James Greer of Old Mutual is reminding financial advisors that there’s a risk of advising clients to stay put and not take a DB Transfer Value.
Our data suggests that only about 15% of transfer values applied for are taken up, these are produced at substantial costs, so the risk to scheme funding of frivolous enquiries is indeed substantial. But I don’t think that James was thinking of the impact on the ceding scheme of frivolous CETVs!
The risk he had identified was “regret risk” where the client felt he had missed out for lack of encouragement to take the cash equivalent. A client who saw a CETV fall by 10% might have foregone tens of thousands in his or her pay-out. Similarly , a client who had invested a CETV in equities over the past year would have had the double-win of 20% + growth on top of a bumper CETV.
I could go on hypothesising on the possible “regrets” that might inflame a client to put a gun to the adviser’s head. But Susan Hill has said it very well.
“The biggest reason for not transferring is that the client has never invested before, and is not happy with anything riskier than cash,”
However, she said it was “dangerous” to advise someone to stay put – especially in writing – as there was not precedent for what would happen if the client complained. She added that she doubted whether her professional indemnity insurance would cover it.
“I don’t think anybody in our industry has sat down and worked out what we should be doing when a transfer is not appropriate,”
As a result, Ms Hill said she simply did not take on clients whom she judged were unsuitable for a DB transfer.
How a transfer value works
I have been sent two comments from actuaries complaining that a myth is developing that high transfer values as a result of low gilt rates. This is only partially true. The Transfer Value is calculated using a discount rate on the future liability that reflects the actual investment strategy of a scheme. A scheme which invests in equities will reflect the anticipated return on equities and one that invests mainly in gilts, a lower gilt-based discount rate.
Two schemes with identical benefits could produce widely different discount rates for the same person and this is not an actuarial perversion. This is the appliance of the law.
These nuances are critical to getting people to understand what appears a transfer-value lottery. In the comments section of the FT adviser article are insinuations that schemes are trying to influence outcomes through the CETV calculation process. In my experience, this is not the case, there is no discretion in the calculation of CETVs as the rules that apply to them, apply equally to the valuation of all scheme benefits.
Is there a CETV lottery?
From the member’s point of view, there certainly is. If you are in a scheme that simply uses the gilt rate to discount liabilities you might get a CETV at a multiple of 40 times your pension and if you are in an equity invested scheme, your CETV might be 50% smaller. This is no reflection on the quality of what you are giving up!
Understanding the value of indexation, of spouse or partner benefits and of the early retirement offers available from the ceding DB scheme is important. But so too is understanding why a certain discount rate has been used.
The discount rate should infact be the critical yield, since by applying it in reverse (e.g. to the CETV as a reducer) you should end up where you started.
No doubt some lawyer will be reading this wondering whether the discount rates themselves are a matter for litigation. Having read a few reports on how discount rates are calculated, I think it highly unlikely that such a challenge should be made.
Advisers who work in the CETV advise market, need to be as thorough in their understanding of how the CETV works as the actuary. Otherwise they should do as Susan Hill advises.
The article in FT Adviser is here;