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Kim North: Wrestling with the challenges of DB

Kim North greySince pension freedoms, I’ve always believed that defined benefit scheme members should have been granted the same freedoms as defined contribution pension members.

Why differentiate? Did the Chancellor believe that DB members are less responsible? Or did he understand that the administration of DB schemes is outdated (in most cases) thereby making it difficult to offer partial transfers or providing requested cash equivalent transfer values quickly?

I’m pleased that there is a move to improve DB scheme administration as it will provide members with a better service. The BT £49.3bn pension scheme has moved the data for its 297,000 members to an improved internal administration system. The £45.3bn Royal Bank of Scotland group pension fund has outsourced its pension administration and many other DB schemes are planning to outsource. The increased demand for transfer values is a big driver for the need for better administration.

In simple terms, a CETV is the expected cost of providing the member’s benefits and shows this as a multiple of the expected annual pension at retirement. If a DB scheme is offering a CETV of x40 you would need to live for 40 years or more to be better off in a DB scheme compared to a minimal risk investment that provided returns higher than inflation. How likely is it that a person will retire at age 60 and live to 100 with the need for the same guaranteed amounts every month? Most pensioners I know need to be able to draw lump sums for cruises or hip replacements or the like, and do not live more than 40 years from retirement.

Last week the FCA wrote a letter reminding advisers with DB transfer permissions of its new rules. It also reminded advisers to compare the risks and returns applicable to the assets in which the pension’s transferred funds will be invested against the DB benefits given up. Most advisers I know spend most of their day advising clients where to invest, so this is not a new skill to master. Taxation mitigation and bequeathing to dependents is also in most adviser’s skill set and they know DC is better than DB in both areas most of the time.

How likely is it that a person will retire at age 60 and live to 100 with the need for the same guaranteed amounts every month?

Market uncertainty, the inherent compliance risk and PI cost of advising on DB transfers have resulted in advisers’ fund choices for the ceded pension transfer money to include passive trackers, with-profit bonds and absolute return funds. The top selling retail funds over the past year include five of the top 10 selling funds being BlackRock tracker funds.

A recommendation for cheap trackers from the world’s biggest fund manager is an easy choice for DB transfer money as it makes the compliance safer. However, trackers, as we know, do not deliver outperformance. Retirees have on average over 18 years to live and a good financial adviser will seek growth for retired clients and not recommend 100 per cent passive.

Pension transfers provide fund managers dominant in the institutional market with a huge challenge to replace the DB benefits transferred into DC to attract the DC money. Many of these large investment brands do not have a history of attracting UK individual retail pension investment. If they get the funds, marketing and distribution right, it may result in a move away from recommending the funds offered by the traditional life and pension providers.

Kim North is managing director at Technology & Technical

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Comments

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  1. “If a DB scheme is offering a CETV of x40 you would need to live for 40 years or more to be better off in a DB scheme compared to a minimal risk investment that provided returns higher than inflation”

    Wow, we spend all this time and money putting together a TVAS when all we need to do is divide the income the scheme will pay into the TV and if it takes the client past expected date of death, we are good to go.

    “A recommendation for cheap trackers from the world’s biggest fund manager is an easy choice for DB transfer money as it makes the compliance safer”

    Silly me, there was I thinking that trackers track a market / index and depending on the market / index they track, can be high, medium or low risk, or am I missing out on knowing about a tracker fund that cannot fall in value.

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