Nigel Chambers: How to make DB transfer regulation better for all

Those blocked from DB to DC transfers by the current regulatory system have as much to lose as those who transfer says CTC Software managing director Nigel Chambers

Nigel Masters, CTC
Nigel Masters, CTC

There are arguably tens of thousands members of DB schemes who could benefit from transferring but are not even reviewing the options. The market experience since the advent of pension freedoms has shown that the clear majority of those who can take advantage of the flexibility when it is available.

There is no reason to believe that members of DB scheme would not make similar choices.

This is a win-win situation because the cost of running DB schemes is a weight around the neck of corporate Britain. One way of easing that situation is to enable more members to exercise their transfer rights.

But there are three core barriers to this happening – the stance of the regulators, primarily the FCA, the sheer cost and complexity of the process and the approach being taken by those who manage DB schemes.

The current starting point for anyone providing advice regarding a DB transfer is that it is generally a bad idea. This approach is having a stifling effect on the market. This starting point comes from an era before pension freedoms were available and with those changes in mind a more balanced approach is needed from the FCA.

It is true that a member with a DB pension guaranteed for life and indexed will be financially better off staying in the DB scheme – provided that they can be sure that they will be living an active and fulfilled life well into their nineties. But that is not the case for over half the members who will die before that point who will instead receive less than full value, delivered in an inflexible way, and who would gain greater utility from their benefits if more money were available earlier in their retirement.

An indexed pension increasing steadily over time does not fit the expenditure patterns of most retirees. These are best described as a Smile with higher spending in the earlier years, steadily declining as activity decreases with a possible significant upturn in expenditure at the end of life. A properly utilised drawdown arrangement where a fund of money remains at age 85 is a better answer. If the member dies before that fund can be used, they can be comforted that the money can be passed on to children. If they are lucky enough to live on the money can be spent on income, if they need to go into a nursing home then that money will go some way to meeting a couple of years of care costs.

It is inevitable that the current process is expensive, the level of expertise needed both because of the underlying complexity of DB arrangements and because of the broad range of options available makes it so. In part this is because there are too few people in the market to provide for even the current levels of demand.

The process can be looked at in 3 stages – triage, transfer value analysis and suitability.

Transfer value analysis is currently a long-winded process in large part because of the way that data is made available by schemes. But it cannot be avoided because rules of thumb are not a good judge of the financial value of a transfer. A 40 times multiple between the pension and the transfer may look attractive, but perhaps not if the scheme offers a normal retirement age of 60 with good indexation.

A more detailed analysis is needed but not necessarily (note to regulator) in the current form which assumes an annuity is purchased at normal retirement age. A recent case showed a critical yield of 52 per cent but deeper investigation shows that that was only the investment earnings needed for a 15-month period, it then being assumed that the annuity would be purchased using an underlying interest rate of 1.5 per cent. A better judge of value is that to match the scheme benefits exactly up until the age of 95, a rate of return of 4.1 per cent was needed. This is a better measure.

Once the degree to which the transfer is value for money has been established, then a full fact find taking into account all the members assets, personal goals and their attitude to risk is necessary. But that is not to say that even if the member has only a small DB pension and no other assets apart from a house a transfer may not be a good idea, as it would be possible to use the transferred pension pot to provide a realistic living standard in the early years with the balance to be made up through equity release later. Greater use of technology to support the adviser and cut their time involvement in this phase of the process is essential.

The whole process is significantly delayed because schemes do not provide the necessary information to fully analyse the benefits being given up alongside the full transfer quotation. In over 80 per cent of cases more information is needed. There is an urgent need for that data to be provided in a standard format and ideally electronically. This would save significant time and cost. One has little sympathy for the many schemes whose data is not fit for purpose and who have not yet even fully accounted in their systems for all the changes relating to the Barber judgement and GMP equalisation – they are not offering those of their members who wish to investigate transfers a proper service.

It is also the case that in too many cases trustees still propagate a message saying that transfer is unsuitable and not making their members fully aware of the more flexible options that are in fact available to them. The member who is in ill health and unlikely to be able to enjoy their pension for long is not well served but there have been as yet no compensation payments in situations where a member was not advised to transfer, or not even made aware of the option.

Many people worry about a new mis-selling scandal but there should be equal weight put upon the situation of those who are deprived of the possibility of making their retirement a more enjoyable time.