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John Lawson: Solution to GARs valuation problem is staring us in the face

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The valuation of safeguarded benefits for measurement against the £30,000 limit has caused more than its fair share of problems since the pension freedoms were introduced on 6 April. But is there a simple solution staring us in the face?

The safeguarded benefit regulations point to the methodology for calculating the transfer value of defined benefit pensions. These are about as much use as a chocolate fireguard when attempting to value a guaranteed annuity rate.

Unsurprisingly, different providers have gone off in completely different directions when trying to apply these rules to GARs.

Thankfully, the DWP recognised the problem and is now consulting. But we may end up with yet another complex actuarial algorithm for valuing GARs to add to the one we already have for defined benefit schemes.

The problem with complex calculation methodologies is that no one really knows how they work. And, to get an answer, you have to make some assumptions. And different people (in this case DB scheme actuaries or trustees) make different assumptions.

So, we have already have calculations that nobody understands and that are wildly inconsistent. Enter second-hand annuities.

People who sell their annuities are also (quite rightly) going to be required to take advice if their annuity is worth more than a threshold set by the Treasury. That means we will need a third valuation methodology – this time for valuing an annuity in payment, which could vary depending on age, health and a whole range other factors.

But there is a much simpler solution to all of this.

Instead of converting defined benefit pensions, GARs and annuities in payment into a cash value to measure them against a cash value limit, why not simply leave them as they are and measure them against a defined benefit limit?

Let’s call that limit £2,000 a year.

If your promised DB pension is £2,000 or more you must get advice if you want to transfer to a DC plan. If your guaranteed annuity rate would give you an annuity of £2,000 or more a year you must get advice before you transfer or cash it in. If the annuity in payment that you want to sell is £2,000 or more a year, you need to get advice.

Is £2,000 the right limit? The best judge of that would be a financial adviser. But maybe a trade-off between the cost of advice and the benefit of advice (the monetary value of the financial damage an adviser can stop or at least advise against)?

We have a great knack of engineering complexity into pension rules.

Let’s use the consultation on GARs valuation and the introduction of a second-hand annuity market to engineer some simplicity into the rules.

It would make a nice change.

John Lawson is head of financial research at Aviva

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. Sometimes the best solution is the simplest – and whilst I’m still thinking in what circumstance this might fall down (or be exploited!), in reality the biggest danger to a client with a guaranteed income stream is the loss of that guaranteed income stream… and perhaps as John points out, that is where the line should be drawn.

    My only concern is that consumers can’t equate £2,000 to a capital equivalent sum (and therefore perhaps down play the reason to need advice at any given level) however if it’s the legislation which sets it at any given level, it’s a mute point in any event.

  2. Risk v Reward?

    Sorry but I can’t see advisers wanting to take any of this type of business on board as it will benefit no one other than the providers who purchase these clients annuities due to the significant loss over time to the client. Oh & the revenue NOW! It’s the proverbial can of worms.

    I for one would not want to expose ourselves to the shifting sands/decisions of the FOS, FSCS, CMC et al irrespective of the currents proposals. This in turn will create yet more alienation of clients with financial advisers with a review to follow when the government can’t understand why no one or the industry wants to engage with these new rules.

    Remember you read it here first!

  3. 2000 pound fee to do for a review of a 2000 a year pension may cause a problem with joe in the street

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