

Q1 – Many companies are not able to carry out full buyout in one go. What multi-layered approaches can they take to de-risk their schemes?

The most important first step is for the employer and trustees to agree a common goal for the scheme. In almost all cases (especially closed schemes), the ultimate goal should be to secure all benefits with an insurance company and wind-up the scheme.

An agreed, transparent objective will then set the path towards the ultimate goal. There are many alternative partial de-risking measures that can be taken, most of which can work in parallel. These include employer led exercises such as:

  • a transfer exercise, offering members the opportunity to transfer their scheme benefits to an alternative arrangement via an incentive in the form of an increased transfer value, or sometimes a cash payment; or
  • a pension increase swap exercise, where members give up future pension increases in return for a higher initial pension.

These exercises can generate significant savings to the employer relative to the ultimate cost of buyout. They are unlikely to generate significant immediate savings on ongoing funding costs or FRS 17, though they do contribute to reducing the risk profile of the scheme.

These exercises can be run in tandem with providing opportunities to members to retire early from the scheme, which can generate savings on cash commutation and also insurers prefer the “certainty” of pensioners rather than deferred members. In conjunction with the company, the trustees can also move towards a lower risk investment strategy, using bonds or LDI type investments, and also consider partial insurance such as pensioner buy-ins. I would caution that for schemes with young pensioners or where the pensioner group makes up a small proportion of the liabilities, it may not be efficient to use significant resources of the scheme to obtain insurance covering only a small portion of the liabilities. There are also opportunities developing in the market to enter into a staged buyout process with insurers, where the terms are agreed up front but the whole premium is not required at the outset.

Nor should the trustees overlook the potential for non-cash funding, such as parental guarantees, contingent assets or “asset-sharing” with the company, such as the whisky-bond deal completed by Diageo .

Q2 – In what ways did trustees’ de-risking choices change during 2010?

The choices remained broadly unchanged, though it was a year of massive change in defined benefit pensions, particularly on the legislative front. The single largest issue was Steve Webb’s RPI/CPI summer bombshell, which is expected to have a significant effect on pension scheme funding. Most schemes are expected to see a reduction in liabilities of between 5-15% depending on the nature of the scheme rules.

This meant that larger exercises tended to be shelved as trustees waited for the full impact of the change in inflation measure to come through. I would say the introduction of innovative non-cash funding solutions and the focus by trustees on obtaining enforceable security was the other main development in de-risking.

The emergence of longevity swaps was supposed to be the big-ticket item for 2010, but this remains the preserve on the very largest of schemes and I don’t see that changing any time soon.

Q3 – What early steps, such as data cleansing, communications and legal considerations, should be undertaken before entering into a de-risking activity?

The quality of pension scheme data can be highly variable. It can be held in multiple formats, for very long periods of time and is often subject to major change (e.g. after mergers, systems migrations, legislative changes). When entering a liability management exercise and moving ultimately towards winding-up a scheme, every effort must be made to ensure that members have the correct pension entitlement. The key message on data is that full and accurate data will reduce the cost of staff communication and liability management exercises as well as ultimately buying annuities as it helps to reduce underwriters’ pricing for uncertainty.

The communication process is also vital, both between the employer/trustees and the member. Possibly even more important is the communication between a financial advisor and the member during an employer’s de-risking exercise.

The need for proper legal input almost goes without saying, but the emergence of the RPI/CPI issue and continued problems with sex equalisation and other scheme amendments, mean that assistance from your friendly pensions lawyer is a necessity, not a luxury.

Neil Copeland

Apparently the Baiji (Yangtze River Dolphin) is amongst the rarest mammals in the world. It may even be extinct. Clearly there’s a fine line between being very, very rare (i.e. only one left) or being extinct (none left). The last definitive sighting was in 2004. It was declared functionally extinct in 2006 but video footage of what might have been a Baiji was taken in 2007 raising the possibility that there was at least one survivor out there, wisely staying well clear of humans.

When it comes to pensions legislation common sense is nearly as uncommon, but we appear to have a confirmed sighting in the DWP’s response to the consultation on the abolition of contracting out on a defined contribution basis.

Now I have never understood why one of Margaret Thatcher’s most lauded sound bites was “You turn if you want to. The lady’s not for turning!” Not turning in the face of irrefutable danger or logic is not a particularly common sense position to adopt. Indeed history and experience teach us that a U turn is not necessarily a wrong turn.

If only the Titanic had been able to perform a timely U turn. Or Thelma. Or Louise.

So clearly I welcome the Government’s common sense U turn on the abolition of transfers from contracted out pension schemes. I had blogged previously about the iniquities of the original provision, sneakily hidden in the regulations regarding the abolition of DC Contracting-out, which could have outlawed such transfers. Respondents to the DWP’s consultation on these Regulations presented a factual and rational analysis as to why, for some people, based on their particular circumstances, transferring out of a contracted out defined benefit scheme is clearly in their interests. A lesson that the Pensions Regulator could usefully learn.  More importantly the DWP appears to accept that the decision about whether or not to transfer should be made by the member, having taken impartial advice, rather than be imposed in some crass one size fits all, we know what’s best for you, diktat from the nanny state.

As I previously noted the draft regulations did rather smack of an admission that the FSA was failing in its duty to regulate this particular area of advice. Rather than address that shortcoming they have tried to foist the responsibility for regulation of transfers onto pension scheme trustees through the Pension Regulator’s “guidance” framework. Some commentators had responded to this development by suggesting that it was wrong and possibly illegal for trustees to fully embrace the Pensions Regulator’s guidance on enhanced transfer value exercises. Given this, abolition may have seemed like an easy option, despite its inherent unfairness.

Yes members need protection from unscrupulous advisers but that is why we have the FSA and, from 2013, the Consumer Protection and Markets Authority. It is certainly not why we have pension scheme trustees, who have a difficult enough job to do without being forced to do the regulators’ jobs for them.

We have consistently argued that properly structured and funded enhanced transfer value exercises are a legitimate approach for employers to engage with their scheme members with a view to managing their liabilities. They also provide members with an opportunity to properly review their retirement planning with a professional adviser.

So credit where credit’s due, well done to the DWP for changing its mind on this one. It will be interesting to see if the Pension Regulator’s finalised guidance on enhanced transfer exercises will also be leavened with common sense.

Now if the DWP could only be persuaded to approach the question of GMPs in the same manner as it has recently dealt with Protected Rights – that is, just make them disappear – then that would be further evidence that, after years of languishing in neglect, common sense is unexpectedly back in vogue at Westminster.

Alan Collins

Open market option for all?

I read with interest the guidance to individuals with money purchase benefits published on 2 November by the Pensions Regulator (tPR) and echo comments from Pensions Minister Steve Webb that “choices we make at retirement are amongst the most important of our lives” and “shopping around can provide better value for money and significantly boost retirement income”, and those from tPR’s acting Chief Executive Bill Galvin who has stated that “members could miss out on a higher retirement income because they are not well-supported in making good choices”.

The engagement of the Pensions Regulator in the education process within occupational defined contribution schemes is welcome, and emphasis has rightly been given to the potential benefits to members of obtaining independent financial advice. In particular, the guidance should act as a reminder to Trustees of schemes which provide both defined benefits and money purchase benefits that the members with money purchase benefits deserve due care and attention.

However, the guidance appears to be in stark contrast to the regulatory approach and pending legislation governing defined benefit arrangements, particularly those containing contracted-out rights. The “presumption of guilt” surrounding transferring benefits out of a defined benefit arrangement, and the potential end to the ability to transfer contracted out rights from defined benefit to money purchase arrangements in 2012, would seem to be at odds with the ethos of encouraging members to make choices which best suit their own circumstances.

For example, the value contained in some defined benefits (such as a prescribed level of pension increases or spouse’s pensions where the member is single or where the spouse already has a substantial pension), could be used to provide alternative benefits which are more suited to the needs of the individual concerned. Also the value of a money purchase pension pot can be retained on the death of the member, whereas this event may cause the value of a defined benefit to be significantly eroded .

I would therefore ask that members of defined benefit arrangements continue to be afforded the same opportunities to exercise their “Open Market Option” in the future.

Ian Conlon

I recently prepared a report in relation to pension on divorce where the husband was retired and in receipt of a pension from the BT Pension Scheme. The pension scheme member’s wife was over age 60 so was in a position to draw the proceeds of a pension share immediately. The CETV was a multiple of approximately 20 times the pension, so for a pension of £20,000 per annum, the CETV would be approximately £400,000.

I estimated that, if the pension scheme allowed the Pension Credit to remain within the scheme, then the ex-spouse would receive a pension of around £10,000 per annum from a 50% Pension Share. However, as the scheme insists that the ex-spouse takes the proceeds of the Pension Credit externally, then the ex spouse could expect to purchase an annuity providing an income of around £6,600 per annum (increasing in line with price inflation as per the scheme benefit). So the result of applying a Pension Sharing Order of 50% was an immediate loss of joint income of around £3,400 per annum, with this loss increasing over time in line with price inflation, equivalent to a 17% reduction in overall income (or profit to the pension scheme depending on your perspective).

An Attachment Order was considered but the cost of insuring against the risk of the husband dying before the wife ruled this option out. Both parties needed an income stream so offsetting was not an option. The only way of maintaining the value of the pension assets was to remain married! Also not an option!!

At the same time in a parallel universe the Pensions Regulator is telling scheme trustees that, if an employer wishes to provide an enhancement to encourage pension scheme members to transfer out, then the trustees should start from the presumption that transferring out of a defined benefit pension scheme is not in a member’s interests. So, in the case where the trustees make the decision, how can they come to the view that it is appropriate to force the ex-spouse to transfer his or her benefits out of the scheme? Are trustees looking after members interests in this case?

This is a far from uncommon scenario; those who receive benefits from a Pension Sharing Order are the only group of beneficiaries associated with occupational pension schemes who lack any level of meaningful protection. Pension scheme trustees should be challenged as to the rationale for their approach given that retaining the benefits within the scheme adds no extra liability.

Brian Spence

At the end of July by the Department of Work and Pensions published a consultation document entitled  “Abolition of contracting-out on a defined contribution basis: consultation on draft consequential legislation.

Hidden within the document (it takes some finding) and then cross referencing  the Contracting-out (Transfer and Transfer Payments) Regulations 1996 (what would we do without Pendragon Perspective!) and it becomes clear – no transfers of GMPs or of post 1997 contracted-out rights will be permitted from DB pension schemes to either occupational DC pension schemes or to personal pensions from 6 April 2012.

Who saw that coming?  The vast majority of DB pension rights are now locked into the DB pensions funding regime until the last member dies, a regulated buy-out is transacted or the sponsor goes bust.

Deferred pension scheme members who may have been thinking for some time about transferring to a personal pension will need to make their mind up soon.  There is a minority of people who would be well advised to take transfers, for example some of those in poor health or without dependents.  Schemes will undoubtedly have to deal with an increased incidence of transfer requests for 18 months and virtually none thereafter.

The whole new industry that has developed around transfer incentives will come to an end.  From the point of view maximising individual choice this is not a good development but there are a number of practitioners who have advised employers to conduct enhanced transfer value exercises in a manner that will in all likelihood result in many of those members who have been advised to transfer coming to regret the advice they have received.

The Pension Regulator’s recent consultation on the subject seemed a rather limp response to some very poor practices on the part of some advisers but maybe this latest announcement goes some way to explaining why.  If the Pensions Regulator and the Financial Services Authority cannot regulate Enhanced Transfer Value Exercises (and certainly over the last few years it is clear that they have failed to do so) then banning transfers seems a logical step.  Whilst we understand the move by the new Pensions Minister Steve Webb, it is a pity that the price of this regulatory failure is to deprive the minority of people who could gain by transferring of that option. It is a price worth paying to protect the majority from the detriment caused by the predatory and harmful practices that have developed.

The whole area of calculating transfer value equivalents to DB benefits has been fraught with difficulty – the mis-selling of the late 1980s and early 1990s having been improved on by some firms only a little in more recent years.

There does however seem to be a high chance of a firesale over the next 18 months as individuals take a final look at their affairs and decide once and for all on whether to transfer out to a personal pension or DC scheme and as employers contemplate making a final and best offer to incentivise deferred members to take their liabilities and leave the scheme.  Hopefully employers and trustees will take the proposed new Guidance from the Pensions Regulator to heart and conduct these exercises in an appropriate manner.  The appointment of an independent trustee in such cases to eliminate conflicts of interest would be good start.

We have argued several times that transfer incentives properly conducted are a legitimate and proper technique for employers to manage their liabilities and at the same time would be happy to advise any employers looking to achieve a fair win/win result in the limited time that now appears to be available or indeed any trustees seeking to meet the demanding new expectations of the Regulator.

Brian Spence is a founder of actuaries Spence & Partners Limited and a director of independent trustee Dalriada Trustees Limited.  You can follow him at @briandspence or @PensionsEndgame on Twitter or link to him on LinkedIn.

Follow @SpencePartners and @DalriadaTrustee on Twitter.

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