There has been a huge increase in interest in transfer values and the number of quotes following pension freedoms and choice legislation introduced in 2015. Here is a look at the reasons for that increased interest and the challenges for actuaries in setting transfer values that are fair for leavers as well as those staying put.
Transfer values are the sums paid from a pension scheme when a member chooses to withdraw their entitlement. They can be paid from defined contribution (DC) or defined benefit (also called DB or final salary) schemes.
Transfer values paid from DB schemes are the only ones that require assumptions about the future, which is always uncertain. Also, due to the pooling of risk between members, the level of transfer payment can also affect other people’s entitlements. It is therefore crucial that the level of TV payment is fair to all.
In the past lethargy and lack of knowledge led many people to leave pensions in previous employers’ schemes until they came to retirement. Some forget that they have entitlements until schemes contact them – assuming that the administrators have been informed of changes of address and so can find members who left jobs many years previously.
Members transfer for many reasons. They might feel safer with an insurance policy in their own name – in case anything happened to the scheme – or perhaps they prefer to keep all their pensions in one place. It also allows defined benefit members to shape their pension to suit their own needs, where these differ from those in the scheme’s rules, for example by:
• Taking their pension earlier or later than the scheme rules offer.
• Allowing for different levels of inflation protection.
• Altering the level of dependents’ pensions to provide more or less for a spouse, or to remove them completely if they have no dependents.
Pension freedoms introduced in 2015 changed this in a big way, encouraging more members to transfer. Since 2015 holders of defined contribution plans:
• Do not have to buy an annuity.
• Can draw their pension more flexibly.
• Can even take the whole pot as cash – although this would be subject to tax.
These freedoms only apply to members of DC schemes, so if DB scheme members wish to take advantage of the flexibilities, they have to transfer. Publicity over the new legislation seems to have energised people into thinking about their pension and taking action, which must be positive.
Similarly, over the past several years, more and more DB schemes have closed and sought to reduce the risk inherent in their arrangements. One way to de-risk is to reduce the number of members and the size of the scheme’s liabilities, which means the members who transfer out are helping the de-risking process.
This has led some schemes to offer incentives – by increasing transfer values – as an inducement to leave. Consequently, DB schemes have found the number of members transferring out has increased. It remains to be seen if this trend will continue.
The level of a transfer value from a DB scheme is not specified in the scheme’s rules, unlike other benefits. It is instead an option members can choose. The terms used are set by the trustees – on the advice of their scheme actuary – at the time of the transaction.