Enhanced transfer values-is there a middle way?

Many UK pension schemes have seen an opportunity to offer members an attractive exit route from the scheme by offering an attractive transfer often combined with a cash bung.

These “ETV” arrangements are attractive to Finance Departments as exiting members reduce the strain of the pension on the corporate balance sheet which more than compensates for the upfront cost of the bung. Members get excited about some cash in hand and a chance to be shot of any dependency on a past (or even current) employer.

But for many Trustees and employers, ETVs are a step too far. After all, the DB company pension scheme was set up to give members with a guaranteed pension and the Trustee’s job is to ensure those pensions are paid in full. Why should Trustees duck such a responsibility? The Company may want to get rid of its obligations but they must also be mindful of their reputation , especially where industrial relations may be strained. Unions do not generally look kindly at ETVs. David Norgrove- the Pensions Regulator doesn’t either

So ETVs tend to polarize opinion and the argument is currently very”black and white”.  A deeper examination of the nature of the liabilities that a pension scheme has when guaranteeing someone’s pension reveals that much of the problem is associated with guaranteeing pension increases to members once they have retired.

In fact, the impact of guaranteeing pension increases is huge, disproportionate to the perceived or even the real benefit to members. Put another way, members would be amazed at how much more pension they would receive if the Trustees were to offer them the choice of either a level or increasing pension (and if the value of the uplifted pension was deemed fair).

It is a lot more palatable to Trustees and employee representatives to offer a choice of an enhanced level pension or an increasing pension, especially where the choice is accomapnied by proper advice (of course the longest living members would do better from an increasing pension).

Some Defined Benefit schemes have looked at this “middle way” and a few have offered this choice to members. The results have encouraged with members splitting 50/50 between those who wish to retain their increases and those who want more money in their early years of retirement.

Even with 50% of members declining the offer of a level pension a Defined Benefit pension scheme’s liabilities are likely to reduce by 3.5%. That may not sound a lot but in accounting terms it is a massive advantage to an employer. It is enough to give an employer breathing space – perhaps the opportunity to invest in a new strategy- perhaps enough to keep the employer in business.

There’s a lot of talk about “risk sharing” between employers and members of DB pension schemes. “Risk sharing” has become a euphemism for booting members out of the pension scheme- a middle way is needed.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in de-risking, pensions, Retirement and tagged , , , , , , , , , . Bookmark the permalink.

2 Responses to Enhanced transfer values-is there a middle way?

  1. Calvin Allen says:

    Henry,

    I’d agree with your concluding paragraph – but I’m much less sure about your enthusiasm for ETVs (yes, I’m one of those trade unionists!). Actually, you identify in your post two different approaches which employers have adopted: a bung essentially to go away; and an ability to swap some indexed pension for a higher amount of non-indexed pension.

    A bung to go away might be an attractive offer when you’ve had a bad experience with an employer – but when you probably can’t find another DB scheme into which to sink it, your only option is a DC pot. You may well end up on your feet but assuming all the risk, and eventually having to swap for an annuity, will for many be a step much too far. In these days of the PPF, taking your money with you as insurance against your old employer going bankrupt is less of a concern than it was. For most scheme members, it’s not a good choice.

    Indexation tends to be an under-valued benefit of pension scheme membership – why this is so, when people coming up to retirement who lived (and saved) through huge levels of inflation in the 1970s and early 1980s, I don’t know. Perhaps it’s the simple attraction of more money up-front (in exchange for a non-indexed element), perhaps it’s the attraction of the enhancement. Perhaps people don’t think they’ll need that much money later in their retirement; and clearly there’ll be some thinking it’s better to have it all now because you don’t know how long you’ll live in retirement.

    Well, that’s true – but you can predict it with a reasonable degree of accuracy. And these days you’re likely to live 25 years plus in retirement. Thinking back to my first salary 25 years ago, I remember how little that was and a pension (or even part of one) based on that right now would be very unattractive.

    The trouble with indexation swap packages is that they look attractive – but the longer you live in retirement, the less good they look – and, ultimately, the more people may well end up relying on the state. As you say, that’s not what occupational pensions are for. The difficulty here is that people don’t know who to trust; they don’t know how to work the calculations for themselves; and they’re simply not sufficiently educated about pensions. ‘Beware a pension scheme sponsor bearing gifts’ would be my approach!

    When the DWP halved the minimum indexation requirement a few years ago to 2.5% (i.e. to below the long-run level of annual inflation), its costs analysis indicated to me that the saving was so low as to be almost hardly worthwhile, in the context of saving schemes. I can’t recall the exact figures off-hand but they seemed small (and certainly too small to do anything about saving schemes, which was supposed to be the intention).

    The big issue in pensions provision is clearly the unforeseen and increased longevity in retirement. Occupational schemes have not dealt with this at all well – they have tended to adopt a head in the sand attitude, and then sought a panicky response by transferring the risk to the individual. However, that’s not dealing with the problem at all – it’s simply passing it on. And it remains true that those in the worst position to bear such risks are those to whom they are being passed, whether they be in DC schemes, in ETVs or in indexation swaps.

  2. henry tapper says:

    Calvin

    The big trade off is as you described it- longevity v early days cash and it could be argued that the swap I’m describing takes advantage of peopl’s refusal to recognise they are likely to live aslong as predicted (I’ve blogged on this).

    But- and it’s a big but, he big win here is that trustees can accelerate the level pension beyond a “cash neutral” position and to the advantage of the member and still put the scheme in a better accounting position.

    If the scheme becomes 3.5-5% more solvent by swapping out its indexation- with member consent- then a lot of members are going to have a lot more security in retirement and perhaps more secure jobs too.

Leave a Reply