Defined Benefit  

Advisers question 'inconsistent' TVC assumptions

Advisers question 'inconsistent' TVC assumptions

The assumptions underpinning the Financial Conduct Authority’s new transfer value comparator have been called into question by a panel of advisers. 

Speaking at the third Big Pensions Debate in North London today (November 8) a group of advisers questioned the regulator’s use of the risk-free rate to calculate the TVC, saying it was used for nothing else in this area. 

The transfer value comparator (TVC) is part of a new set of rules introduced by the FCA in October in response to the evolving debacle and increased pension transfer requests following the pension freedom reforms.

This comparator shows, in graphical form, the transfer value offered by the DB scheme and the estimated value needed to replace the client's DB income in a defined contribution environment. 

To ensure consistency the calculation of the TVC is done on a fixed basis using a set of assumptions set by the FCA, including the risk-free net rate of return used to discount the purchase price of an annuity at the normal retirement date back to the transfer value calculation date.

The risk-free interest rate is the rate of return of a hypothetical investment with no risk of financial loss, over a given period of time. It reflects that the DB scheme is risk free.

David Penney, director at Penney, Ruddy & Winter, felt the TVC calculation methodology contradicts the existing methodology used for redress calculations.

He said: "It is the same core principle so it should be the same figure – but there are two calculation methods.

"The TVC uses a risk-free rate of 1.69 percent, which means that figure has to be much higher than the redress amount that is discounted back using half of the assumed return on equities.

"There is an inconsistency in the calculation methods between the two figures."

The risk-free rate is based on gilt yields, which are lower than other measures. The rate is meant to show the rate of return a saver could expect to receive. 

Dan Atkinson, paraplanner at EQ Investors, said the risk-free rate had never traditionally been used in DB transfers. "It is an inconsistency," he said. 

Mr Penney said the regulator had cited using the redress rate during its entire consultation on the issue, only to switch it at the last minute.

"I can’t understand it," he said. "I agree with the TVC concept, but using the risk-free rate is flawed. Either the risk-free rate or redress rate is wrong."

However, another adviser in the audience said she liked the risk-free rate as she could use it to show her clients how their DB pensions were effectively invested with no investment risk on them – something valuable that they would be giving up if they transferred. 

Apart from the risk-free rate the TVC assumes no tax free cash has been withdrawn, the annuity purchased is a joint life one and on the same escalation basis as the current pension, and no adviser charges have been deducted.