Take one
The fall of 7% over May was due to a further increase in gilt yields and a further fall in long-term inflation expectations, despite the continued current high inflation rates, it said. In April it was £232,000, representing a drop of 5% compared to the end of March.
The discount rates that drive transfer values are rising, that’s because of inflation. It’s why defined benefit schemes are looking increasingly solvent. So what happens now…..?
This is a blog I started in mid 2022 as transfer values were falling fast. I didn’t finish it at the time and this blog answers it’s question.
Take two
October 2023
This is what happened, transfer values continued to fall and their take up has fallen even faster.
What can we learn?
The value of a pension is not properly reflected in a transfer value no matter how much we believe in the actuarial science in the discounting process.
The pension that is exchanged for a cash equivalent transfer value is a sting of payments that is paid to us, for the period of life remaining to us (us possibly excluding a partner).
That string of payments cannot be anticipated with great accuracy, many will outlive expectations baked into the discount rate, many will not. The actual return achieved on the assets backing pensions may be gilts + or it may be quite different.
What we know is that what is today valued at “less than £150,000 was in 2021 valued at £400,000. We know that the value of the future promise – in terms of the utility it brings us, has not varied in the meanwhile.
We have learned that the system of valuation of pensions is counter-intuitive and overly dependent on the vague abstraction of the gilt-curve rather than common sense.
Why did we encourage those transfers?
In 2017, Merryn Somerset-Webb (pictured) advised readers of the Financial Times “If I had a DB transfer value” , I’d take it now.
She didn’t quite capture the peak of the CETV cycle but she wasn’t far off.
Many who took her advice , now have large amounts in SIPPs, some who came out of DB schemes at low valuation multiples , or whose SIPPs have under-performed or who have spent their pot have seen their financial security crumble before them. It is not as simple as saying “people were badly advised”, it is more that most people have been transferring on a hunch and hunches don’t always work out.
People like Merryn saw the economics of transferring out of DB schemes where the CETVs were inflated by impossibly low discount rates as working in the favour of the financially savvy FT readers and she said it like she saw.
Arguably, she was no different to the “sausage supper” factory-gating advisers of Port Talbot in what she was saying.
But she was talking to the privileged FT readership not to steelworkers coming off shift.
We encouraged CETVs for a variety of reasons ranging from the positive impact members taking them , had on balance sheets, to the positive impact of contingent charges on adviser bank accounts.
But those artificially high transfer values were paid in real money and have depleted schemes of liabilities at a price which today could be halved. That’s a really bad deal for schemes and while it might be argued to be a really good deal for some members, it has not led to much happiness for advisers, regulators or for many of those now stuck with pots and no pensions.
Missing the point
For some time, those in the wealth management industry, whether running funds, platforms or providing wrappers, got fat on the fees from transfers and many regret that the years of plenty have come to an end.
But the surge in transfers from DB schemes to SIPPs over the five years from 2016 to 2021 which resulted in over £100bn leaving the DB system was dwarfed by the loss in value from DB schemes in 200 (now estimated at £600bn).
In real money terms , we are missed the point. We thought that in transferring risk from schemes to individuals , we were de-risking pensions.
We were however doing quite the opposite. We were making pensions a risky business for hundreds of thousands of savers who now have little prospect of formal income – other than the state pension.
Those that remain in the denuded pension funds that support DB income streams, have lost much of the asset cover for their pensions due to the investment strategies that went wrong in 2022 and to a lesser degree, through the over-payment of transfer values in the preceding five years.
This is the real point. Behind all the loss of assets from DB funds is a consistent trope “the tyranny of the gilts based discount rate”. Measuring the cost of pensions by the yield of gilts is the root cause of the demise of our “great economic miracle”.
The Mansion House reforms acknowledge this, though not so overtly as to do with gilts + liability valuations. Moving to a discount rate that was based on the schemes long-term funding assumptions, using a best-estimate basis , would put an end to the mystery of transfer values, indeed it would make pension transfers unnecessary.
For now , we will continue to get fake news on CETVs which have few interested in taking them and even fewer to advise them to do so.
LCP/Professional Pensions