Both the Times and the Financial Times report today on the anticipated voluntary withdrawals from Britain’s DB pensions through cash equivalent transfer values (CETVs).
The FT, relying on Mercer as a source, estimate the withdrawals to be as much as £50bn since April 2015, the Times estimate £45m. Aon and Towers Watson estimate CETV activity up 15 and 10 times since 2014 (the Aon figure just refers to high value transfers). There is sufficient corroboration of these numbers to suggest that there is a significant “flight from quality” and that the 210,000 people Mercer estimate have taken CETVs are many more than previous tPR estimates.
It would be good to have official figures, but we have little but the estimate from tPR that 80,000 people transferred in the last year.
FCA published a 65-page con doc this week on pension transfer advice reforms but did not give an estimate of total value of payments.
— Josephine Cumbo (@JosephineCumbo) June 23, 2017
Not all schemes are seeing transfers at the same rate. The evidence we have suggests that the money is being pulled from banks and insurers whose schemes pay high CETVs (their scheme investment strategies are conservative, investing in gilts creating discount rates that pay particularly juicy multiples of pension forsaken).
And it’s clear that there are separate markets. There is a highly advised market where white collar staff are paying as much as £10,000 in advance for a passport for their CETV to go where they like. There is a mid-market where money is flowing into solutions of the adviser’s choosing with fees contingent on these scheme being used and there is a bargain basement market where money is flowing into any old tat with very little proper advice ( very small DB transfers don’t need a passport).
I’m not writing here about the reducing quality of advice, it has been a subject of many recent blogs. I am questioning why the spectacle of this huge shift of pension wealth is only now being publicised.
An undercover operation
I don’t subscribe to a conspiracy theory. Despite this blog shouting about this for a couple of years, my writing has been speculative, based on anecdote and frankly it does not carry the weight of an FT or Times.
But what is more surprising is that this shift has not been picked up on the radar of the Regulators as a major financial risk. For the FCA, the risk is potentially bad consumer outcomes; for the Pensions Regulator, the risk is the further destabilisation of the defined benefit occupational pension schemes for whom £50bn in outflows is a material loss.
In the short-term, many consultants, trustees and especially plan sponsors can celebrate that £50bn as a quick win. The money that voluntarily leaves a scheme is valued using a best-estimate discount rate that is likely to be higher than the discount rate used to account for the underlying liability in the FRS102 accounts. That means that CETVs are giving corporate balance sheets a healthy short-term windfall.
We know of circumstances where these windfalls are not only being booked retrospectively but being accounted for on a forward basis – the assumption being they can be accounted for today, on the expectation they will happen tomorrow. This is particularly good news for the short-term targets of the C-club (bonuses all round).
Put another way – if , as the Pension Institute claim, there are 1000 DB schemes in a “stressed state”, why are only a handful reducing CETVs through an insufficiency report?
It is hardly surprising that a “don’t rock the boat” attitude is prevalent, the C-club need as little disturbance to the current transfer deluge as possible. This is one of the reasons for the low profile given to this trend.
Embarrassment
I believe there is something else at play here. I suspect that the people who are supposed to be managing DB schemes are hopelessly conflicted and embarrassed about it. I know many investment consultants who sheepishly own up to have recently taken transfers and I have seen swathes of long-serving senior executives who are following suit. There’s definitely a “don’t shout about it or there’ll all want one” feel about this exodus.
Why it can become professionally embarrassing is that the plans set up by the said advisers and senior execs (either trustees or close to trustees) are playing into their hands. These highly loaded bond based investment strategies are what gives rise to the high transfer values in the first place.
Worse, the advisers and trustees have locked schemes into such strategies through the purchase of contracts for difference (derivatives) that can greatly increase the scheme’s exposure to bonds through gearing ( a process known as Liability Driven Investment of LDI).
But if the current trend continues, then many of these strategies will have to be adjusted and potentially even unwound, to create the liquidity to pay all the transfers. I know of one scheme that had a cash call of £250m in March from unanticipated transfers.
The problem is , as John Ralfe is pointing out to anyone who listens, a lot deeper than the admin hassle of having to arrange the transfer. We have an unanticipated risk to a scheme’s investment strategy.
The key word here is “unanticipated”. What happens when you want to keep transfers quiet is you neglect to write their likely impact into your investment strategy – here is the conflict and the embarrassment.
No victimless crime – a cancer within.
I have given up on “win-win” , let alone “win-win-win”. In financial markets, for every winner there is a loser. The winners in the CETV game are the advisers, wealth managers and a few very lucky people who can afford advice to get into the right products for their privileged circumstances. There is a further immediate winner- which is HMRC who stands to pick up penal taxes through LTA and AA busting quite apart from the penalties it can meet out on unauthorised payments through scams (see ARC).
The losers are those who end up in the wrong financial products, or no product at all. The losers are the trustees that see their pension schemes convert to cashpoints. The losers are future generations of corporate executives who have to manage the consequences of the current CETV bonanza.
The losers are the non or poorly advised who quickly find the cashpoint has no “repeat” button.
The losers are future generations of savers who are losing the rights to good quality occupational pension provision as the infrastructure is dismantled through this “flight from quality”.
Calling time on this nonsense
The FCA consultation on transfers published this week proposes we no longer denigrate the CETV and promote it to having equal status to the scheme pension. This will be loudly applauded in the boardrooms of asset managers, DB corporate sponsors and both instructional and retail advisers. It is a fundamentally stupid thing for the FCA to have done.
The damage of losing scheme pensions in favour of swollen cash balances will haunt us for decades to come. Those like Merryn and Ros who pander to populist cash-craving will be called to account for their public statements
There is nothing this blog can do to stem the tide of nonsense transfers. I can say for myself that I ignored my CETV last year and now draw a scheme pension (I even ignored my tax-free cash in favour of more scheme pension ). I am lucky to have had this choice.
I called time on the nonsense of my £1m + CETV because I could see no long-term value in it. I want an income that lasts as long as I do, one that protects me and my family against the consequences of growing really old. I want a pension like my Dad’s and his Dad’s and I wish that my Mum and her Mum had had one too!
The corrosion of DB schemes by this mania for freedom is bad news for society and it is time that more people said so. The arguments for short-termism are everywhere (see above). The prudent arguments of decent people like my colleague Alan Smith are less appealing but a lot more serious.
Smith heartily disagrees with the pension freedoms. “People need a wage in retirement, not a dollop of money to waste.” #pensiondebate
— Josephine Cumbo (@JosephineCumbo) June 19, 2017
I am really surprised that none of the actuaries valuing schemes have yet recognised that the CETV represents a very valuable option to scheme members. It is of course extremely expensive for the pension scheme upon which it has been foisted by accident or stealth. It is an option on the pay-off associated with the discount rate applied to liabilities – it is the introduction of a new source of cost and risk to the scheme. Like most american style options, which may be exercised at any time during their life, it rarely makes sense to exercise them early -the residual value militates against that. As should be obvious with the massive multi-decade decline in discount rates, this option is deeply in the money. To justify exercise, taking the money, at this point in time requires the member to believe that rates are not going yet lower and may even be likely to rise.
There is a paradox here – to be preaching lower for longer to trustees while is not consistent with advising members to take the money and run – indeed lower for longer as an adopted belief will provide incentives for members to take the money. Hardly the reason that pensions were granted tax concessions.
It would be interesting to know how many of David Blake’s 1000 “stressed schemes” have currently issued an insufficiency report and reduced CETVs to protect themselves,
Comment from Jon Spain – by email
“Thank you for that. One basic problem is that the value of a supported guarantee is just not understood by too many people (consumers, trustees, some actuaries). In the 1980s, shortly before CETVs became a requirement, John Quarrell (then senior partner for pensions at Nabarros) and I seriously suggested switching from “retirement benefits” to “withdrawal benefits”, so that the focus would be on the continuum rather than the end. The only traction I observed was a complaint from a major client (I was then at C&P)!”
Whatever the rights and wrongs “pensions” lost their way years ago. Freedoms was just the final nail. Complexity. Govt intervention. Holidays. Simplification. Poor communication. Endless rule changes. Societal move to short termism. But to let. QE fuelling asset bubbles. Greedy fund managers. Lack of transparency. It’s a good battle Henry but the war was lost years ago. People live in the now and have no idea of the future. Celebrity is pensions. Poor old you.
I don’t often put a thumbs down to a comment David, but I did to yours. Much changes but the need for people to have a replacement income in their later years doesn’t. The Freedoms don’t change that, nor do any of the matter you rightly raise. The need for income in later life persists. Until someone comes up with a better way, the need for pensions, state, occupational, annuity and drawn-down persists.
Very good very considered article.