Responsibility for the assumptions used in calculating transfer values has effectively passed to trustees. However, actuaries were never likely to be removed from the process altogether and the prescribed calculations insist on the use of an “actuarial basis”.
Trustees are required to treat all members of the scheme fairly and equitably, whether leavers or joiners. Therefore, if transfer values are ever to represent fairly the value of the benefits given up, the people most likely to make that outcome a reality are the trustees.
Advisers are well aware that the transfer values offered to early leavers are deficient. When invested in a personal pension, the rate of return, or critical yield needed to match the defined benefit surrendered is simply unachievable.
If transfer values represent the ex-member’s fair share of assets, then the scheme as a whole needs to make similar unachievable rates of return in order to pay the benefits promised. Despite reports of scheme surpluses, scheme funding is weaker than stated because trustees and their advisers are still making optimistic assumptions.
The only other possible explanation for deficient transfer values is that scheme funding uses one set of assumptions and transfer value calculations another. If this is true, then it is a practice that should end on October 1, when these new regulations come into force.
Trustees are legally obliged to treat all members fairly. If that means deferred members being allowed to take their fair share of the fund with them when they leave, then so be it.
However, trustees also have a relationship with the employer, relying on them to pay contributions into the scheme. Some of the trustees may also be executives in the business and, regardless of the need to wear different hats, that is easier said than done.
Reducing the liabilities of the scheme at a lower cost than the value of the liabilities lost will remain a temptation for trustees. Offering transfer values at less than fair share of assets or low tax-free cash commutation factors are examples where trustees do not always act as they should.
Advisers should continue to expect defined-benefit schemes to make special transfer value enhancement offers. Advisers are also key in ensuring that the interests of the ex-member are protected.
The Pensions Regulator recognised the important role that financial advisers can play in giving advice to ex-members. Here is what it said on the subject last year:
“Trustees should also ensure that where an offer does go ahead, members are made aware of the importance of taking independent financial advice. And trustees should check that that message comes out strongly in the employer’s inducement offer.”
The Pensions Regulator will issue further guidance in the next six months, this time for trustees. Let’s hope that this guidance spells out to trustees that getting rid of ex-members on the cheap does not fit the definition of treating members fairly.
John Lawson is head of pensions policy for Standard Life