Why we’re forever blowing (transfer) bubbles!




It’s a shame that Alistair Cunningham’s thought-piece on behavioural bias’ encouraging herds of us to “cash-out” our DB pensions, is behind a pay-wall.

If you are an FT subscriber you can use the link at the end of this article. If you aren’t you’ll have to make do with my synopsis and further thoughts.

Al concludes

It is concerning that the unscrupulous are meeting with the unwise, and the biases that we all share assist the worst possible outcomes, when most individuals should be leaving their final salary pensions untouched.

The article concerns itself with the difficulty of not taking a transfer value. It deals with the dynamics of the adviser/client relationship. The 100% year on year rise in CETV take-up (Xafinity consulting), is having a material impact on the way defined benefit schemes invest and their impact on corporate balance sheets.

One large pension scheme I have dealings with is reporting transfer requests at over £1bn a month, these are materially impacting not just the cash-flow planning of the scheme but its investment strategy. The potential “profit” from restating  FRS120 liabilities after dispensing with CETVs on a “best estimate” basis, looks like a CFO windfall.

Put in lay-man’s terms. CETVs are calculated using a discount rate that reflects the actual asset allocation of the defined benefit schemes. Pensions are accounted for on company balance sheets using a discount rate based on corporate bond yields. Every CETV paid out will reduce scheme liabilities by more than the recognised cost of those liabilities on the balance sheet (unless the scheme is purely invested in bonds!).

We are hearing stories of employers who are not only booking historic gains but booking projected gains based on estimates of the CETV take up in 2017 and beyond. Some employers are booking these CETVs years in advance with whopping great financial windfalls appearing in the 2017 accounts.

Small wonder that we are hearing little from employers or their groups about the phenomenal increase in CETV activity.

The Trustee’s duty of care is to the member

The pension trustee’s duty of care is not to the employer but to the member. For all the talk of “integrated risk management” – this continues to be the case. If I can get the FT to all me to publish Alistair’s arguments in full, I will as they should be in trustee board packs throughout the year; but here they are in summary

Behavioural finance tells us that humans make decisions in ways that reflect their biases, and may not always operate with robot-like logic.

The prospect of poor decision-making is particularly prevalent in complex decisions, especially when they are made infrequently and are irreversible.

Transfer values have gone up in the last year. Individuals “anchor” – retaining recent values in mind, creating a bias towards transferring now.

People assume that falls in transfer values will represent a “missed opportunity” not a change in the costs of providing the defined benefit (pension).

Herd thinking is driving group-think, if it’s good for my colleague it is good for me. The traditional bias towards staying in a scheme can quickly be flipped.

There is a behavioural bias towards over-confidence, people make heroic assumptions about their investment returns while discounting the impact of future inflation.

Eight years into low inflation and an investment bull market, there’s a temptation for advisers to be complicit with this over-confidence, especially when they are the likely managers of the capital generated by the transfers. We are too used to real returns of 6% + over inflation to remember these are unusually high.

Alistair talks of availability bias, by which he means our fetish for freedom. The lure of a huge capital reservoir rather than a prescribed income stream is vivid and real. The reality of retirement is a drop in income to a floor of £155 p.w. (max). This is not so easy to visualise.

Add to these bias’ the “regret risk” of an irrevocable decision either to stay (and see CETVs fall with gilt rates) or leave (and see CETVs fall below return expectations) and the angst posed by consideration of the DB transfer option just grows!

Alistair also identifies risks surrounding a lack of pension education – especially among the well-educated professional classes. Pensions are different from other financial products, they need a lot of engagement; many professional clients allow their wider expertise to over-rule the need for personal due diligence – they take decisions instinctively and get pensions decisions wrong.

This is where confirmation bias kicks in, people who have a pre-determined instinct are saying “don’t convince me with the facts – my mind’s made up”. This can lead to an assumption – even when an adviser is against transferring – that “he would say that wouldn’t he”.

Finally Alistair points out that hindsight bias only ever works one way – to blame someone else when things go wrong! “You should have known” is such an easy phrase to throw at someone with deep pockets (or a liability insurance policy).

The momentum trade is hard to stop

The DB pension trustee is the guardian of a member’s best interests. But when the member is being presented with such an attractive offer as a CETV that tells him he will live for 40 or more years, the momentum to take the CETV can be unstoppable.

The DB pension trustee is not only arguing against all the behavioural bias’ that Alistair points out, but he’s arguing against the immediate interests of his sponsor (the employer). The reticence of the Pensions Regulator to get involved in this discussion has left such authorities as Ros Altmann to increase the momentum to switch.

Indeed , the former pensions minister was even found encouraging delegates at the latest DB conference to negotiate CETVs higher. Let’s be clear, the transfer value is not negotiable – its calculation is agreed by the trustees with help from the actuaries and should reflect the cost to the scheme of the liability given up. IT IS FORMULAIC. It is not to be challenged. ROS ALTMANN IS WRONG TO UNDERMINE THE TRUSTEE’s calculations, she is only adding to the confirmation bias’ that pre-exists in members minds and her encouragement to negotiate is deeply irresponsible.

There remains one further reason that CETV’s are challenged and this is not a challenge to the CETV. It is the deplorable practice among some high earners of seeking compensation from the scheme or employer, for the fiscal implications of taking a CETV,

For those who have pensions of up to £50,000 pa, there is no liability to a 55% pension taxation rate on their pension. But if you take a CETV of £1m + there is. A CETV calculated at 40 times the pension could see someone with a pension of £25,001 paying higher rate tax.

We are now hearing of employees approaching trustees and employers for compensation for breaching their lifetime allowance, because they have or will be taking their CETV.

If proof of the mad-house state of thinking among DB members is needed, that such a practice is even being talked about, is that proof.




You can read Alistair’s article in full from this link (if you are an FT subscriber)



About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to Why we’re forever blowing (transfer) bubbles!

  1. Con Keating says:

    This cashing out is entirely inimical to good pension provision. If there ever was any doubt, let just quote Roy Goode on the member’s rights with respect to a DB scheme:
    “The pension promise is a promise to provide a pension; it is not a promise to
    hand over a share of the assets.” when addressing the parliamentary Social Security Committee
    and “The pensioners … have an interest in the fund as a whole, although they do not have any claim on the assets. Their entitlement is to a pension, and not to the assets which enable that pension to be paid.” in volume two of his eponymous report.
    It is one thing to allow transfers for cause, such as changing jobs, but quite another to offer members a free option on the performance of financial markets – the cost of that is ruinous.

  2. Brian Gannon says:

    Whilst a majority of people would be very unwise to give up the security and guarantees of defined benefit pension income for life, the latter part of this article is somewhat of a rant about the behaviour of a minority of higher rate taxpayers trying to negotiate higher CETVs. I have no truck with such talk from any potential clients who would seek to try and talk up the CETVs, and these kind of people would not become my clients since such behaviour is scandalous. There are many reasons why most people should not transfer out of a final salary scheme, and you have stated most of them. However for those people with other assets elsewhere and who do not need or even want some (or sometimes all) of the guaranteed income provided by the scheme, it can and sometimes does make sense for them to transfer. Your talk (in previous blogs) of the morality of taking TVs is fair but really fails to recognise the abuses that employers commit day after day in terms of how they treat their employees. If we were to become obsessed with fairness the whole tax system and the whole economic system of distribution of wealth and assets would need to be totally amended, so I think the morality angle is not one you should pursue. It is a fact that where clients are being offered transfer values 45 times the value of the income they are giving up this represents considerably less risk to transfer out than when the transfer values are only 15 to 20 times the income given up. WIth such inflated transfer values, someone with a medium risk tolerance (or higher) can reasonably expect to achieve the rate of growth needed to change their mind in future and use their transferred pots to buy an annuity on the open market, and in the meantime if they die or don’t live so long they get to leave behind everything to their family or to whoever they so choose. If inflation were to increase then some schemes limit the indexation to as little as inflation or 2.5% per year. If inflation stays below this level, then there is no reason why well managed funds and assets should not generate the levels of return needed to protect fully against inflation, although there are clearly risks that investment losses could still occur over the longer term.
    When you are offered more than 40 times the income given up this really does make it a far more likely option to transfer for those who are not afraid to take on board the very real risks of transferring out, and for those who are properly advised and understand the risks. People will always have regret risks for things they have and have not done, and a lot of what you and Alastair is bang on about herd mentality and following the crowd. But that is where good honest advice comes in, and good advisers do not do insistent client transfers. I have never given someone a signed piece of paper confirming to the trustees that advice has been given unless I have recommended the transfer. And no good adviser would. Therefore if clients fully disclose their situation to good professional advisers, then transfers will continue to happen and so they should. I reiterate I do not disagree with the main points raised for most DB members, but wish to redress the balance about some people for whom they should consider transferring out.

  3. henry tapper says:

    Nevertheless the law says that members are entitled to a CETV once a year and that’s what we have to live by!

  4. ‘CETVs are calculated using a discount rate that reflects the actual asset allocation of the defined benefit schemes. Pensions are accounted for on company balance sheets using a discount rate based on corporate bond yields. Every CETV paid out will reduce scheme liabilities by more than the recognised cost of those liabilities on the balance sheet (unless the scheme is purely invested in bonds!).’
    The difference here between valuation of the liabilities by each of the scheme and the sponsor is quite a subtle one but I expect you intended it. The more obvious point is that, unless the liability is fully hedged, the assets are reduced by less than the liability – the appropriate discount rate used to calculate the CETV being higher (thanks to the equity component) than the discount rate used to value the liability (100% bonds). This would seem to negate the point you have made in the past, Henry, that leavers penalise remainers by weakening the scheme.
    In relation to Con’s point above, as long as the discount rate is appropriate, is a member buying out the liability fundamentally different from an insurance company buying it out? Both are selling insurance with an expectation of gain.

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