15 October 2018
Since 1st October, the information supplied to people thinking of transferring out of a defined benefit pension will have to be presented in a new way.
Until now, financial advisers have generally gauged the generosity of the transfer value on offer by reference to a ‘critical yield’. This is the rate of return that would be needed on the sum transferred to generate a pot large enough at retirement to buy an annuity that matched the DB pension given up. Perhaps not surprisingly, regulators have taken the view that such a concept is not very helpful in explaining to clients whether a transfer represents good value.
In future, clients will be presented with a bar chart with two bars. The lower bar will be the cash equivalent transfer value (CETV) on offer. The higher bar will also be a capital sum – the amount which, invested in a risk free way up to retirement, would generate a pot large enough to buy an annuity which matches the DB pension foregone. The idea is that this will enable a client to see graphically how much of the ‘value’ of their pension they are giving up.
LCP’s recent paper with Royal London shows that people ten years away from retirement will routinely be told that the money they are being offered is barely half of the value of the pension they are giving up. Those with an actuarial mindset might assume that clients will, as a result, walk away from pension transfers in their droves.
But the survey we undertook of financial advisers, summarised in the paper, together with the conversations I have been having with advisers in recent weeks, suggests that the impact on behaviour may be much smaller. The majority of advisers surveyed by Royal London suggested that although they thought the new way of presenting this information was clearer, it would not have much impact on transfer behaviour.
The first reason is that the decision on whether or not to transfer is rarely a cold-blooded statistical exercise. Two of the key reasons why people transfer are to give themselves greater flexibility over when they can retire or because they want their children to inherit a capital sum from their pension fund if they were to die. In the latter case they may be mentally comparing the CETV figure with a baseline of zero, which is what a single member of a DB scheme could get for their children if they were to die. These sorts of issues are far more powerful in the minds of clients than a new bar chart.
Second, even if the CETV looks low relative to the ‘true’ value of the pension, it is often still a very large absolute sum, potentially comparable to the value of someone’s house. If you are someone on an average wage being offered the best part of a quarter of a million pounds, you may struggle to feel that you are being ripped off.
Third, although FCA rules require this information to be presented and explained to clients, they are not very specific about exactly how. One example of the paperwork that will be sent to scheme members by advisers has the new bar chart on page 30 of 43, following pages of other charts and commentary. It is unlikely that an additional chart presented in this way will make a huge difference.
In sum, whilst the new approach will provide greater transparency about transfer values and may prompt some interesting discussions about the approach being taken by different schemes, it seems unlikely to stem the tide of individuals looking to transfer out of their DB pension scheme.
Sir Steve Webb is Director of Policy at Royal London.
You might also like...
- Survey results: See how transfer values differ across schemes when looking through the lens of the new Transfer Value Comparator.
- Joint policy paper, Royal London & LCP: What will the FCA's new rules mean for DB to DC pension transfers?
- Recent press release: New FCA rules on pension transfer values set to shake up transfer market
- Latest quarterly analysis: All change for DB transfers? - issue 12