Will higher transfer values lead to more members moving their benefits out of DB pension schemes?
The summer transfer window closed on 31 August and Premier League football clubs reported record levels of transfer activity. A greater number of player transfers and ever higher transfer values. A similar picture is emerging with defined benefit (DB) pension schemes, with more frequent requests for transfer statements from deferred members and higher transfer values being quoted. Will higher transfer values lead to more members moving their benefits out of DB pension schemes?
Whereas summer football player acquisitions appear not to be affected by the vote to leave the EU, Brexit has had a dramatic impact on DB pension schemes. Lower interest rates and lower expected investment returns have resulted in the calculation of higher deficits and higher transfer values. Not good for the trustees of DB schemes, but maybe good for the deferred members?
Low yields, high transfer values
A cash equivalent transfer value (CETV) is this present value of a member’s expected retirement income from their DB pension scheme. Most Scheme Actuaries calculate CETVs using a set of economic assumptions that change every month in line with yields on government gilts and corporate bond assets. Using a lower yield places a higher present value on inflation linked income payments during retirement. At the start of 2016, long term gilts and corporate bonds were yielding 2.6% and 3.7% respectively. Eight months later, these yields are down to 1.4% and 2.5%. In broad terms, using a yield that is 1.2% lower could add 25% to the CETV figure. A deferred member, having taken advice from their financial adviser, may have declined a £160,000 CETV at the start of the year on the grounds of poor value. With a revised transfer value of £200,000, will they revisit that assessment and decide to transfer out of the DB scheme?
The decision to transfer benefits out of a DB scheme will depend on the specific circumstances of the individual member. And if the CETV is over £30,000, the member will have to receive independent financial advice before the trustees of the scheme will pay out the transfer value. The financial adviser will consider a long list of member specific factors including age, marital status, attitude to risk, health, and other retirement savings before coming up with a recommendation to transfer or remain in the scheme. Before the recent increase in CETVs, the usual stance was that a transfer is not in the member’s financial interest and therefore transfer recommendations from financial advisers were few and far between. TDC’s experience over the last 18 months is that approximately 5% of deferred members are requesting CETV statements but only 1 in 10 of these members go on to transfer out of the scheme. It will be interesting to monitor how these statistics might change going forward with higher CETVs now being calculated.
Reduced transfer values
As mentioned earlier, many schemes are now reporting lower funding levels and bigger deficits. The trustees of the more distressed schemes will be asking the Scheme Actuary to check if the scheme can afford to pay out CETVs to all the deferred members. If the value of the scheme’s assets is less than the total value of CETVs for all members, the trustees have the right to reduce CETVs, usually by a fixed percentage, until the scheme is better funded. I have seen reductions of up to 40% of CETVs for some distressed schemes. Stating the obvious here, reduced transfer values will be viewed as poor value and members are less likely to transfer out.
Enhanced transfer values
On the other hand, for the better funded schemes, and there are some out there, the sponsoring employer and trustees may agree to offer enhanced transfer values to deferred members, eg quoting 130% of the standard CETV amount. This enhancement could be funded partly by the scheme and partly by the sponsoring employer. The employer may also pay the full cost of the required member advice from the independent financial adviser. This combination of higher standard CETVs from lower yields and the offer of an enhancement could result in a clear recommendation to transfer out of the DB pension scheme.
Win, win, win
In May last year I wrote an article on transfer values and used the phrase “Win, Win, Win” to refer to the possible situation of the member, sponsoring employer and trustees benefiting from a transfer value being paid from the DB scheme. I remain convinced that this situation is still possible, but only for the few deferred members with very significant benefit entitlements. Almost all of the small DB pension schemes that we manage for our clients have half a dozen or so members with above average benefits. It is likely that these members are more interested in considering a (suitably high) transfer value, particularly if they are close to the scheme’s normal retirement age. The payment of a high transfer value for just one member can make a big difference to the funding level of a small DB pension scheme. So who is the Paul Pogba* in your DB pension scheme?
*Paul Pogba recently transferred from Juventus to Manchester United for a world record transfer value of £89 million.