Pension freedoms’ unintended consequences

The former chancellor’s bold assertion in his March 2014 Budget - “No-one will ever have to buy an annuity” - hit the headlines for two reasons: it represented the biggest change in pensions policy in decades in the UK, and it caused the shareprices of the UK’s largest listed life offices, rich in annuity business, to plummet.

One year on since the pensions freedom regime came into force on 6 April 2015, it is clear there have been many unintended consequences of the new rules.

Not the least of these are the huge regulatory hurdles advisers and providers must now overcome when pension scheme transfers are concerned - along with several hundred pages of pensions legislation post-freedoms specific to pension transfers.

The ability to take into their own hands, the capital value of their promised pensions and the currently super inflated value of them has driven many to try and take this control Martin Tilley

In fact, Mike Morrison, head of platform technical at AJ Bell, says: “One of the most significant unintended consequences pension freedoms have had on pension transfers is the shroud of regulatory danger that now hangs over defined benefit to defined contribution transfers.”

For defined contribution (DC) scheme members transferring to another DC scheme, the situation is relatively straightforward, but not so for defined benefit (DB) schemes.

Safeguarded benefits

This is largely because DB schemes carry safeguarded benefits, which the government has defined in legislation as “pension benefits which are not money purchase or cash balance benefits.

“In practice, safeguarded benefits are any benefits which include some form of guarantee or promise during the accumulation phase about the rate of secure pension income that the member (or their survivors) will receive, or will have an option to receive.”

The legislation to protect such schemes means, transfers DB schemes with safeguarded benefits worth £30,000 and above have become exceptionally difficult for advisers, providers, trustees and scheme managers to handle.

Carolyn Jones, head of pension product at Fidelity International, comments: “While not suitable for everyone, pension freedoms made transfers from some schemes, including final salary and other safeguarded benefits, a more appealing proposition.

“With an increased range of choices, navigating members through these has become a lot more difficult. Though there are many benefits to transferring, there are also some clear risks in doing so.”

Flood of requests

Martin Tilley, director of technical services for Dentons Pension Management, says the government’s freedoms has made it seem attractive to transfer, but has resulted in both a lack of understanding and potential problems with funding DB schemes.

He explains: “Sadly, a mistrust of some financial organisations and to a degree the government, who constantly fiddled with legislation, has led many with the opportunity of getting their pensions into their own hands to so.

“This latter issue has contributed to a rise in DB pension transfer requests. The ability to take into their own hands, the capital value of their promised pensions and the currently super inflated value of them has driven many to try and take this control.

“The understanding they can access sometimes 30 times their annual pension is attractive as is the understanding that this capital remains under their control on death and can be passed down generations instead of lost as it is in a DB scheme.

“The flood of transfer requests of course has an impact on the funding of DB schemes. Many of those leaving may have health issues which skews the mortality pool of the remaining members which in turn increases the cost of the scheme to employers continuing to offer these arrangements.”

Need for advice

Because of the importance to scheme members of such benefits, which would be lost if the member transferred or converted their pension to acquire more flexible benefits or access their benefits using the new pensions freedoms, the government introduced a new safeguard on 6 April 2015, requiring them to take appropriate independent financial advice before doing so.

This was first outlined in the July 2014 document: Freedom and Choice in Pensions - Government Response to the Consultation.

Two powers were brought in: the requirement for advice from a qualified professional financial adviser, and new guidance for trustees on the use of their existing powers to delay transfer payments and take account of scheme funding levels when deciding on transfer values.

Between the Financial Conduct Authority (FCA), the government, the DWP and The Pensions Regulator, the message that DB pension transfers will require advice and that trustees can delay transfers to protect consumers has been clear.

But does this go far enough to protect consumers and help the industry fulfil clients’ requests?

Bob Scott, chairman of the Association of Consulting Actuaries, gives a helpful overview:

■ The pensions regulator has outlined regulatory guidance on DB to DC transfers and conversions (April 2015).

■ There is a requirement under FCA rules that a specialist transfer adviser provides advice on DB to DC transfers.

■ The FCA has consulted on (but not progressed) a review of the rules for transfer value analysis.

■ The Industry Code of Practice on incentive exercises has been updated.

■ The Institute and Faculty of Actuaries has issued a communication to its members reminding them of the public interest considerations arising from pension freedoms.

“Is it enough? In one sense”, says Mr Scott, “it is more than enough. In another, important, sense, it is not enough as what is really required is an overhaul of the FCA’s rules and guidance on transfer value analysis.

“Consumers are potentially being denied access to valuable options as a result of the cumbersome and outdated advice process. This could be viewed as protection in the sense they do not give up their DB benefits easily, but for some, transferring would be optimal although the process does not allow that easily.”

According to Claire Trott, head of pensions technical for Talbot and Muir: “The need for advice is key when looking at pension transfers and those that are forced to receive advice will hopefully be well protected by their advisers from doing anything that will put their retirement plans at risk.

“This only however applies to those with safeguarded benefits in excess of £30,000 but those with smaller pensions really need as much help as those with bigger pensions, in some cases more because they may be more reliant on it.

“The £30,000 is an arbitrary amount which doesn’t take into account any other factors such as what else they may have to rely on or not as the case may be.”

Bulk transfers

Steven Cameron, pensions director for Aegon, says with their enhanced powers, trustees have been driving more bulk transfers post-freedoms than before, but there is a huge need for independent advice on this.

Consumers are potentially being denied access to valueable options as a result of the cumbersome and outdated advice process Bob Scott

He says: “Post-pension freedoms, we have seen bulk DB transfer exercises driven by trustees as they look to secure the best outcome for scheme members, where these cannot be achieved through a DB scheme.

“These are in addition to traditional incentivised bulk exercises, driven by employers. The role of advice is particularly critical in these situations.”

Unfunded schemes

The government also acknowledged the potential problems which might have ensued in relation to unfunded public service DB schemes if there were high numbers of transfer requested post-freedoms.

The government’s view was: “Transfers from unfunded public sector DB schemes should be banned.

“Transfers from funded DB to DC schemes will be permitted, and safeguards similar to those in the private sector will be introduced where appropriate” (Government Response to the Consultation on Freedom and Choice in Pensions).

As a result, Chapter 4, section 68 of the Pensions Schemes Act 2015 imposed restrictions on unfunded public service DB schemes.