Interest rate cut may boost pension transfers

Falls in interest rates and long-dated gilt yields mean transfers offered from DB schemes will increase in value, as the promised future benefits being given up will be discounted at a lower rate.

Paul Darlow, actuary for Xafinity, explains: “The recent rate cut will increase DB transfer values due to the knock-on impact on gilt yields.

“One would expect that to lead to an increase in the number of members considering DB-to-DC transfers.”

Xafinity’s Transfer Value Index showed this to be the case. Throughout July the index reached a maximum value of £227,500 – a record high for the index.

The interest rate cut has reduced discount rates, which were already historically low, having previously been affected by the Brexit vote Steven Cameron

As at the end of July 2016, the Xafinity Transfer Value Index stood at £225,000.

This is £2,000 higher than the figure at the end of June 2016.

Mr Darlow adds: “The reductions in gilt yields we saw immediately after the Brexit vote have persisted.

“This has kept transfer values high. If this continues, it will raise interesting questions for pension scheme trustees, particularly if significant numbers of members request transfers at a time when pension schemes’ deficits have tended to increase.”

According to Andrew Pennie, head of pathways for Intelligent Pensions: “The cost of securing future income will now be more expensive and hence transfer values should rise to reflect this.”

Carolyn Jones, head of pension product at Fidelity International, says: “The cut in interest rates could be good news for people in final salary schemes.

“Actuaries tend to use the return on UK gilts to discount the cost of future pension payments when calculating members’ cash equivalent values and hence the transfer rate.”

In some cases, according to Bob Scott, chairman of the Association of Consulting Actuaries, members of DB schemes are seeing higher values in terms of multiples of 30 to 40 times the alternative pension.

As a result, “they may be more inclined to investigate the possibility of transferring”, he suggests.

Martin Tilley, director of technical services for Dentons Pension Management, agrees: “We are close to the “perfect storm” of factors which have transfers peaking at their highest levels ever which makes DB transfers out all the more attractive.

“The opportunity to capitalise a pension at sometimes over 30 times its annual value will be seen by many as too good an opportunity to pass up. Advisers reviewing the bigger picture of not just critical yields will also find it easier to make positive recommendations for DB transferring clients.”

Figure 1: Xafinity Transfer Value Index 2016, Jan-July

According to Steve Cameron, pensions director at Aegon, the rate cut on 4 August from 0.5 per cent to 0.25 per cent - the first cut since March 2009 - has had a significant effect on discount rates.

He says: “The interest rate cut has reduced discount rates, which were already historically low, having previously been affected by the Brexit vote.”

Ms Jones says: “As gilt yields reduce, assuming all other assumptions remain unchanged, so will the discount rate that is applied.”

Mike Morrison, head of platform technical for AJ Bell, says people should not be lured by the “big-number transfer”, however: “Cash equivalent transfer values (CETVs) are calculated using assumptions for gilt rates/interest rates.

“The lower they are, the higher the potential CETV. This can potentially have an effect on the decision-making process, because people can sometimes be lured by the big-number transfer value as opposed to the smaller pension each year.”

Side-effect on deficits

Mr Cameron adds: “A related consequence is that deficits in DB schemes are likely to increase, depending on their asset mix”.

Peter Bradshaw, national account director for Selectapension agrees: “It is difficult to quantify whether the recent rate cut affected pension transfers but some scheme deficits will increase because of low returns.”

Data from consultancy Mercers has suggested this is the case. Its latest Pensions Risk Survey data shows the accounting deficit of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies increased by £10bn in just five days following the vote to cut the base rate.

It found:

■ DB accounting deficits in top 350 firms rose from £139bn at the end of July to £149bn on 4 August

■ As at 4 August, asset values were £721bn, a £4bn rise on the corresponding figure of £717bn at 29 July 2016.

■ Liability values were £870bn, an increase of £14bn compared to the corresponding figure of £856bn at the end of July.

Mr Pennie adds: “The increased cost to buy future income has had an impact on DB schemes, with Hymans Robertson now estimating total DB deficits stand at a record £1trillion. Defined benefit pension schemes are on a hiding to nothing. The cost of matching their liabilities looks to be going down a one way street – in the wrong direction.”

Moreover, the Pension Protection Fund index already has 4,864 of its 5,945 listed schemes already in deficit, according to its June 2016 report.

Therefore, Mr Cameron warns: “We may see more employers looking at traditional incentivised bulk transfer exercises to try to control their future pension liabilities.

“Again, the role of appropriately qualified and experienced pension transfer specialists is critical to ensure scheme members receive the best possible advice for their own circumstances.

“A key unknown is how many schemes might be forced to scale back transfer values to reflect their overall funding position to protect remaining members’ interests. I believe this is likely to increase.”