When it comes to defined benefit transfers, it is important to focus on striking a balance between being fair to members transferring out and the majority who are left behind, says Royal London's Steve Webb.
Key points
The Pensions Regulator is concerned that a high volume of transfers may undermine scheme funding
Trustees may need to review transfer values out of the three-yearly cycle
If employer covenant is weak, trustees should consider downward adjustment to CETVs
The letter in question covers a range of topics, including the importance of schemes maintaining good electronic records of transfer activity and the importance of flagging to members the risk of scams if they transfer out.
The regulator’s letter is a reminder to trustees of the importance of being fair both to those leaving the scheme and those left behind when setting transfer values
But the section of the letter that has attracted most attention is the suggestion from the regulator that schemes may need to review the transfer values they are offering.
A surge in transfer volumes
Until a few years ago, transfers out were a fairly marginal issue for most DB schemes. Requests for transfer values were relatively infrequent and even where people did transfer out this did not have a material impact on the scheme.
But a combination of record high transfer values and the new ‘pension freedoms’ available in the defined contribution world mean transfer volumes have surged.
The regulator estimates nearly 200,000 people have transferred out in the past two financial years, and with an average transfer value of around £200,000, the sums involved could significantly affect the funding position of schemes.
If a sponsoring employer looks strong, then there is less risk to the remaining members of a DB scheme if members transfer out, even with decent transfer values.
Striking a delicate balance
But if trustees believe there is a significant risk their employer might not be around in years to come, then they have to strike a delicate balance between being fair to the members transferring out and the majority who are left behind, who could find themselves in the Pension Protection Fund in the event of employer insolvency.
The watchdog’s guidance letter, which seems to have been aimed primarily at schemes where there is some question about the strength of the employer covenant, says the regulator “would expect you to take advice from your scheme actuary about whether the basis on which CETVs [cash equivalent transfer values] are calculated remain appropriate”.
It goes on to say that the watchdog “would also expect you to consider whether a new insufficiency report should be commissioned from the actuary. This would allow you to judge whether a reduction or further reduction should be applied to CETVs in light of their assessment of covenant strength”.
At the moment, few larger schemes reduce transfer values to reflect a deficit in the scheme.
However, they are empowered to do so by means of the production of an insufficiency report.
On its website, the regulator describes the process as follows: “In certain circumstances, trustees are permitted to offer transfer values which are less than the ICE [initial cash equivalent] under the best estimate method. One of the permitted reductions is to allow for the funding situation of the scheme. However, trustees may only reduce ICEs for this reason after obtaining an assessment by the actuary of the funding of the scheme using the transfer value assumptions and known as an 'insufficiency report'.”
More regular review of TV basis may be appropriate
Under rules that have been in force since 2008, trustees are already expected to undertake periodic reviews of the basis of their transfer value calculation, normally to coincide with the triennial valuation of the scheme.
But with the dramatic changes in transfer behaviour that have happened in the last couple of years, leaving it to a three-yearly review may be too slow.
The DB to DC transfer market experienced a surge earlier in the year as a result of the large number of transfers out of the British Steel Pension Scheme, but the market remains relatively buoyant and trustees should continue to expect a significant volume of transfer requests on an ongoing basis.
The regulator’s letter is a reminder to trustees of the importance of being fair both to those leaving the scheme and those left behind when setting transfer values.
Steve Webb is director of policy at Royal London
