Just when you thought you had pinned down all the issues for transfer of preserved benefits from a defined benefit scheme along came a couple more – how strong is the employer's covenant, and how might the cash equivalent transfer value (CETV) basis change over the next few years?
Until quite recently, a DB benefit promise was always taken at face value but now everyone is waking up to the difference between a promise and a guarantee.
Companies such as ASW have gone bust and people not yet retired are getting benefits much less than they were promised. Companies such as Maersk have not gone bust but are nevertheless winding up their DB scheme, again with the result that people not yet retired are getting defined benefits much less than they were promised.
I understand that both ASW and Maersk were funded in excess of 100 per cent of minimum funding requirement. If someone with a preserved benefit had taken a transfer out of the ASW scheme or the Maersk scheme a few years ago, would they be better or worse off than they are today?
To answer that, you would need to examine what the CETV basis was at the time and what the transfer would have been invested in, then compare today's investment value with what the member is getting in the scheme wind-up.
But what has become painfully clear is that you cannot automatically regard the preserved entitlement as the “safe” option and a transfer as the “risky” option unless you are a public sector employee whose preserved entitlement is effectively guaranteed by the Government.
In the private sector, you have to look not only at the financial strength of the defined-benefit scheme and the financial strength of the employer but also the degree to which the employer is actually committed to making good any deficiency in the scheme.
Sometimes there is a contractual commitment on the employer to do so, in which case the spotlight falls on the employer's ability to meet any shortfall.
But where there is no such contractual commitment, to what extent is the employer willing to make good deficiencies? Remember also that times change and managements change, so where there is no contractual commitment, the answer in a few years time might be different to the answer today.
Pension scheme actuaries were reminded in a September 2002 letter from the actuarial profession that a CETV basis which is simply the MFR is not likely to be a reasonable basis.
This point is reinforced by an article in the March 2003 edition of The Actuary magazine, which states: “If the current MFR were to be compared with the cost of actually buying out the benefits with an insurance company, it would probably only secure around 15 per cent of the benefits for a younger member.”
So, many schemes are likely to be strengthening their CETV basis if they have not already done so. But remember that scheme-specific funding standards are likely to replace MFR in a few years time and CETVs would probably then be based on this new scheme-specific standard.
Today, it is anybody's guess whether this new standard will be stronger or weaker than the current CETV basis for a particular scheme.
Does all this uncertainty mean that IFAs should throw up their hands in horror and walk away from the transfer market for DB preserved benefits?
Surely the opposite should be the case. The IFA can do all the usual transfer analysis stuff, but can add further value by asking additional pertinent questions, for example, “Is the employer contractually committed to funding any deficiency in the scheme, especially on scheme wind-up?”, “Is there an independent measure of the financial strength of the employer?”, “Has the CETV basis recently been strengthened and, if not, what is the scheme actuary's view of the profession's letter entitled, Professional Responsibilities in Volatile Markets, of September 2002?” In the end, the decision to transfer (provided that the DB scheme will quote in the light of Opra's recent transfer waiver) may be more down to the client's reaction to the answers to these questions than to critical yields. But the IFA must document everything.