Someone , somewhere on the multiple threads surrounding USS, has asked me if I think that transfers out of USS are likely to be the next miss-selling scandal. I think it unlikely, and to explain why, I need to explain a concept that I could call the “vulnerable defined benefit pension scheme”.
The vulnerable scheme
In the “old days”, advisers tried to judge a transfer by the critical yield resulting from a transfer value analysis (RVAS(. This was an inefficient way of doing things, the TVAS showed the adviser the critical yield needed to better outcomes, but as the TVAS comparison was based on annuity comparisons (and people were looking to be free of annuities), TVAS has fallen into disrepute.
Instead, advisers are resorting to a much simpler comparison; they simply look at the multiple of prospective pension within the CETV. So if you have a £15,000 pa pension promise and a £600,000 CETV, you are on a 40x multiple and it’s all systems go for a transfer.
The multiples for USS are likely to be a lot lower than 40x, that’s principally because USS is an open pension scheme and therefore adopts a growth based investment strategy involving a relatively high allocation to equities. These equities are expected to grow faster than gilts and so they allow those valuing USS pension promises to use a higher discount factor which leads to lower transfer values.
USS is not a “vulnerable scheme” in the way that schemes that have moved to “de-risk” by selling their equities and adopting a gilts based funding strategy. Barclays and Lloyds have such investment strategies and they provide transfer values over 40 times the pension.
Schemes like Barclays and Lloyds, which are reporting multi-billion pound outflows to CETVs, are “vulnerable schemes”.
But it’s not just a high income multiple that can make a scheme vulnerable. Other factors that can expose a scheme to high volumes of transfers are loss of confidence in the scheme sponsor (this is what happened at BSPS), a time limited transfer option (BSPS again ) and a well organised IFA marketing campaign (BSPS again).
British Steel Pension Scheme’s transfer multiples are around 25x, but in all other respects, it has become a “vulnerable scheme”.
There is (maybe) one other factor, the financial sophistication of members and their appetite for pensions rather than pots. I suspect that the USS membership are relatively sophisticated and have a higher regard for pensions rather than pots than other memberships, but that has yet to be tested. USS could become a mis-selling scandal but I suspect that advisers have got better schemes and easier memberships to target.
Targeting vulnerable schemes
Most IFAs I know, are fairly familiar with “vulnerable schemes”, they don’t need to know why a scheme is giving high income multiples, they just need to know they are on offer.
Once an IFA has done one transfer, word soon gets around and without too much effort, an IFA can pick up a number of referrals from other scheme members anxious to capture a pot from their pension
There may be many such “referral deals” out there. We certainly know of them at BSPS.
IFAs don’t need to have to work too hard where they are into a vulnerable scheme, unsurprisingly, their biggest threat is other IFAs competing for the same customers.
As has been rehearsed on this blog many times recently, the key breakthrough for IFAs has been their discovery that their clients can pay for transfer advice out of the transfer without having to write a cheque from taxed funds and without having to pay VAT.
In extreme cases, as happened with Active Wealth in Port Talbot, the adviser appears to have been part of a complex matrix of cross subsidies that made it appear to be charging rock bottom prices while the customer was paying exorbitant fund management costs.
Ultimately, Active Wealth Management had the perfect marketing approach for their customers, offering superb service at no price at all. What was going on behind the scenes is now a matter for FCA investigation.
Readers may be asking themselves, why two schemes with similar benefit structures (Barclays and USS) can offer different CETV multiples . At a technical level, it’s because of differing discount rates, but philosophically – it’s because the Trustees of a Barclays, or an Aon or a Lloyds have chosen to do what the Pensions Regulator want them to do, and target “self-sufficiency”. That means the Trustees immunising themselves against market shocks by moving into gilts, matching liabilities to assets – effectively making the scheme invulnerable.
Bizarrely, in adopting this super-prudent approach, such schemes are making themselves vulnerable in a new way – vulnerable to transfers. Barclays has lost £4.2bn of its scheme assets (probably around 25% of transferrable assets) in a single year.
There may be those within the bank who see this as good news, (CETVs are less expensive to pay than the liabilities are accounted for in the Banks accounts) but most stakeholders – including the Regulators, are not in the business of promoting CETVs against pensions.
Whose prudence is it anyway?
It is hardly surprising that this question is being asked by those who are giving away the prudence they have built up in their scheme, through ultra-high transfer values.
Trustees can rightly point at the Regulator for an answer. If tPR has demanded a prudent investment strategy, surely it should have protected the schemes from the ravages of CETVs. Evidently this is not what the Pensions Regulator consider its job. If it did, it would have taken reasonable steps to protect schemes by either enforcing insufficiency reports – to dampen down demand, or it would have worked with the FCA to restrain the activities of advisers who have been filling their boots with contingent charging.
Some blame also attaches to consultants who have egged on their clients to adopt ultra-cautious strategies without any consideration for the consequences. As many of these advisers have themselves taken CETVs from schemes they were in , there inactivity in respect to this is understandable (but not forgivable).
“Too prudent for its own good?”
One Trustee asked me last month if I considered her scheme too prudent for its own good; I replied – “yes”!
We are in an era of de-risking. But it seems to me that in de-risking, many occupational schemes have simply passed risks that were retained by Trustees as their core purpose – the payment of pensions, for risks now managed by wealth managers but born by members.
If that was the intention of the Regulators (tPR and FCA) then it was never explicit. I doubt it was and suspect that it is only now that the consequences of this “flight to quality” is becoming clear.
It is not too late to stop the carnage, but urgent action is needed, if we are not to see another year – like 2017.
Members of USS would undoubtedly get higher transfer values if its scheme pursued a more cautious investment strategy, but they should beware the impact their pensions.