I ended my last article by noting the position of members of final-salary schemes who are offered enhanced transfer values to effect an individual transfer to a personal pension before remaining scheme members are transferred compulsorily to an alternative pension arrangement selected by the scheme. I can perhaps best illustrate this point by citing an example of an enquiry submitted to my firm.
A prospective client asked us to assess his benefits within a scheme which was in the process of being wound up. He remitted to us an offer from that scheme he had received some months earlier. Unfortunately, the guarantee was almost about to expire, leaving us no time to complete our enquiries and assessment.
Working on the transfer value within the offer and comparing it with the benefits promised by the second option, the critical yield came out a little over 5 per cent a year. This might appear a very realistic target but the client had only a small number of years to his selected retirement age and he required minimal risk.
The recommendation to transfer could, in our opinion, only have been marginal. Of course, if we had been asked to assess similar offers for younger members – especially with a higher acceptance of risk – a transfer would almost certainly have been preferred.
The transfer value was quoted at around £220,000. The guarantee date having passed by, we were obliged to request a revised transfer value but were instead referred to an insurance company where the scheme’s members had been transferred to deferred annuities. The insurance accompany then quoted a transfer value some £60,000 less than the prospective client had been offered by his scheme.
The revised critical yield came out at around 13 per cent which, especially for a client nearing retirement age with a minimal acceptance of risk, clearly dictated a recommendation not to effect a transfer. Note that the guaranteed deferred annuity, with a highly reputable and financially sound pension provider, now provides complete certainty for the client with almost absolute security of benefits.
There are many lessons to be learned from this not uncommon example.
First, clients must act quickly to assess their options when they become aware that their scheme is being wound up. This assessment should be started even before any final offer is made to them by the scheme but any correspondence to the member at any stage in the winding-up process must be considered and assessed without delay.
Second, financial advisers should endeavour to maintain their awareness and knowledge of employers’ schemes – at least in their geographical area – which have announced the start of winding-up proceedings or might be expected to do so in the near future. There could be very rich pickings for these advisers and, even more rewardingly, for scheme members who, depending on the alternatives offered by the scheme, could enjoy much greater benefits.
Third, do not forget that the Pension Protection Fund does not guarantee all benefits promised by the scheme. As I have discussed in a previous article, members might expect only 90 per cent of their promised benefits as well as losing indexation on their pension in payment. The alternative of an individual transfer to a personal pension should in these circumstances be compared with the PPF guarantee and not to the level of accrued benefits within the scheme.
Note that, with a few exceptions, bulk transfers from wound-up schemes are made to guaranteed deferred annuity contracts or their broad equivalent. Although properly securing the promised benefits, the form of the benefits is usually inflexible. The age at which benefits become payable and the inclusion or otherwise of a spouse’s pension (with further inflexibility as regards the definition of spouse/partner) and/or escalation can all be affected.
This leads me to a final observation. These bulk transfers usually lead to poor transfer values if the member subsequently seeks to transfer to an individual arrangement, perhaps for greater flexibility, as the example above illustrates.
To conclude my discussion on wound-up schemes, I feel it might be useful to share with readers a comment from an actuarial commentator I noted a few weeks ago. He suggested that the only reason why many more final-salary schemes are not being wound up is because most are in deficit and, where the sponsoring employer is financially solvent and continues to trade, winding up would require a massive additional employer contribution to enable all the promised benefits to be secured.
This in itself is not a revolutionary or novel observation but I found his supplementary comments and suggestions to be very thought-provoking. Schemes in deficit must make and adhere to proposals to aim to be fully funded within a specified period of time. He suggests that when that fully funded position is reached, there seems little or no reason why the sponsoring employer should not then wind up the scheme to avoid further funding uncertainty in future years.
If correct – and my view is that his line of reasoning is sound – then we can expect many more and bigger schemes to be wound up in the coming years. I would suggest that financial advisers keep a close eye on the ongoing funding position of final-salary schemes with employers of all sizes, noting the potential benefits of individual transfers against the bulk buyouts traditionally favoured by winding-up schemes.
This is unlikely to happen for several years, however, as, despite the rise in share prices over recent months to six-year highs, the level of underfunding in final-salary schemes has not improved noticeably.
There have been a number of comments and articles by actuarial firms pointing out that many final-salary schemes have disinvested progressively from equities and therefore have benefited little from equity price rises or that the increased fund value has been at least partly offset by other factors such as the cost of increased life expectancy or the continued accrual of final-salary-related benefits. It appears that underfunded schemes will be with us for a good while yet.
That leads me on to the topic of my next article in which I will look at financial planning implications for individual members of schemes which amend their benefit structure. This includes schemes moving from a final-salary definition to a lifetime average or those closing to further accrual for existing members.
Clients or prospective clients in these situations can benefit from an assessment of their accrued pension benefits just as much as clients who have changed employment.
So, let me summarise the different stages of a scheme wind-up to consider from the individual member’s point of view. If the scheme has already been wound up, the newly secured benefits must be the only comparison against which a transfer is made. If the scheme is in the process of being wound up, then a comparative transfer analysis should be made against the promised benefits, the scheme’s offer or the PPF benefits, depending on the state of the scheme and the employer.