Advisers have welcomed plans by the FCA to overhaul transfer value analysis calculations to place less emphasis on critical yield.
Under current rules, the calculations must compare the forgone benefits with those available through the receiving scheme. A critical yield, or rate of return, is generated to give an idea of how investments would need to perform if the client wanted the same level of benefits.
While this should be taken into account in planning, the FCA said in a consultation paper on defined benefit pension transfer advice last week that it was aware “that advice has become focused on the TVA output rather than on making a rounded assessment of suitability”.
Part of the problem is that clients, with limited investment knowledge, do not understand the difficulties of achieving their critical yield returns.
Yet errors from firms included regarding TVA as a box-ticking exercise or failing to explain volatility and transfer risk to clients in addition to the critical yield.
This applied also to pension transfer specialists, with the regulator seeing examples of them just running the calculation or checking numbers but not looking at the recommendation as a whole.
The FCA’s consultation reads: “In the most concerning scenarios, the TVA is undertaken first without any knowledge of the client and then made to fit the client’s circumstances.”
The new test
The regulator proposes a new “appropriate pension transfer analysis” test. As part of this the FCA would build on the current calculation method, but would add the present value needed today to fund the annuity for those more than 12 months from their scheme retirement date.
“Instead of determining the required rate of growth, firms must determine an appropriate discount rate to value the amount needed to reproduce the safeguarded benefits, after appropriate charges,” the regulator explains.
The FCA also wants to tighten some technical assumptions behind TVA on mortality, annuity rates and DB scheme indexation and revaluation.
Richmond House Group managing director Paul Beasley says: “In principle, it’s the right thing. There’s far too much focus on critical yield. What we are finding is a lot of DB transfers we have done over the past 12 months have been for clients with other wealth, other income.”
Beasley says his firm has conducted DB transfers with critical yields as high as 50 per cent in cases of inheritance tax planning, where the client was never going to touch the DB funds but wanted just to pass them down. Out of 12 advisers at the firm, five have specialist pension transfer qualifications.
Many advisers say they already pay little heed to critical yield when deciding if a transfer is suitable.
Optima Regulatory Strategies consulting director Esrar Moitra says: “If a firm is providing DB transfer advice properly, a lot of the changes here aren’t really going to change its advisory process, just update parts of it.”