Are some schemes over-paying on Transfer Values?

Royal London have requested and got the notorious letter sent earlier this year to certain schemes perceived to be vulnerable to pension transfers. It includes the following sections.

tpr transfer

There is nothing new about this guidance; Steve Webb is spot on when he says

‘I would hope that well run pension schemes would be taking expert advice when deciding how much to offer to members wishing to transfer out.  But the Regulator’s letter is a helpful reminder to all schemes that they need to be fair not only to those transferring out but also those left behind, especially where the scheme in question is in deficit’.

The key statement

Let’s look at that key statement in more detail.

‘In light of recent events concerning your scheme sponsors, we would expect you to take advice from your scheme actuary about whether the basis on which the CETV [transfer value] are calculated remains appropriate… This would allow you to judge whether a reduction or further reduction should be applied to CETVs in light of [an] assessment of covenant strength’.

There’s a lot of code (and jargon) in this statement – here’s an explanation

Recent events –  bad PR for pensions and trustees

Scheme sponsors– Tata Steel, BHS , Carillion  and troubled employers in general.

CETV – Cash equivalent “transfer value”

Reduction – calculated by actuaries based on the state of the scheme via an “insufficiency report

Covenant Strength – the capacity of scheme sponsors to make up deficits from their own resources.

What this adds up to is a warning to trustees that they should not be paying transfer values in full unless they have a properly funded scheme and/or they have confidence their sponsor can make up any deficit.

I have yet to hear whether recent casualties such as Carillion, House of Fraser and BHS were paying CETVs in full prior to the employer’s demise but it would not surprise me if they were.

Why some schemes are overpaying (and not cutting transfer values)

There are compelling reasons why employers and trustees shy away from issuing “insufficiency reports” on schemes – which allow CETVs to be cut. They include

  1. The short term benefit to sponsor balance sheets of shedding scheme liabilities at below the FRS102 accounting costs
  2. Avoiding alarming members by hinting the scheme is insufficiently funded
  3. Managing scheme costs – especially where trivial pensions are costing plenty to administer and can leave the scheme relatively easily (e.g. without advice)

In all three cases, an insufficiency report can be “unhelpful” in meeting the strategic aims of trustees and sponsors. There is a bias not to issue an insufficiency report and (as so often in pensions) it’s a bias in favour of short-term gain and against the long-term interests of the scheme.

The impact of over-paying

If your KPIs are set on a rolling three year basis (as many CFOs are), then the long-term impact of over-paying on CETVs is not a personal consideration (especially if you are not in the pension scheme).

But if you are a remaining member of the pension scheme and your time horizon is the rest of your life, the long-term impact of over-payment in 2018 of CETVs should be a matter of some concern.

If you are a Pensions Regulator which has statutory objectives to keep schemes out of the PPF and to protect member’s interests , then you don’t want the cost of over-payment in 2018 to come back and bite the sponsor a few years later (in larger recovery payments).

Nor do you want employers, faced with larger recovery payments, packing it in and abandoning their obligations to fund the pension scheme. That way leads to the PPF, to job losses and to expensive pre-pack restructuring with disastrous consequences to shareholders.

In short, over-paying CETVs by trustees in 2018, risks schemes closing in future years, risks people’s livelihoods being lost, risks loss to shareholder value, risks a further impairment in confidence in pensions.

Which is why the Pensions Regulator may need to go further

This letter may be a case of “too little too late”.

There is an argument that where an insufficiency report is in place, CETVs should not be paid. This would have made a big difference at BSPS which paid reduced transfers throughout 2017 (though this did not stop more than £3bn being paid from the scheme through CETVs).

The reduced CETVs still produced £ signs in advisor and member’s eyes and many transfers that took place are now being contested with litigation being considered against trustees for insufficient warnings.

In its standard letter (the one revealed by Royal London), tPR go on to guide trustees on these warnings

tpr cetv response.PNG

Unfortunately, the reaction of some members ( prompted by some advisers) is to dismiss such warnings with “they would say that”. Such warnings get put in the “fake news” tray – aka “project fear”.

The Pensions Regulator is right to insist on better warnings , but wrong if it thinks that such warnings will stop flows. Infact there have been recent cases where, when reports of transfers being obstructed reached members, some – who had not considered transfers before – headed for the door.

I think there is a strong argument for the Pensions Regulator to have powers to stop transfer payments in extreme circumstances, such as the run on BSPS.

The enormity of 2017 transfers cannot be over-estimated

ONS transfers Q1 2018 2

The billions that flowed out of DB schemes in 2017 will have given a short term fillip to corporate balance sheets.

But they leave a legacy of increased burden for employers in terms of meeting pension liabilities, especially where insufficiency reports were not issues – or under-cooked.

Members who transferred out on inflated transfers are happy enough today , but have they got the support to manage their finances throughout retirement. Will they overspend their pension pots – or hoard them in fear of running out of money?

Will Trustees come to look back at the CETVs paid out in the past eight quarters and wonder just how they came to give away the family silver as they did?

The Pensions Regulator and the FCA may look into the stable and mark the open door, but will they look back at this period with pride? I suspect they know, what I think, that they failed in their statutory duties to protect the public and the pension scheme members.

This letter was the right letter, it should have been issued 18 months earlier.

There’s some good comment on this subject in today’s Times (29/08/18)

Good stuff from @thetimes and @davidbyers26

— Pension Plowman(@henryhtapper) August 29, 2018


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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9 Responses to Are some schemes over-paying on Transfer Values?

  1. Adrian Boulding says:

    I’ve sat in trustee meetings that have debated reducing transfer values and it’s very hard for them to do this as
    1. It feels like an admission that they haven’t been managing the scheme properly
    2. It feels like they don’t trust the employer to honour its promise which feels very insulting to an employer that many trustees still work for
    3. It feels like they are short changing their former colleagues, especially those that have a good reason to transfer, like emigrating to another country

    It might be better to take this power away from the trustee and give it to TPR instead as something that TPR will look at every three years when the statutory triennial review is filed with them


  2. Mark Meldon says:

    Not so very long ago, I looked at a potential DB transfer for a client who had a decent preserved benefit in the scheme of a well-known drinks firm. The CETV was 51 x the deferred pension, the highest I have seen. Another case, for a lady with a similar deferred pension with a financial services firm was, IRRC, 22 x the deferred pension. As far as I could see, the funding state of the schemes was similar, so why the big difference, aside from ‘polititcs’?
    Neither took the CETV, by-the-way, and both now are enjoying their shiny new pensions (nor did they take any PCLS – a good result!) with huggable index-linking.

    Is there any element of ‘sticking a finger in the air’ here? I hope not.

    Schemes need to address what I think is a looming ‘confidence’ issue. I have spoken to several members of statutory schemes lately (NHS/Teachers) who believe that their pensions will not be paid ‘cos my mate knows so’. Others have needlessly taken a higher PCLS in lieu of pension ‘cos it’s safe’. This is very hard to counter, even though it isn’t true!

    Then we will see, should the markets tumble, a wailing and gnashing of teeth when the ‘nastiest problem in finance’ bites those in DC drawdown, just like it did 10 years ago.

    Hey, ho.

    • Eugen Neagu says:

      Mark, the difference would have been in the asset allocation of the pension scheme. The scheme with a higher multiplier would have derisked and as a result invested all in corporate bonds and gilts, when the other may have had a higher % invested in growth assets. This results in a different discount rate.

      There could be small differences between the life expectancy assumptions for the different cohorts of members / deferred members, and also even the pensions may revalue in deferment or increase in payment differently.

      • Mark Meldon says:

        I do appreciate what you say and realise that the underlying assets and assumptions are key; but 40+ x pension CETV’s are still, IMHO, way too high!

  3. Gerry Flynn says:

    The answer would be to ditch the “Pension Freedoms” introduced by Mr Osborne thus eliminating the potential temptation to transfer, simples.

    • henry tapper says:

      People transfer for many reasons, the freedoms are just one! But agreed – the freedoms are “freedom from pension” – many will miss their pensions in years to come – because of them

  4. You ask whether this further mooted adjustment would make a difference. From an adviser’s perspective, I doubt it would, Henry.That’s not just because of the cognitive issue you mentioned around large sums – that’s dealt with by the FCA rules that require conversion of the large capital sum to a stream of smaller income amounts. It’s because the main driver of the transfer rationale, a difference in risk tolerance of the scheme relative to the member, will remain. There are a number of changes that will affect future volumes: moves towards more derisking; interest rates and the expected equity risk premium; whether the remaining members (or members of schemes yet to derisk further) do in fact have a different risk tolerance. But we ought to expect volumes to remain high.

    As advisers we can also comment on the mooted adjustment itself. Most advisers do not question the ‘fairness’ of the CETV nowadays: we rely on TPR rules to deal with fairness. We only seek to gauge accurately an individual’s preference given information about the possible income differences. That information, or at least its format, is to a large extent prescribed by the FCA. It includes an adjustment to income for the impact of entering the PPF. This is not a probability-weighted adjustment, though, which might be useful as an addition to the worse-case assumption (always useful). But that would require the adviser to have unreasonable risk assessment skills (let alone risk information). TPR seems to be aiming at a CETV that reflects a risk-weighted probability – on the basis that the scheme actuary, at least, has the risk assessment skills and information.

    I don’t think this is as compelling logically as it sounds. The risk TPR wants to address is partly explained by the deficit position (so theoretically already reflected in the CETV) but is not otherwise idiosyncratic but systematic: any company can suffer rapid changes in its fortunes (or accounting). Hence the sponsor covenant risk over the relevant period that the PPF adjustment applies to is not a factor of the individual sponsor’s current condition so much as the length of that period of exposure to the risk (which may be either an actual cut or effective cuts by weakening the inflation protection). We might also then assume that the additional mooted CETV adjustment and the adviser’s time-based probability-weighted PPF-related risk of loss of real income would be identical and ‘accurate’, being based on the same non-specific approach with the same information.That should cancel out any effect on the transfer logic, leaving only the risk tolerance difference.

  5. henry tapper says:

    I think you’re right Stuart. The impact of insufficiency reports is to keep money in the scheme – either to keep the scheme solvent or to reduce its burden on the employer. Of course the remaining members might benefit from not going to the PPF, but those who take CETVs seldom worry about the clip the insufficiency report took. £3bn reasons to agree with you from BSPS.

  6. Eugen Neagu says:

    Just to bring some clarity, I advised one year ago on one of Carillion’s pension schemes – Mowlem pension scheme. Carillion bought Mowlem in 2006.

    The CETV was reduced by 20% or so, but if I remember well not by the full deficit which I think was 30%.

    The member was very adamant to transfer out, because of rumours that Carillion won’t survive and as as result the scheme will fall in the PPF.

    So I advised not to transfer and the member followed my advice and explained to him that PPF is not that bad as an option. As a result of Carillion insolvency which started a few months later, he will have a pension paid by the PPF in 2 years when retiring.

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