Transfer of risk

Mike Morrison discusses the issues that individuals need to consider when looking at pension transfers

The number of defined benefit schemes still open to new members continues to decline and schemes that previously closed to new members are ceasing future accrual. As we know, the two main reasons are cost and what has become onerous regulation and legislation.

The current economic climate has led to more schemes closing and more schemes entering the Pension Protection Fund (PPF), as the sponsoring company is unable to continue, and this has led to some fear on behalf of scheme members as to the strength of their employer and a comparison of the benefits they expect to get versus what the PPF is likely to pay.       
Transferring from a defined benefit scheme is never an option to be taken lightly due to the sacrifice of what are guaranteed benefits, but there are some circumstances where it might be justifiable.

The pension protection fund

Schemes that become subject to the PPF aim to provide 90% of the scheme benefits subject to a cap of £31,936, for the year beginning 1 April 2009. In addition to the cap, the benefit can also be reduced for early retirement.

For individuals with benefits from the scheme that are above the cap or who might be subject to any other restrictions, there is a vested interest in making sure that they do not lose benefits.

With more and more schemes moving in to the PPF there have also been questions about the viability of the PPF and whether or not it can pay out what it promises. This is only supposition but must be borne in mind.

Other reasons to transfer

While the guarantees offered by defined benefit schemes are the holy grail of pensions there may be individuals who want to change the ‘shape’ of their benefits. For example a member of a scheme who is single might have a part of his transfer value earmarked to provide a spouse’s benefit. Or an individual might want to ‘phase’ into retirement, an option not available under the occupational scheme.

The qualitative versus quantitative factors must be considered, alongside a consideration of whether the transfer value offered by the scheme actually reflects the value of the benefits being given up.  A ‘transfer analysis critical yield calculation’* is vital.

In October 2008, the Occupational Pension Schemes (Transfer Values) (Amendment) Regulations 2008** came into force. These new regulations replace Actuarial Guidance Note GN11, although they largely reflect GN11 in the way a cash equivalent transfer value is to be calculated. The real difference is that the balance of responsibility has now been moved to the trustees of the scheme who will need to act on actuarial advice.

The new regulations work on a scheme specific approach and so the level of transfer value is based on the cost to the scheme if the member had remained in the scheme rather than transferring out.

Salary related schemes

The trustees must determine the assumptions with the aim that, taken as a whole, they should lead to the best estimate of the initial cash equivalent to make provision within the scheme for a member’s accrued benefits, options and discretionary benefits, and in calculating this amount, the trustees must determine the economic, financial and demographic assumptions having taken the advice of the actuary.

The trustees must also have regard to the scheme’s investment strategy when deciding what assumptions will be included in calculating the discount rates and should have regard to market rates of return in assessing this.

The other key features of the regulations include:
•    The ability to reduce the initial cash equivalent to take account of scheme underfunding
•    Increased disclosure requirements for trustees when dealing with possible transferring members
•    A procedure for calculating the minimum basis for cash equivalent transfer values
•    Amendments to other regulations that concern cash equivalent transfer values such as pension sharing legislation.

What does this mean?

In the year or so since the introduction of the new regulations, we have seen a lot of fluctuation in investment markets, interest rates are low, gilt rates are low and after the volatility of the last year, as I write, stockmarkets are strongly on the way up.

The moves in investment markets are all assumptions underlying the calculation of transfer values. Lower investment projections and cautious returns can mean that transfer values increase and rising stockmarkets can help lower scheme deficits, even if on a temporary basis.

So, for some individuals considering a transfer who did not think that the value offered was appropriate, could this now be the time to ask for a re-quote?

*www.moneyhighway.co.uk/pension_transfers.html
**www.opsi.gov.uk/si/si2008/uksi_20081050_en_1

Mike Morrison is head of pensions development at AXA Winterthur Wealth
Management