According to a recent study, 55 per cent of defined benefit (DB) members who spoke to a financial adviser chose to transfer out in 2016/17, compared to just 36 per cent during the previous tax year.
Why are more and more individuals willing to give up their DB guaranteed income for what is perceived as uncertainty as to what they will receive in retirement?
Over the past few years, for the DB schemes that we administer, we have seen a substantial increase in the number of members requesting a transfer value and then subsequently transferring their benefits to a defined contribution (DC) arrangement.
There are numerous reasons why transferring out from a DB arrangement is an attractive proposition, not least because of the present inflated values.
Why are current transfer values so high?
The main drivers for placing a (transfer) value on a DB pension are gilt yields, inflation and mortality.
- There has been a substantial increase in the number of members requesting a transfer value.
- The main drawback to members of defined benefit arrangements is their perceived lack of flexibility.
- A partial transfer could be the ideal solution.
When gilt yields are low, everything else being equal, transfer vales are high and vice versa. To combat the impact of the effects of the 2007 credit crunch, quantitative easing was implemented. This is where the Bank of England purchases government gilts, which reduces their supply, increases the gilt price and in turn, reduces the gilt yield. Gilt yields have fallen by around 3 per cent since 2007 and now stand at around 2 per cent.
To put it into context, a 1 per cent fall in gilt yields could increase a transfer value for a 40-year-old by almost as much as 50 per cent. These extremely low gilt yields mean the value placed by the actuary on a DB pension is high and hence, given the current numbers, is very tempting to those who are considering transferring.
Expectation of long-term inflation is also a major factor when it comes to placing a value on the pensions of members of the 6,000 or so defined benefit schemes in the UK. The market’s expectation of inflation right now is relatively high compared to the last few years. As DB pensions generally increase in line with inflation, when the expectation of inflation increases so does the value placed on them.
When it comes to mortality, there are differing views within the pension industry as to whether life expectancy will continue to increase. If people are expected to live longer, as we are being told, then the DB pension will be paid for longer and hence the value placed on it will be higher.
However, according to the Continuous Mortality Investigation (CMI) in recent years mortality improvements in the UK have slowed down and, since 2015, have started to worsen, meaning people are dying younger.
If this is the case, this will reduce the value placed on a DB pension, although it will only have a relatively small impact, compared to the two former points, reducing transfer values by around only 4 per cent to 5 per cent.
Flexibilities and freedoms