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2017 was a high profile year for defined benefit (DB) pension schemes. Did you know that one of the most significant trends emerging for employers who sponsor a DB pension scheme, was the rise in transfer values paid out to scheme members who have yet to draw their pension?
The regulatory backdrop
Since April 2015, when George Osborne unleashed the pension freedoms on the masses, individuals seeking to transfer £30,000 or more from a DB scheme must take independent financial advice from an Financial Conducted Authority (FCA) authorised independent financial adviser (IFA).
On the face of it, the requirement for members to get advice from an IFA was a sensible measure. However, the reality is that, with some notable exceptions, the IFA community has struggled to meet the huge increase in demand.
The FCA, finally, seems to be aware that there is a skills gap that needs plugging. The FCA’s most recent survey of the quality of DB to DC (defined contribution) transfer advice showed that only 47% of cases sampled could demonstrate that the advice given to the individual was suitable. It appears it now intends to collect much more data from all IFAs who advise on DB transfers to build a ‘national picture’ in this area.
We expect the national picture to show a mix of outcomes for individuals, with the best served being those in DB schemes that have taken steps to partner with a credible IFA.
Tackling the demand for transfers
The demand for transfers is unlikely to subside in 2018. Given the regulatory backdrop, how should scheme sponsors respond to this?
"From the sponsor’s point of view, a DB transfer is often a very cost-efficient way of discharging their liability"
From the sponsor’s point of view, a DB transfer is often a very cost-efficient way of discharging their liability. Depending on the age of the individual, for every £100 paid out as a transfer value, securing the same pension with an insurance company could cost anywhere from £120 to over £200.
So, for a sponsor looking to (eventually) off-load their pension scheme to an insurance company, increasing the volume of transfers paid out can reduce the cost significantly. It also shrinks the size of the DB scheme and therefore shrinks the ongoing financial risks the DB pension scheme poses to the sponsor’s balance sheet (even if it does not reduce the headline deficit in the accounts).
Historically, sponsors have driven forward exercises designed to encourage members to transfer, often by partnering with an IFA, paying for the advice and offering an enhancement to the standard transfer value to encourage more members to transfer. This is still a valid way to meet the demand for transfer values, whilst getting some economic benefit in return. Actuarial advice should be taken to structure such exercises in the optimum way.
Working with scheme trustees
However, in our experience, the attitude of scheme trustees in this area is changing and this presents an opportunity for sponsors to work in partnership with their scheme trustees to drive better outcomes for all parties.
Historically, trustees have been reluctant to promote transfers to their members for fear of being asked to pick up the pieces if it all goes wrong. But the FCA’s recent work in this area highlights the real risk that scheme members, tempted by record-high transfer values, are left to their own devices to arrange a transfer and pick a ill equipped IFA to advise them. Schemes and sponsors that select a reputable and capable IFA to provide the advice mitigate against this risk.
So, as well as considering one-off transfer value exercises, sponsors should consider working with trustees to put in place increased support as scheme members approach retirement. This could consist of:
- Partnering with a credible IFA and paying for their advice to all members who approach retirement in the scheme as a matter of course;
- Reviewing, and amending if necessary, the terms of the options available to members; and
- Overhauling the communications to members so that they actually engage with the scheme and the IFA, rather than get put off by a mountain of paperwork.
In our experience, a well-thought through implementation of the above could result in around 30% of members who have yet to draw their pension electing to transfer out of the scheme – which is a substantial number.
And what of the benefits?
- For sponsors, it is a less expensive mean of discharging the liabilities compared to offloading them to an insurance company. It can also be possible to generate modest reductions in funding or accounting deficit deficits, which could translate to lower deficit contributions or profit and loss charges (though this is by no means always the case).
- For trustees, scheme liabilities are discharged more quickly and the risk of members being targeted by pension scams or receiving sub-standard advice is much reduced; and
- For scheme members, they are given the means to be able to consider all their options as they can take advice from an IFA they can rely on. They can then come to the best decision for them, with minimal hassle.