Financial advisers are calling for more consistency between the discount rates used when giving advice on pension transfers and those used for calculating compensation for clients.
Since 2017 the Financial Services Compensation Scheme (FSCS) has been using a discount rate of 3.7 per cent, based on 50 per cent investment in equities, to calculate the compensation due to a claimant in a failed pension transfer case.
However, since October, financial advisers have been asked to use a transfer value comparator (TVC) for defined benefit (DB) transfers – which means they have had to calculate the cost of buying the client’s benefits on an open market using a risk-free rate of 1.6 per cent.
The difference between the two figures came to light last week in the plight of the British Steel workers who were asking the FSCS to use the 1.6 per cent rate instead of the 3.7 per cent currently being applied.
Philippa Hann, solicitor at Clarke Willmott and representative of the steelworkers, told FTAdviser: "I find it a very difficult situation for the FCA to hold having two different calculations, established one year apart."
She explained when calculating compensation, the FSCS compares the actual value of the individual’s pension pot with purchasing the benefits from the ceding scheme at age 65, with the resulting value being discounted to today’s date, since these savers will receive that money early.
She said: "If you are putting these people where they would have been if they were properly advised, they would be in the BSPS II which is a no-risk ceding scheme. It has safeguarded benefits.
"The FCA's own rules provided under Cobs 19 [the TVC] show how to calculate the cost of replacing the benefits in a safeguarded benefit ceding scheme, and I don’t see why they won’t be compensated on this basis."
An FSCS spokesperson told FTAdviser the discount rate that "applied in the BSPS cases has been used in all such redress cases, in line with FCA guidance".
He said: "There are other discount rates which could be applied, but we would need a compelling reason to use a different one, because we must act consistently. We are very happy to continue to listen to representations from stakeholders on this and related issues."
Ricky Chan, director and financial planner at IFS Wealth and Pensions, said there needed to be more consistency applied to both calculations.
He said: "Otherwise, not only is it confusing, but it also leaves the possibility of anomalies being created where clients may be better or worse off, simply due to their circumstances and the past performance of equities at the date of their redress (due to the assumption of 50 per cent expected return on equities while consumers are at least five years away from retirement)."
Andrew Boyt, pension transfer specialist and freelance consultant, agreed, adding that all calculations in respect of DB transfers should be "carried out using the same parameters since they should always be centred on ‘putting the client back in the situation they were in before the advice was given’".
He said: "An extra ‘difficulty’ with BSPS is that the underlying benefits cannot be reinstated since BSPS no longer exists, the comparison will need to be made with the Pension Protection Fund (PPF) or BSPS II, which are less generous due to the PPF ‘haircut’ and the lower revaluation and escalation bases of both PPF and BSPS II when compared to the old scheme."
While pensioners will see their benefits unchanged if their scheme enters the pension lifeboat, scheme members who have not yet retired will see a 10 per cent cut.
Paul Stocks, financial services director at Dobson and Hodge, said: "Unless the client is due to be put back into the position they were within the scheme, accurately working out the true cost to the member is almost impossible.
"Where assumptions are used, I would be of the view that if they are considering the same factor, they should essentially reflect the same rates.
"However, given that both are rudimentary assumptions, I feel that both, at best, are akin to sticking a finger in the air and trying to discount back (potentially) 30 years of assumptions to a number – however it does feel that there is a broad ‘gap’ between the two."
An FCA spokesman said: "The TVC and redress methodologies have been developed for different purposes and are not intended to be compared. The redress calculation acknowledges that former scheme members are unlikely to be invested in risk-free assets.
"The TVC approach, which is just one part of the advice process, recognises that scheme members are yet to be advised about whether to give up what are generally considered to be risk-free benefits.
"As with any new initiative, we will monitor the effectiveness of the TVC and how advisers are using it as part of the advice process."
maria.espadinha@ft.com
