In recent weeks there has been a lot of discussion in the media about research from a leading consultancy firm showing that a worrying proportion of final-salary pension schemes operated by FTSE-100 companies are underfunded.
The suggestion has been that perhaps hundreds of thousands of these pension scheme members do not enjoy the degree of security of their benefits they had assumed.
I am not quite sure what recommendations the consultancy firm would give to these employees – surely not that they should opt out of these schemes and effect a personal pension instead?
Perhaps the research was conducted to illustrate some belief that regulation and supervision of the funding of these schemes is not all it should be. However, even the briefest of consideration of the truth behind this research shows just how unimportant the whole time-wasting exercise has been.
The research was out of date before it was even published as it was based on the last published scheme accounts which show only the picture from many months earlier and, in many cases, years earlier.
Underfunded schemes must produce and adhere to proposals to rectify an underfunded position and a number of schemes “accused” of under-funding in that survey have noted that proposals have been implemented and the scheme is currently at least fully funded.
Moreover, and to my mind this is the major issue, underfunding represents a debt by the employer to the scheme and so does not, or should not, represent a problem to employees so long as the employer remains solvent.
In summary, I believe that almost all of the hype around this research and report has been blown out of all proportion although I suppose it has at least served once again to bring to the ordinary person's attention the need to take their retirement planning more seriously and not make too many assumptions.
However, there may well be some more fundamental and important messages behind this research which should be heeded by IFAs and their employee clients, as well as by final-salary schemes.
In particular, away from the FTSE100 companies which were the subject of this research, there are thousands of much smaller schemes which are perhaps not so well supported by financially secure employer companies.
Here, underfunding can represent a potentially worrying problem and should be seriously considered – at the very least by early leavers considering whether or not to effect a transfer out of their previous employer's scheme.
Such transfer assessments, and subjective issues similar to the underfunding consideration, are the theme of my articles over the next few weeks.
Also requiring serious consideration for early leavers from final-salary schemes, is the possibility or probability of employers winding up final-salary schemes and effecting a bulk transfer of members to money-purchase schemes.
Note here that I am not talking about simply closing the scheme to new members – which, of course, does not affect the position of those fortunate enough to have joined before the stated cut-off date. I am particularly referring to what is commonly termed “bulk buyouts without consent” – members' consent, that is.
Where such buyouts are effected, the transfer is usually made to non-profit deferred annuity. This is an option which is expensive for the scheme and employer. It also leaves scheme members in a restrictive contract with only a poor chance of obtaining a reasonable transfer value if they should want to move funds to a more attractive and appropriate pension vehicle such as a personal pension or, at retirement, drawdown.
Where is this discussion leading? Well, whether due to employers falling into liquidation (scheme closes altog-ether, possibly underfunded) or due to a gathering trend of schemes to move away from final-salary schemes, many early leavers should now be more seriously and urgently considering a transfer of their rights to a private pension arrangement.
I am not suggesting that the whole approach of advisers should be on a “buy now while stocks last” basis or a return to “if you don't trust your previous employer, get the hell out of his scheme” approach that we know occurred in the late 1980s and early 1990s. I am simply bringing to the debate the importance and relevance of current trends in occupational pension schemes which have not in the past been so important or prevalent.
I also want to confirm that subjective or “soft'″factors should be at least as important in determining whether to transfer preserved pension benefits as the objective or “hard” factors most commonly relied upon – primarily the critical yield.
I will be looking at the way transfer values are calculated, the variables involved in those calculations (and the implications of those variables) and the reasons why transfer values have been falling – in some cases quite dramatically – over the last few months.
We need to start with the objective factors, primarily the way a transfer value is calculated and the methodology and the frequent failings in the way a critical yield is calculated in a transfer analysis.
There are four – and frequently five – fundamental stages in the calculation of a transfer value for early leavers and although I am fully aware that very few readers will need or want to ever calculate a transfer value, there are important transfer messages at each of these stages. These are:
Calculate the value of the preserved pension and identify the value of ancillary benefits (primarily death benefits to a spouse or other dependant).
Revalue that preserved pension to the member's normal retirement age.
Calculate the projected fund required, at normal retirement date, to buy the revalued pension benefits.
Discount this projected fund back to a current value. That is, “what fund, invested today, would be likely to grow to the fund needed at normal retirement age” – the fund quantified in stage three.
Multiply the answer by a factor designed to reflect current market investment conditions (used in calculating MFR-based transfer values).
Keith Popplewell is managing director of Professional Briefing