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Article | Pensions Briefing

DB to DC transfers: reflecting the new reality

The FCA’s consultation on advising on pension transfers

Pensions Corporate Consulting|Defined Contribution|Retirement
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By Stewart Patterson | July 19, 2017

Last month the Financial Conduct Authority (FCA) published a consultation on how financial advisers should advise individuals considering DB to DC pension transfers. Stewart Patterson gives his take on the proposed changes and what they mean for trustees and sponsors of DB pension schemes

Why is the FCA updating its Rules on pension transfers?

The pensions landscape changed fundamentally in 2015 when freedom and choice were introduced. However, the current rules on advising members who are considering leaving a DB scheme to access the new freedoms do not reflect this. The proposed changes seek to ensure that financial advice considers the customer's circumstances in full and properly assesses the range of retirement options now available to members.

Transfers will be right for some members

The FCA proposes to remove its outdated guidance that “an adviser should start from the assumption that a transfer will be unsuitable.” This will be replaced with “an assessment of suitability should focus on whether a transaction is right for the individual and should be assessed on a case by case basis from a neutral starting position.” This is a key change in emphasis which I welcome, as it reflects that – post-pensions flexibility – the one-size-fits-all nature of DB isn’t always best; transferring is right for many people.

The change in the FCA’s stance mirrors what we are seeing in reality. Our DB Member Choice Survey 2017 showed that 55% of members who spoke to a financial adviser about their retirement options chose to transfer (Figure 1).  The financial advisers we spoke to as part of our survey told us that members transfer for a number of reasons: inheritance planning, to better match their planned outgoings or because the member’s personal characteristics mean they can get a more suitable pattern of income outside of the DB scheme.

Figure 1. Choices members have made after talking to a financial adviser as part of a bulk Retirement Transfer Option
2015-16
Figure 01. Choices members have made after talking to a financial adviser as part of a bulk RTO
2016-17
Figure 01. Choices members have made after talking to a financial adviser as part of a bulk RTO

TVA to be replaced with a new (but similar?) value test

The current FCA rules require financial advisers to carry out a transfer value analysis (TVA or TVAS). This aims to indicate whether a transfer is a good deal by estimating the investment return (critical yield) required on the transfer value to replicate the DB scheme benefits that are being given up. The higher the critical yield, the worse value the transfer value appears.

However, transferring members are not generally looking to use their transferred funds to secure benefits similar to those in the DB scheme. The investment return that would be required to replicate the DB benefits is therefore of little interest to members looking to access benefits in a more flexible way.

In addition, the FCA is aware that some financial advisers have become too focused on the TVA output rather than making a rounded assessment of suitability. In my experience this does not apply to all financial advisers; many already advise based on the whole picture but, no doubt, a problem exists in some quarters.

The FCA proposes that instead of a TVA, a prescribed transfer value comparator (TVC) is included in the analysis. The TVC will require a calculation involving:
  • A projection of the ceding scheme benefits to normal retirement age (where relevant)
  • The estimated cost of purchasing those benefits using an annuity, and
  • Determination of the present value needed today to fund the annuity (for those more than 12 months from their scheme retirement date).

While I welcome removing the TVA, the proposed new test still has a key limitation which is unchanged from the existing analysis: it looks at the cost of replicating the DB scheme benefits, which very few members are likely to be aiming to do in practice. It will be interesting to see what the final FCA rules say after the consultation has concluded.

What should DB scheme sponsors and trustees be doing?

The FCA’s change in stance from an initial negative view of transfers to one of neutrality is a refreshing change that reflects the new reality of pensions flexibility. For many members, transferring is the right match for their individual circumstances. 

This should give trustees and sponsors even more reassurance that supporting members who wish to explore their options outside the DB scheme is the right thing to do. Two key actions schemes can take are to effectively communicate about the options and to facilitate financial advice for members who wish to explore these options. This provides the comfort of knowing members are making an informed decision, and is expected to result in reduced scheme costs through a lower lifetime administration burden, reduced individual member or financial adviser queries and an overall shrinking of the DB scheme as members transfer out.

As a minimum, I would expect to see all schemes informing their members of what other options are available; trustees who don’t do this potentially face a risk of mis-selling down the line if members discover that they could have chosen an option that they were unaware of.

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