New pensions transfer value calculation basis, which is relevant to defined benefits scheme, was introduced in the Occupational Pension Schemes (Transfer Values) (Amendment) Regulations 2008. This new basis applied from 1st October 2008.

How this currently affects pension transfers
As with all previous changes in Transfer Value calculation basis this has meant that many schemes have been unable to provide transfer value details for some time. The scheme trustees and scheme actuaries have held meetings and discussions to ponder how the new basis impacts on the scheme and how they are intending to interpret it. Once that has been agreed the actuary and his team will create a calculation method – usually a piece of software to undertake the calculation. This will then be demonstrated to the pension administrators who will actually use it to provide the figures we need to offer financial planning advice.
So no transfers could proceed for a while, whilst this was all occurring, and there are still some backlogs, which are continuing to create delays, even though most have started issuing the revised values.
The History

Originally, Pension Transfer Values were calculated by the scheme actuary who assessed the basis appropriate for the scheme, within the Guidance provided by the Actuarial bodies. This Guidance was always covered in Guidance Note Number 11 (GN11).

You may have heard of GN11 in relation to maximum benefits and certification requirements for cash for high earners and controlling directors. The GN11 set parameters for the assumptions needed such as investment return &, growth in RPI and the actuary adjusted the assumptions to suit the specifics of the scheme.

Minimum Funding Requisite

The government decided that there should be one basis for all schemes and invented the Minimum Funding Standard (MFR) which imposed various assumptions on transfer value calculations. The MFR was introduced as part of the Pensions Act 1995 (PA95) and was supposed, as much of that act was, to protect individual members.

The most basic way to explain this is to appreciate the requirements imposed on actuaries. When calculating transfer values, actuaries had to assume all members who had over ten years to the scheme Normal Retirement Age (NRA) were wholly invested in equities. As higher growth rates are generally expected from equities as against any other investment, this reduced transfer values for those with over ten years to retirement.

The corollary was that for those within ten years of retirement it was assumed a proportion of their investment, which increased as they approached retirement, was invested in Gilts. That meant that the transfer values for them increased, as the investment return assumed was lower. This basis applied irrespective of what the actual scheme funds were invested in and so was entirely disconnected from the scheme. Theoretically everyone was therefore treated the same.

In practice, the PA95 imposed so many extra expenses on final salary schemes that it was the beginning of the end of the defined benefits scheme. In fact, therefore rather than protecting members it had entirely the reverse effect, because the costs imposed on employers outweighed the perceived value of the scheme to members. That combined with the downturn in investments led to the massive deficits in many schemes.
The introduction of a new accounting requirement (FRS17), which meant companies had to disclose the actual cost of their pension schemes allowing for future expectations of benefits as well as the real cost in terms of monies paid into the scheme in the year, added a further nail in the coffin of defined benefit schemes.

Future alterations
So the powers that be had to come up with a way of preserving defined benefits schemes. One step was the facility to reduce transfer values reflecting the funding deficit. That meant that individuals transferring away received smaller transfer values, but protected the members that remained behind. It is rather like the Market Value Reduction applied on transfers out of a With Profit fund.

The next step was to introduce some sort of protection for scheme members and the Pension Protection Fund was born. As with all these compensation schemes, it has limits and rules which means it only offers a proportion of the benefits, which is, in practice are much lower than the headline rate. Also, it has to be paid for, which means any improvements in the benefits it provides have to be justified in additional costs.
The other idea was to move away from the prescribed basis for calculating transfer values, which was imposed with the MFR and to a “scheme specific basis”, which was really where we all started!
This idea was first mooted to be effective from September 2005; it actually arrived on 30th December 2005. Prior to that there was, as always, significant consultation. That meant that in the end, rather than a total change with a new more prescriptive methodology, the result was a few adjustments to GN11. These amendments did not result in the much higher transfer values, which had been predicted because there was no alteration in the assumed investments and no change in growth rates assumed.
The facility to reduce the Transfer Value in view of deficits remained, and so the move from a final salary scheme was still likely to involve accepting a transfer value which undervalued the benefits and so created a higher Critical Yield.

The big changes in the assumptions were put on hold at that time. In fact the use of the MFR basis was retained by many schemes as it was available until after the next full actuarial valuation report, which schemes have to complete every third anniversary.

The recent alterations

The next time this was all looked at again was the consultation which started on 6th July 2007 and closed on the 17th August 2007. This resulted in the latest regulations the “Occupational Pension Schemes (Transfer Values) (Amendment) Regulations 2008”. These are the latest rules which govern the transfer value calculation basis effective from 1st October 2008.

The legislation defines various terms including the scheme actuary, member and prescribes the calculation basis.

The calculation of the initial cash equivalent is to be on an actuarial basis and should reflect the amount required within the scheme to provide the members accrued benefits, options and discretionary benefits. This reflects the original declared intention that the scheme should offer a cash equivalent transfer value i.e. of the amount equal to the cost of providing the member’s benefits. The trustees are required to determine the extent to which they take into account the value and likelihood of members taking up options available within the scheme. Options include the facility to commute pension for cash or more spouse’s benefits and drawing benefits before NRA. The Trustees are also allowed to consider whether or not to include any provision for discretionary benefits. Once the basis has been set, it will apply to all members and individuals cannot be treated differently.

The calculation basis is further prescribed in terms of the assumptions which must be used and that advice must be sought from the actuary in relation to economic, financial and demographic assumptions. The legislation says these should be based on the actual scheme membership, but may be influenced by statistical evidence from external sources.

Furthermore, the Trustees are obliged to ensure that the scheme’s investment strategy is taken into account. This is expanded to include discussions with the actuary about the statement of funding principles and the investment adviser regarding the financial landscape. This does mean that it is unlikely the future investment return will be linked 100% to equities and so has tended to result in an increase in the initial cash equivalent for those with longer terms to retirement.

Trustees are required to obtain evidence of all the factors considered, which confirms the fact the basis will differ for each and every scheme. There is also a requirement to review the assumptions. The inference is that this to be undertaken with the triennial actuarial report, though there is a requirement to review if the scheme alters the investment policy or discretionary policy or if the demographic assumptions become inappropriate or new standard mortality tables are published.

Virtually all schemes appear to be changing assumptions every month, by linking one or more of the factors to Gilt Yields or some other index. This means there is a larger variation in the revised transfer value if the transfer does not proceed within the three month guarantee period.

The trustees retain the right to reduce cash equivalents in relation to scheme deficits. There is a requirement to base this on an Insufficiency Report prepared by the actuary. This will usually be prepared alongside the triennial valuation, but can be commissioned at the trustees request at any time.

The legislation does offer an alternative manner of calculating cash equivalents, but as the requirements included specifically state the result must be higher than that obtained from the usual method, it is unlikely to be used by any but the most generous types of scheme. That probably means it will be used by the various statutory schemes which have the advantage of being backed by the tax payer.

All transfer values are to be accompanied by the usual caveats regarding the need for financial advice and must be produced within three months of request and guaranteed for three months. On return of the discharge forms, schemes do have up to six months to actually pay the transfer value.

We have noticed that some schemes have undertaken further full formal reviews one year one i.e. as at October 2009. The results we have seen so far indicate reductions in values reflecting the upturn in Gilt Yields, following the reduction in their capital cost.

One other new idea becoming more prevalent is to charge the member a fee for recalculation of the transfer value when the discharge forms are submitted outside the three month guarantee.

How does this affect you?

Transfer values can alter significantly and so swift processing of cases is key. Do please get in touch with us as soon as possible after you obtain the transfer value and the initial go ahead from the client. We will endeavour to get the report completed in good time. This saves an enormous amount of work and heartache in terms of reviewing revised values and fees imposed by schemes.
Comparing the Critical Yield

Over the last few years we have little option but to accept the transfer value being quoted by the scheme. On occasions, we have managed to persuade schemes to review and increase figures, but this has been rare in the last couple of years. Now the whole process is more subjective, we have the option to question and wrangle and potentially improve the fund being offered.
This does rely on having good information and an accurate assessment of the Critical Yield.
* If you are still opting for the free Transfer Analysis from a series of providers and accepting those as an accurate estimate of the position, beware, they are inaccurate and so invalid and undermine the suitability of your advice.

* If you are obtaining an accurate assessment from one of our competitors, all well and good, but do you have the time and ability to do battle with the scheme to ensure they are giving you a true cash equivalent.

* If you do the whole thing in house, are you maintaining levels of accuracy with regard to the information input and do you have in place a true four eyes checking system?

How can we help?

We offer a full financial planning service:

* Gathering the data,

* Preparing the transfer analysis to the highest possible standards to obtain an accurate Critical Yield.

* We then prepare a Suitability Report which reflects the wishes and needs of your client and sets out not only the recommendation, but how it meets those desires.

* Within our team, the four eyes principle is automatically retained, as at each stage i.e. the data gathering and report preparation the data is reviewed and double checked.

* We provide a revised Transfer Analysis where the cash equivalent value changes within our fixed fee.
* We can assist with negotiating reviews of transfer values, where the figures do change. This is subject to additional fees where appropriate.

* Finally we undertake a formal sign off of the transfer and return the entire record to you electronically, so that you can incorporate it in your filing system.
* We only have contact with your client if you want us to – you undertake the fact finding and the final presentation, we do the donkey work!

If you think we can help, please contact us hdclimited@btconnect.com or 01892 838 917

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