The Financial Conduct Authority has hit back at claims their new pension transfer value analysis requirements are flawed.
Last week the regulator published new rules, set to be introduced next year, for what advisers must consider when recommending a client transfer out of defined benefit pension scheme.
Current rules require advisers to make a comparison, commonly known as a transfer value analysis (TVA), between the benefits being given up and the benefits available under the receiving scheme.
The analysis calculates the rate of return – often referred to as the critical yield – that is necessary to reproduce the safeguarded benefits being given up, assuming the purchase of an annuity is based on the same benefits.
The output from this analysis should be taken into account in the overall assessment of suitability.
The regulator now proposes replacing TVA with an overarching requirement to undertake appropriate analysis of the client’s options - an ‘appropriate pension transfer analysis’ or APTA.
Part of this process will be providing a financial indication of the value of benefits being given up.
But rather than embracing the new analysis, some pension experts were swift to point out the proposed new transfer value comparison shares the same flaw as the current transfer value analysis, in that it puts annuity rates at the heart of any calculations.
The argument is that since pension freedoms giving people unfettered access to their retirement savings were introduced in April 2015, leading annuities to be shunned, calculations based on the outdated product are irrelevant.
Post pension freedoms in April 2015, consumers have more options available to access their pension savings.
Previously, pension savings could only be used to provide an income in retirement (through an annuity or drawdown).
Pension savings can now be accessed as income or cash. But DB pensions must be transferred to a defined contribution (DC) scheme in order for a pension holder to use the pension freedoms rules.
This has combined with more recent changes to the financial environment leading to historically high levels of transfer values.
The craze for full cash withdrawals seen in the first year of pension freedoms continued in the second year, the most recent figures from the Association of British Insurers revealed.
In the second and third quarters of 2016 a total of £1.62bn was taken in full pension withdrawals.
If that were repeated in the following two quarters, it would bring the total value of full withdrawals to £3.25bn in the second year of pension freedoms.
Andy Bell, actuary and chief executive of AJ Bell, said: “Annuities are wholly irrelevant, unless someone wants to take a transfer value now and then buy an annuity at the point of retirement, which would be perverse.
“The analysis needs to reflect the substance of the transaction in hand. Our preference would be to project the income that can be generated from the transfer value from normal retirement age, using sensible growth rates and a standard table of sustainable income drawdown rates and then compare this level of income with that being foregone.”
Chris Daems, director of Cervello Financial Planning, said whilst he disagreed with Mr Bell that annuity rates are entirely irrelevant the reality is advisers needed a better way of calculation.
Mr Daems said: “In my mind using cashflow as standard would go a long way to seeing whether transfers may be worthwhile and whilst it's not a requirement it's something we certainly look at in our business.”
When asked to respond to criticism of the new calculation, David Geale, director of policy at the FCA, said the regulator believes annuities are the closest proxy to what retirees are giving up in terms of a stable, long term income.
He said: “It’s quite difficult to replicate that on products that are by their nature more flexible, for example, drawdown.
“We feel that showing against annuities is a suitable proxy, however we welcome feedback from the industry and others in terms whether they feel there are more appropriate ways of doing that analysis.
However Billy Burrows, director of Retirement IQ, backed the assumptions made by the FCA’s new rules.
He said: “In the new world of pension freedoms it is easy to forget what a pension is, i.e. a guaranteed income for life.
“Annuities may not very popular at the moment but they are still the only way (except for a defined benefit pension) to guarantee a lifetime income.
“I think the FCA is right to have an annuity comparison in the proposed TVC because it is important that to have a like for like comparison.
“There are many good reasons why it may be good advice to transfer out of a DB scheme but in many cases this is because the client doesn’t actually want a pension in the traditional sense or they want to take advantage of the new personal pension death benefits.
“However, there will be some clients who may want to have a regular pension income and are more concerned about living too long rather than dying too early so it stills makes sense to have “an annuity comparison.
“Finally, let’s be clear, there is nothing wrong with the annuity concept, the problem is low yields. If yields improve in the future and the equity market underperforms annuities may come back into fashion and become a hard act to beat again.”
emma.hughes@ft.com
