In my inbox is a powerful statement from a steel-worker in Port Talbot who has suggestions about how transfers from defined benefit schemes are conducted.
It asks a fundamental question, if we are seeing such a number of such transfers, why is there not a single way of doing things? Why is it all so complicated?
I have just finished reading the technical note for advisers – outlining the basis for transfers for BSPS2 benefits.
It stops short of saying that the transfers for BSPS2 will be lower than for the old scheme (which ceases to be on March 29th). We must get used to calling BSPS2 the New British Steel Pension Scheme.
But it is a very complicated document and reinforces the need for expert advice – not least to help ordinary people know what is going on.
Valuing your defined benefit rights
It is as natural to under-value a pension as it is to over-value a cash sum. The bias is behavioural and you don’t have to be a behavioural economist to work out why £1,000,000 is more enticing that £25,000 pa increasing by CPI.
Since the cash equivalence of pension rights is subject to so many obscure factors. Here is Willis Tower’s Watson’s (excellent explanation in its preamble)
The following is a simplified description of the method used to calculate a member’s CETV:
1. The benefits that are due to the member at their Normal Retirement Age are estimated. In most cases this will include an estimate of the annual increases that will apply to the deferred pension each year until the member’s Normal Retirement Age, based upon unknown levels of future inflation.
2. The estimated cost of paying the benefits at and after Normal Retirement Age is then assessed. This calculation considers how the payments are expected to increase each year (often based upon unknown levels of inflation), how long the pension is expected to be paid for (based upon how long the member is likely to live after retirement), an estimate of the amount of spouses pension payments to be made after the death of the member, and how long the spouse’s pension is expected to be paid for.
3. The estimated cost is adjusted to allow for the fact that the assets held by the Scheme are expected to increase each year with investment returns, and that these investment returns can be used to help pay for the member’s benefits in future.
The CETV calculation makes a number of assumptions about the future, including future expectations of investment returns on the Scheme’s assets, expectations of future inflation, and expectations of life expectancy.
It goes without saying that WTW are using scheme specific mortality and the very latest CPI tables, that the future expectations of investment returns are subject to expert analysis and the scrutiny of likely future inflation is flawless. Nonetheless, WTW admit that the CETV itself is no more than a guess.
Assessing the value of a CETV
Since the CETV itself is a “good guess” and the judgement of most people offered a CETV – subject to the bias’ in favour of cash, the job of an adviser is to encourage confidence in rational decision making, not to pander to prejudice. This is where so much advice I have seen has failed.
Since the reward for advisers is also biased towards the taking of the transfer, where the adviser is paid for the investment , management and drawdown of the proceeds, there is an almost unassailable drift towards transfer. Indeed, we have seen members of BSPS who simply take their Transfer analysis from one adviser to another till they find one who sill accept them as an insistent customer or find a good reason to reject the advice to stay put,
The value of a CETV, despite the FCAs repeated warning that it is typically less valuable than the defined benefit, seems simply irresistible.
What is to be done
My suggestions about how we resist the irresistible are outlined in my Five Christmas Crackers blog
- Full disclosure of all transfer costs and cost of ongoing advice to include an estimate of exit penalties from fund management and/or advisory contracts.
- Independent sign-off from a second IFA where total cost of transfer exceeds 2% or £2,000.
- Banning of all marketing expenses paid from funds to third parties for provision of services (e.g. lead generation). Lead generation costs to be explicitly stated where total cost exceeds 2% or £2000
- Transfer analysis and advice certificate to be paid for prior to request for funds and not charged conditional on transfer transaction completing.
- Advisers engaging in this business to submit fee model to FCA prior to annual authorisation. Re-authorisation subject to inspection of previous year’s business, cost of PTS to be calculated by FCA to include this extra regulatory burden.
The remedies demanded by my friend the steel worker are more fundamental. I think our proposals aren’t mutually exclusive.
What we agree on for sure is that SOMETHING MUST BE DONE!