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Mel Holman: Are critical yields a waste of time?


Not long ago, if a client had asked a firm to help them transfer from a defined benefit pension scheme, most would be turned away.

The introduction of pension freedoms has turned that trend on its head, with many firms now fearing that not considering a DB transfer would result in a client complaint further down the line.

What of the reports suggesting that, while high, the critical yield is irrelevant? This could be as a result of recent FCA guidance published on occupational pension schemes which states: “We would expect the firm to consider the likely expected returns of the assets in which the client’s funds will be invested relative to the critical yield. The firm should also consider the personal circumstances of the client before making any personal recommendation, taking into account other specific factors as they apply to the client.”

The message appears to be that the critical yield figure is not the be all and end all; that you have to take into account the client circumstances and objectives as usual. But it is not saying that the critical yield should not be considered altogether. Basically, advisers must have a healthy respect for the figure.

Ombudsman focus

The Financial Ombudsman Service continues to put great focus on the critical yield figure as a starting point for occupational pension scheme transfer complaints.

The FOS also maintains the client must fully understand the guarantees being lost on transfer and in turn why they wish – or need – to give up a guaranteed income for life, which provides indexation and a spouse’s pension.

So it goes without saying the critical yield must be the starting point of the DB research process. It is vital the transfer value analysis is correct so it generates the right critical yield figure.

From there, the adviser can decide, given the client’s objectives, health and financial circumstances (including attitude to risk and capacity for loss), whether a transfer is in their best interests – even if the critical yield is 20 per cent.

Statements such as “the critical yield is just a number” and “the critical yield does not apply to you” will not go down well in the event of a complaint.

Common errors we see in transfer value analysis reports are:

  • Charges (that is, investment, platform and adviser) not being stated
  • Incorrect interpretations of revaluation rates
  • No reference to step up guaranteed minimum pensions
  • No reference to small details such as whether the client is married or not, or attitude to risk.

Early retirement factors are quite often missed too, which is relevant if the client’s objective is to retire before the scheme retirement age.

In some cases, a protected retirement date at age 50 has been shown in deferred statements provided by the trustees.

“Statements such as ‘the critical yield is just a number’ and ‘the critical yield does not apply to you’ will not go down well in the event of a complaint.”

The FCA is due to publish the findings of its Retirement Outcomes Review later this year, which will hopefully update some of the rules and guidance around TVAS reports where necessary.

Until then, however, we are where we are, and advisers need to remain mindful of the importance of the critical yield.

Mel Holman is director at Compliance and Training Solutions


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There are 7 comments at the moment, we would love to hear your opinion too.

  1. Critical Yield as as much use as any illustration when advising any client, that being not a lot of use at all. The problem being no one actually knows what the future will bring, high inflation, low inflation, high returns, low returns or what the clients life or future may be. I have argued for years that all illustrations are in fact nothing more than a tool to hold companies and advisers to account when these projections do not appear. They are only good for comparison of charges, nothing more. These figures give consumers expectations of what they will achieve, but we have no way to support these fictional figures.

    So, as advisers we can do no more than explain the risks, disadvantages clearly, possible outcomes perceived advantages. It is then down to the client to decide which option best suits them. The problem, the FOS will point at critical yields should they not perform as expected and hold any adviser to account should the consumer complain.

  2. It’s always in FOS’s interests to uphold complaints. As this ensures continuation of ongoing existence regardless of clients circumstances.

  3. “The likely return on assets …..relative to the critical yield…” What does this mean if not that a high CY will put the mockers on a transfer recommendation? To state the blindingly obvious it is not the FCA who will adjudicate on a complaint, it is the FOS. Until these institutions get together the recommendation of many pension transfers will remain a risky business that many will prefer to avoid.
    On other point – pensions under DB contracts are entitlements or promises -they are NOT guaranteed-if the scheme cannot pay them then they do not get paid and the compensation available for those not yet retired is limited to 90% and capped at some 34k. The funding status of the DB scheme is therefore highly relevant and needs to be considered along with all the other factors.

  4. I am reminded of shills for Wonga who say that “the APR is misleading because our loans are not supposed to be held for a year”. No it isn’t. The APR is an excellent illustration of how expensive a loan is. Loans from Wonga and its ilk have an APR in the thousands because their loans are ruinously expensive. Wonga dislikes APRs not because they are misleading but because they are accurate.

    For a similar reason, it is correct to say that the critical yield is not the be-all-and-end-all and there are other factors to consider, however anyone who says “The critical yield if you transfer out will be 12% per annum but it’s OK because critical yield is just a number” should be regarded with extreme suspicion. A critical yield of 12% does not suggest that the concept of critical yield is flawed, just as an APR of 4,000% does not suggest that the concept of APR is flawed. It suggests that the transfer is probably going to leave you worse off. And a bigger weight of evidence is needed to show that it won’t.

    Anyone who says things like “the critical yield is just a number” shouldn’t be allowed anywhere near any amount of money larger than a fiver. Pi is just a number, the gravitational constant is just a number. Would you drive a car or live in a house designed by an engineer who thought there’s such a thing as “just a number”?

  5. Critical Yield is a good illustration to be read with other assumptions – it can assist in setting Risk and Capacity for loss – but it does form part of the burden and volume of jargon trotted out by the industry of insurance – to create anxiety and the propaganda that insurance is so difficult you need a university degree to understand it. Confusion rules in the industry of insurance to protect the few – against the policyholder – the pension holder and the victims of Endowment missselling, pension missselling, PPI – or is it just Fraud ? and the Insurance Industry’s tied agents the Banks.

  6. Terry Mullender 10th April 2017 at 6:45 pm

    The critical yield growth rate within a TVAS report was introduced when clients had no option but to secure a conventional annuity no later than age 75 (ASP excluded….). At best it was always a “best guess” using a range of assumptions e.g RPI, mortality & an annuity interest rate.

    Thankfully clients are no longer compelled to buy an annuity at their intended retirement age and wish to transfer for several reasons OTHER THAN trying to match their estimated DB benefit by buying an annuity.

    Anybody wanting to match or beat their DB scheme pension income & PCLS on a “like for like basis” at their scheme normal retirement age by purchasing a conventional annuity, with record low interest rates and very low annuity rates, is frankly living in cloud cuckoo land!

  7. Based on Freedom of Information request, the FOS do not keep a central record of their staff qualificatons and no one at the FOS has the CII- AF3 or G60 qualifications. The do not employ pension transfer specialists. This is the equivalent to the hospital janitor judging the work of a brain surgeon and urgently needs addressed.

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