Home > News > 2004 > March 2004 > Understanding Transfer Value Payments
Understanding Transfer Value Payments
What is Best for the Employer?
Transfer values are paid from a scheme when a member chooses to transfer their accrued pension rights to another pension arrangement.
In an underfunded scheme, the trustees may choose to reduce the amount of the transfer value paid to reflect the funding level of the scheme and avoid reducing the benefit security for the remaining members. Although this may be an appropriate option for the trustees, offering reduced transfer values to members may not always be in the best interests of the sponsoring employer. Quoting reduced transfer amounts will discourage people from transferring their pension rights which may lead to uncertainty for the employer as to the long-term cost of the benefits.
If a pension scheme is underfunded, employers should talk to trustees to understand the implications for both the scheme and the company, of offering reduced transfer payments and to decide whether or not it would be appropriate for the employer to pay funds into the scheme to facilitate the quotation of full transfer values.
The bar charts above show the values of a typical deferred member's benefits under different valuation bases. The second column shows the full transfer value liability payable to a member leaving the scheme. This will reflect a transfer value calculated on an "on-going" actuarial basis agreed by the trustees and their Scheme Actuary. If the scheme is underfunded on this basis (and many schemes are at the present time), the trustees can reduce this total to reflect the current funding level of the scheme. (If the scheme is above 100% funded on the minimum funding requirement (MFR) basis, the MFR amount is the minimum that can be paid - the MFR amount is shown in blue, so the maximum reduction is shown in red. If the scheme is less than 100% funded on MFR then a transfer of less than the full MFR amount may be offered.)
Members must be told if they are quoted a transfer value of less than the full transfer on the trustees' agreed basis. Some members might have particular reasons for wanting to take a transfer but in all cases members should take careful personal advice before agreeing to a transfer.
Members are less likely to accept a reduced transfer value; instead they may leave their deferred benefits in the scheme. It may therefore be in the financial interest of the company to make up the transfer shortfall (the amount in red in this example) to pay transfer values in full to those members who do decide to transfer. Paying this difference might benefit the company in three ways, if it results in the member accepting the transfer:
In the event that a pension scheme goes into wind-up, or reaches the natural end of its life, members' benefits are usually bought out with an insurance company. Since 11 June 2003 a solvent employer has had to meet these buy-out costs in full. This is the amount shown in the fourth column of the graph. The buyout cost of benefits is normally substantially higher than the transfer value, as represented in the graph by the amount highlighted in green.
If a member is offered a reduced transfer value but chooses not to transfer, the benefits they leave in the scheme may need to be bought out in due course. If instead the member is quoted a full transfer value (with the employer making up the shortfall), and this leads to them transferring their benefits, there would no longer be a prospective buy-out liability. In other words, it may be in the interest of both the transferring member (who receives a higher transfer value) and the company (who meets the value of the benefits calculated on an "on-going basis") to support the transfer value shortfall.
The FRS17 accounting basis may also place a higher value on deferred members' benefits than the transfer value basis (which can allow for anticipated long-term equity investment returns, whereas FRS17 cannot). The FRS17 valuation is illustrated in the third column of the graph. The employer will have to show this cost in its accounts. If the employer makes up the shortfall on the transfer value basis, and the member transfers, the liability for the member will have been discharged at less than the valuation under the FRS17 basis (the saving corresponding to the amount highlighted in yellow).
Whilst less relevant than the points above, over time members choosing to take transfer values will reduce the costs of administering the pension scheme. Deferred pensioner members can request a transfer value quotation and other information from the scheme annually, and will ultimately retire with administration costs being incurred throughout their and their spouse's lifetime. If a member transfers they cease to be a member of the scheme therefore reducing administration costs. An additional administrative benefit from quoting full transfer values is that if a members divorces and part of the benefit becomes an entitlement of the members former spouse the trustees can choose to insist that the former spouse takes a transfer value from the scheme rather than becoming a member in their own right. If reduced transfer values are paid the trustees cannot require the former spouse to take a transfer and the former spouse can insist on becoming a member of the scheme with a resulting increase in administration costs.
Conclusion
In the uncertain climate of pension provision, employers need to understand the procedures being followed by their scheme trustees in respect of transfer values. In an underfunded scheme, reducing transfer values may intuitively seem financially effective but there are circumstances when paying full transfer values (with the company making up the shortfall) can reduce the long-term costs for the employer.
If you would like to discuss this note please contact any of our offices.
Barnett Waddingham, March 2004.