PensionsNov 17 2017

Percival reveals FCA plan behind pension transfer changes

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Percival reveals FCA plan behind pension transfer changes

Planned changes to how savers are told about the size of their defined benefit pension are designed to give another ‘big number’ to distract them from focusing too much on high transfer values, former Financial Conduct Authority (FCA) technical specialist Rory Percival has said.

The watchdog has introduced the concept of a transfer value comparator (TVC) in its consultation paper CP17/16, Advising on Pension Transfers, published in June.

The draft rules suggest replacing the current transfer value analysis (TVAS) with a requirement to undertake appropriate analysis of the client’s options - an ‘appropriate pension transfer analysis’ or APTA, which will include the TVC.

With the introduction of pension freedoms in 2015, savers have been seeking to take advantage of sky-high transfer values and to move their nest eggs into defined contribution schemes.

According to the latest figures, transfers values stood at £231,000 at the end of October.

Speaking a seminar for advisers organised by Prudential in London, Mr Percival said the regulator is really interested in behavioural science, how people think and make decisions, and the biases they have.

“[The FCA] has recognised that clients are fixated by the big number that is the [cash equivalent transfer value] CETV, and they don't adequately value the ongoing income stream that the defined benefit pension is providing.”

Until now, critical yield was used in TVAS to determine the value of the benefits being given up in a transfer, which was not understood by clients, Mr Percival said.

Critical yield calculations typically make a comparison between a drawdown pension fund and a conventional annuity. This is based on the role of investment return required on the drawdown pension fund to provide and maintain an income equal to that obtainable from an annuity purchased with that fund at the outset.

But under the planned new rules, advisers will have to provide their clients with a value of how much the benefits in the defined benefit scheme would cost today in the open market, which is the TVC.

For example, an adviser can say to the client that his CETV is £500,000, but he is having to give up £615,000 worth of value to get that, Mr Percival said.

“You provide a second big number that the client can compare with the big number they see in the CETV statement.

“And the client is going to say 'I can understand that', or is much more likely to say that he understands what he’s giving up.”

Alan Chan, director and chartered financial planner at London-based IFS Wealth & Pensions and one of the advisers at the seminar, argued that the TVC “will work with the right controls in place from the regulator”.

He said: “It’s a fact that people understand pounds and pence more so than percentages. Traditionally the TVAS would only produce a critical yield which is the annual compounded growth rate required to match the scheme’s benefits, i.e. a percentage.

“The proposed rules will allow the client to see the real value of their pension in today’s money, and there’s a much better chance of them understanding that and fully understanding the risks and the real cost to transferring.”

Mr Percival argued that the regulator “has been quite smart” in introducing this change, and that the industry criticism on the proposal has been misplaced.

Pension software provider CTC Software, for example, said, in its response to the FCA consultation, that the introduction of the TVC was a “disappointment”.

“The TVC is built on the assumption that an annuity is purchased where, unless they are in ill-health, any consumer considering a transfer is almost certain to opt for some form of drawdown arrangement in the expectation of higher returns than those underlying the purchase of an annuity."

Mr Percival noted that the current transfer value analysis is also based on an annuity purchase, and that focusing on this aspect “is completely missing the point”.

Another change being proposed by the FCA is the inclusion of a mandatory cashflow analysis in the DB transfer advice process.

Mr Percival said he is a “big fan” of this change, and that advisers should be already using it, even though it isn’t mandatory yet.

He said: “I think this is good, because the TVAS that you use at the moment doesn't really help you much in assessing whether to transfer or not, because it is comparing to something a little bit artificial and not necessarily relevant to that individual client.

“But with a cashflow plan, you can personalise it exactly to the client’s circumstances.

“That will help you understand what is the best course of action and it will help you to explain to the client the two options and the pros and cos of those.”

A policy statement from the watchdog on the new rules and on the result of the consultation is expected in the first quarter of 2018.

maria.espadinha@ft.com