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DB transfer activity has begun to stabilise, with far more transfers being quoted and taken every quarter compared with the position before the new freedom and choice flexibilities were introduced by the Government in 2015. Bart Huby LCP Aug 2018
LCP, one of the brightest of pension consultancies estimate the average pension transfer value at £448,000, twice the value of the average house in the UK.
Before the introduction of Pension Freedoms only 10% of CETV quotes they issued were taken up, that figure now stands at 29%.
Last year Barclays Bank’s massive pension scheme reported £4bn taken via individual transfers, they’ve accounted for an expected 20% (nearly £5m) to flow out this year.
Small wonder that LCP had to book a bigger hall to present their “Survey of DB Transfer Comparators”. A year after the Port Talbot scandal broke, transfers are still the big news.
What’s the big deal about Transfer Value Comparators (TVCs)
The FCA hope that transfer activity will not just “stabilise” but improve in quality. It is introducing a way of comparing Cash Equivalent Transfer Values with what would be given up. The joint paper between Royal London and LCP has an illustration
LCP estimate that for someone 10 years away from retirement, the TVC will on average show that someone only gets 57% value from the CETV, this rises to 75% the year before retirement but even then represents a loss of 25% purchasing power in taking the transfer.
The FCA want us to consider this loss as the price we pay for freedoms – or at least for the flexibility that having a big fat cash pot brings – over a wage for life.
Also presenting at the event was Steve Webb, who’d been up all night to get happy (or at least performing on Radio 5 Live). Steve showed a chart which explained what people valued from having a big fat pot and all those things were behavioural not fiscal. People like the inheritability of a pot, they like its flexibility to be spent as the owner chooses and of course they like the idea that it is their money- not an insurer’s or trustees’.
What the FCA are hoping is that people will stop and think how much they are prepared to pay for those heuristics- even 25% of £500,000 is well over £125,000.
This – they hope – is the big deal about TVCs.
Is this the right way of presenting the argument?
Steve Webb pointed out the principal risk of the FCA’s approach
“There is a serious danger- if the advisers think the bar charts are “nonsense on stilts” that they are going to struggle to deliver TVCs to clients”.
Webb pointed out that in the original FCA mock-up he’d been shown, the TVC appeared on page 30 out of 43 – by which time the former Pension Minister had given up the will to live. He went on to say that recent versions have seen the TVC move up to page 5, but it clearly is not being treated as “headline news”.
Webb pointed out that for people who are trying to get rid of a guaranteed wage for life , presenting them with the cost of repurchasing what they have given up is hardly the most intuitive of advisory tactics.
For Steve Webb and Royal London, The TVC arrives to some scepticism, with which I have some sympathy.
Why can’t you just repurchase what you’ve given up at the same price?
The FCA have chosen to set the TVC as the full cost of buying back the pension lost, it could be put the other way round and express the amount of pension lost if the CETV were used to buy an immediate annuity.
The reason that TVCs repurchase so much less than the pensions given up is threefold
- Individual annuities do not enjoy the economies of scale achieved by group schemes paying pensioners from a payroll. They also involve insurance companies taking a margin. This makes them inherently more expensive to provide than scheme pensions and hence they purchase pension pound for pound than the pension they replaced
- The time between a pension coming into force and the CETV being taken is investable time. The TVC is calculated using a risk-free rate of return whereas the CETV is discounted against the investment return of scheme assets (on a best estimates basis. The TVC does not enjoy the investment return the Scheme Pension gets between its calculation and normal retirement.
- The scheme pension is itself invested and is not invested in risk-free assets, you have to put aside less to pay a scheme pension than an annuity because of the greater freedom trustees have than insurers.
Add together the greater operational efficiency, the opportunity cost of purchasing an annuity early and the long term investment disadvantage that annuities suffer against scheme pensions, you get to why TVCs are so much lower than the scheme pensions they are compared with.
Financial economists like John Ralfe will look at those three points and will say “bollocks”, but them is the rules.
We expect economies of scale, we believe in the equity risk premium.
The Transfer Value lottery.
Much of LCP’s presentation was spent explaining something I’ve touched on this blog before. The biggest factor impacting the CETV is the discount rate being used to create it.
Since the discount rate is a function of the investment strategy and the investment strategy is decided upon by the Trustees, CETVs are effectively a lottery – as far as the member is concerned.
The chart above shows how someone who’s CETV value is calculated using a discount rate generated by the scheme being invested in 80% risk-free assets will get the blue circle’d 70% TVC while the poor wretch with a scheme invested only 20% in risk-free assets will only get a 50% TVC.
The conclusion is that not all transfer values are calculated the same , but the output of the CETV – a cash amount paid into a personal pension, differs only by the size od the payment! That is a total lottery as far as the member’s concerned.
For Trustees, the equation is simple. If you think people will take any notice of TVCs, the more aggressive your investment strategy, the less likely you are to lose prospective pensioners through CETVs. Conversely, if the intention is to get rid of your scheme, the faster you “de-risk” from equities to gilts” the more transfers you can expect.
Ongoing questions for people who transfer.
Having had 24 hours to cogitate, I agree with LCP’s four questions
- What is the Transfer Value Comparator?
- How do transfer values differ between different schemes?
- How does the scheme’s investment strategy impact the TVC?
- How might TVC illustrations impact the number of members transferring?
No adviser – advising on a transfer, should ignore these questions. If I was the FCA and I wanted to know that the person who had paid for transfer advice, had understood that advice, I’d be focussing on these questions which might be rephrased for ordinary people
- What did you make of the Transfer Value Comparator?
- Did you understand how your CETV had been calculated – do you think you did well?
- Did you understand what your former pension scheme was investing in and how it affected your CETV
- Did the TVC influence your decision to transfer – and if it did – how?
Are we asking these questions too late?
My worry, and it’s clearly a worry in LCP-land too, is that in 10 years time, the vast majority of those in DB schemes will have reached pension age. By then they’ll have either taken a transfer or it will be too late to do so.
While it’s good that the FCA are still testing the water on what works, it’s bad that in the meantime there’s a risk that the TVC test won’t work and that we’ll be revisiting this subject in three years time after another Port Talbot.
The FCA could have taken a much more draconian step to reduce transfer activity and banned contingent charging. On this Royal London and LCP do not see eye to eye. I don’t see eye to eye with Steve Webb on this either.
Royal London’s position is that advisers can be trusted and mine is that the only advisers who can be trusted are those who work on an upfront fee – paid whether the transfer is taken or not.
I know that some advisers who I do trust (such as Al Rush) work on contingent charging but I cannot make the rule fit his exceptional probity.
My conclusion with regards TVCs is that they will be effective as advisers want them to be and – so long as we have advisers working on a “no CETV no fee” basis, they won’t make much difference.
A large part of the cost difference is the covenant. With an annuity you get a strong insurer covenant and in the unlikely event of the insurer failing you get a 100% replacement from FSCS. But with a DB scheme you get a weak employer covenant (1 in 10 employers go bust every year and today it could be Patisserie Valerie’s turn) and if your DB sponsoring employer does go bust you fall back on PPF paying out somewhere between 50% and 90%.
So the comparison is apples and pears and if as a transferor you are happy with a less than 100% covenant then take the transfer, use some of it to buy an annuity and put the rest in drawdown
Adrian
I think a more fundamental issue with the comparators similar to the one you show is only one of the columns is real i.e. the TV on offer. The other is some ethereal number based on a whole host of assumptions that are hotly disputed. Why would anyone trust the value displayed? Making it the cost of buying an annuity would solve that but then as we have seen with pension freedoms in DC, people have shown they much prefer lump sum over annuity – why would you expect a different outcome when applied to DB?
Pension Transfer reports have shown the ‘equivalent annuity purchase price’ at selected retirement ages for years, so the capitalisation of annuities as part of pension transfer analysis is extremely old news.
The only new thing here is discounting that capital figure back to ‘today’s’ purchase price by the risk free return.
It really is no more use than critical yield – very much the “6 of 1, half a dozen of another” of pension analysis in my opinion. Perhaps less so as a typical client is more likely to understand the concept of a hypothetical annual growth figure than a hypothetical discount rate.
Critical yield – must includes all charges (adviser, platform, and investment charges, both initial and ongoing), and charges must be specific to the transfer destination. Can be calculated to retirement age (of scheme) or any other selected age. Can also be calculated to account for taking maximum TFC or none.
TVC – assumes a fixed ongoing charge which is deliberately non-specific but could bear no relation whatsoever to the specific charges the client might pay on transfer. Only calculated using retirement age of scheme. Always run on an ‘income only’ assumption.
I fail to see how TVC is a step forward.
Quite frankly TVC should be a relatively small part of the transfer discussion, as the APTA should offer a full analysis of the client’s anticipated needs and objectives in retirement.
Henry, you once described final salary benefits/annuities as ‘insurance’ against requiring that income (please forgive my loose take on the exact words), and I think that is effectively what APTA ought to show: how crucial is guaranteed/promised income in meeting the client’s retirement needs, in the context of any other assets/incomes they might already have?
The more crucial it is, then (everything being the same) the less likely a transfer will be in the client’s interests.
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