Long ReadMar 21 2023

Pension transfer values need to be clearer for members

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Pension transfer values need to be clearer for members
Pension transfer values need to be clear not only to actuaries but members themselves. (FT Montage/iStock/hudiemm/kraphix/Getty)

As we are now firmly into the grasps of 2023, and hopefully leaving the volatility of 2022 behind us, it seems appropriate to take a look back at how this volatility might have affected members of defined benefit pension schemes, specifically the value of their benefits.

First off, let's tackle the majority. For the vast majority of DB pensioners who keep their benefits in their pension scheme, the investment market volatility will not have affected how much they are getting paid in a pension.

It is in the name; their benefits are defined. Therefore, it is the sponsors that support their pension schemes that will have had to deal with the impact that the volatility of the past six months has had on scheme funding positions. Investment returns will not have affected the amount of money the pension received. 

However, let’s turn to the minority group: those who choose to transfer their pension away from a DB arrangement in the period before they retire. 

We all have a responsibility to make sure that members are making the most informed decisions possible. 

As a reminder, these members have a defined pension within the scheme that is not dependent on market movements. If they choose to transfer it to another arrangement, say with another employer or a defined contribution fund, then a value is placed on it – a transfer value.

That transfer value is calculated to be at least the best estimate value of the cost to the scheme of providing that member’s benefits. So surely, thinking as a member, if the value of that pension does not really change with market movements, then we could assume the value placed on their benefits also does not change? That would be all too simple, however.

Instead, schemes will calculate the value of providing the benefits, by working out how much money they would have to set aside now to pay that benefit for the rest of the member's – and potentially their spouse’s – life.

When working that out they take into account the potential return that they would get for their money over time in the investment markets. 

So what happened to transfer values over the last year? 

Below is a chart to show the illustrative transfer value over 2022 for a 55-year-old male member with a pension of £10,000 a year when they left service 10 years ago.

So what the data is telling us is that if this member wanted to take a transfer value in January of last year, they would have received £393,000, whereas if they waited until November they would only have received £239,000.

Now, at first glance, this would suggest that in this example the member is over £150,000 worse off.

However, using some actuarial rules-of-thumb, what we can see is that if our hypothetical member took their transfer value and invested it in a defined contribution pot where returns are linked to investment markets, because returns were more than 2.5 per cent a year higher by November 2022 compared with the start of the year, then actually the two pots are in theory both able to provide the same benefit.

Seems hard to believe, but then last year’s markets were also hard to believe. 

We have seen lots more queries from members trying to make sense of quotations, so I would suggest this is an area trustees could be more proactive in.

Now that is fine for actuaries to understand, but what we as an industry need to do is to help members make sense of this, so they can make a more informed decision on whether, and when, transferring is right for them. 

Key information that all members should be helped to make sense of includes:

  • Understanding that if they choose not to transfer, their pension within the DB scheme will not change with investment returns.
  • Understanding if they choose to transfer that value will vary with market conditions. Generally, if investment returns get higher, then transfer values get lower (because less money now combined with higher investment returns gets to the same value overall).
  • Understanding that, in theory, if they are transferring to another scheme the amount that other scheme will 'charge' to provide the same benefits (either within a DB arrangement or via an annuity purchase in a DC arrangement) will also move. However, each scheme uses different assumptions, so the movement in values may not match, and so members could be better or worse off depending on what actions they take. 

We have seen lots more queries from members in recent months trying to make sense of the quotations they have been receiving, so I would suggest that this is an area trustees could be more proactive in – perhaps including guides on their member website or accompanying documentation to transfer value quotations to provide a little more information on how they work.

While we can all only hope for less volatility in markets this year, we have just seen Jeremy Hunt’s first Spring Budget, the full impact of Brexit is still to be realised and another general election may not be too far away. Therefore, it is important to be on the front foot and support members as they start to think more about their choices for accessing their pensions. 

After all, a member’s pension is one of their greatest assets, and we all have a responsibility to make sure that they are making the most informed decisions possible. 

Kerry Lindsay is head of scheme actuary services at Hymans Robertson