The silliness of pension transfer values

Anyone who can make sense of this graph needs to have a very warped sense of value. It represents the value to an actuary of a £10,000 pa pension due to a 64 year old member of a DB scheme , and it includes basic inflation proofing (up to 2.5% pa).

At the back end of 2021, the promise could be “bought out” by the member at over £270,000.  A year later it would have yielded less than £150,000. Although the value of the transfer has increased since then to £160,000, it is still a shadow of its former self.

Although the downward spike in March 2020 is down to something we can all relate to (Covid lockdown) when financial markets panicked , the fall over 2022 makes no sense to the person in the street. It is of course down to the increase in interest rates , the impact of which was amplified by the loss of confidence in Government economic policy that has made Government borrowing a lot more expensive. But what has that got to do with the value of your pension ?

Let’s go back to basics

The cost of paying you a pension in later life is dependent on how long you (and perhaps your partner/spouse) live, the rate of inflation proofing the scheme has to pay you and the realisable value of the assets that need to be sold to provide cash to your bank account.

Because pension schemes guarantee to pay you as long as you are around, and to meet the cost of inflation,  and to pre-fund the promise with investments, the cost of you as a pensioner (your liability) can be estimated  by the scheme.  It’s valuers (actuaries) can use a process known as “discounting” to calculate the strain of your pension as a monetary amount (the cash equivalent transfer value or CETC)

The CETC is the estimated cost to the people ultimately responsible of  the money that arrives in your bank account. These people are the trustees of the scheme.

The only way that trustees can manage the scheme without a squeaky bum, is to make sure that the liabilities (paying you pension payments)  are managed with no risk of the money running out. This means investing in “risk-free assets” and valuing the liabilities on the basis of what the risk free assets are likely to produce as cash.

Right now , the risk free assets (loans to Government known as gilt) are likely to meet the pension payments with considerable ease. So the strain on the scheme of the £10,000 pa promise that generates the transfer value is around 40% lower than it was when the cost of meeting guarantees from cashing in gilts was at its highest (Dec, 2021).

Are you still with me?

Why this is so incredibly silly.

While in theory , the cost of paying your transfer varies as indicated by the dramatic peaks and troughs of the graph, in practice, the string of payments made to you is pretty well the same whatever the financial position. With limited inflation protection (up to 2.5% in a year), inflation is not the major factor. How long you live matters, and estimates of how long you live are constantly monitored and revised (at the moment they are being revised downward). But what makes all this so silly is what is called “the tyranny of the discount rate”.

The discount rate, used to value the cost of meeting your pension payment is linked to the gilt rate and – as we all have heard – the gilt rate is no longer stable – as it was when Government controlled borrowing costs through quantitative easing.

No sir! Government borrowing costs shoot up and down as Government lurches from one crisis to another and (as a broad rule of thumb) the worse it is for Government, the worse it is for your transfer value.

There are two reasons why this is so silly for us to worry about

Reason one –

For most people, the transfer value is an unnecessary distraction, like the price of your house when you’ve no intention to sell it or mortgage it.

Reason two –

Even if you did want to take your transfer value, you would almost certainly be unable to do so, because you would be blocked by expensive bureaucracy designed to stop you cashing out the valuable guarantees in your scheme.

Reason three

And there is a third reason why transfer values are silly and that is down to the lunacy of linking the perceived value of a benefits to something so obscure as the speculative value of paying it.

It comes back to the point at the top of this blog. The value of the benefit £10,000 pa for life, is the same to you or me, as it was in December 2021. That the imputed cost of the payment is now half of what it was , is an accident of valuations which is entirely irrelevant to the person getting the benefit.

Put another way, just because the transfer value has nearly halved, doesn’t mean the benefit has nearly halved.

We need a reset on all this

In the old days , transfer values were unpopular because they were low and because people expected pensions to be paid. Then schemes were forced to value liabilities using a valuation technique that led to wildly fluctuating transfer values which gave rise to an industry of transfer value watchers who pounced when transfers looked good value. Their time came during the period of quantitative easing when there was a transfer boom.

Throughout that period, I raged that transfer values were too high and were unrepresentative of the true value of the promise. I had to wait for 2022 to happen before I was proved right.  Transfer values are now close to their historic averages (going back to 1988 when they first came in).

But transfer values will continue to be volatile so long as they are linked to the return on gilts (the gilt yield) and so long as expectations of inflation and mortality swing around.

Personally I would call time on transfer values and make the process of granting a transfer value discretionary. Trustees should only grant a transfer in extreme cases and should be under no obligation to do so.

I will go on to talk about why I feel this way in my next blog. But for now, I will conclude that the transfer value system is in disrepute, it is thoroughly silly as is shown by the silly graph at the top of this blog and the sooner we get rid of thinking of Defined Benefits in terms of their Cash Equivalent Transfer Value – the better.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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5 Responses to The silliness of pension transfer values

  1. John Mather says:

    Looks like an indexed gilt

  2. Allan Martin says:

    Just to add to the debate; 5m members of UK DB schemes aren’t eligible for CETV payments – in unfunded public sector schemes – NHS staff, teachers, police, firefighters, the armed forces and civil servants. If they were, the CETVs would have rocketed on 30th March 2023 with the reduction in the country’s least appreciated discount rate (SCAPE). These higher calculations are however reflected in pension values on divorce and the £8bn pa of increased (deferred) pay in April 2024.

  3. con keating says:

    Henry – All you have done here is rediscover the stupidity of valuing pensions using gilt based discount rates. Incidentally, I am aware of transfers which took place at prices over 50 – that is more than twice the highest shown in that XPS index.

  4. Henry heskeh tapper says:

    Yes- this pantomime horse looks as silly from behind as it does from in front

  5. It’s not silly at all. In a market where cash flows can be bought and sold, then it simply recognises that arbitrage opportunities will emerge unless the buyers and sellers are paying attention to market prices. To the pensioner, they can retain the income stream if they want. But they shouldn’t be able to make an arbitrage profit just because the trustee decided not to adjust buy out values in a dynamic market.

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