A fair deal on transfers

As the issue of transfer values continues to drag on Graham Edmonds, Simon Powell and Tim Jones outline what has happened so far

It's a cold spring morning in March 2006 and a dozen naked pensioners are protesting outside the Treasury, demanding compensation for the pensions they have lost. Over the previous decade, following a wave of scheme collapses, some 80,000 of their fellow pensioners have lost all or part of their benefits and the Government is refusing to provide compensation.

As if 80,000 angry (potentially naked) pensioners weren't enough to scare the Chancellor, the Parliamentary Ombudsman then launches a scathing attack on the Government's "inaccurate, incomplete, inconsistent and potentially misleading" leaflets on final salary pension schemes.

While the battle for compensation continues (albeit dampened by the introduction of the Pension Protection Fund and the Financial Assistance Scheme), one of the often overlooked aspects of the Ombudsman's report was how taking a transfer value from a scheme in peril may have offered members a potential escape route. The Government disputed this, claiming that leaving an occupational scheme was "a decision fraught with financial risk". Nevertheless, it has sought to mitigate this risk by seeking to introduce new legislation to make it easier (and fairer) for members to transfer from their final salary scheme.

The story so far

Perhaps having learnt its lesson from the pensions mis-selling scandals of the 1990s, the Government had already acknowledged the risks of transferring out of a final salary scheme. It set about trying to minimise these risks, the ambition being to ensure members receive "fair" transfer values should they ever decide to leave their final salary scheme.

The Government initially delegated the responsibility for determining how "fair" transfer values should be calculated to the Actuarial Profession and, in May 2005, the Actuarial Profession began consulting its members.

Perhaps unsurprising for a group of actuaries this consultation provoked a wide spectrum of differing views. So with concerns being raised from the wider pensions industry and being unable to reach a consensus, the Actuarial Profession, perhaps also worried by the lack of agreement, handed back responsibility for specifying a transfer value framework to the Government. Consequently, in this new era of "Pensions Simplification", the Government instigated its own consultation process with a view to legislating how transfer values should be calculated.

Draft regulations were subsequently published in July 2007.

New draft regulations

In line with other recent pensions legislation, the first thing you notice is the introduction of some new terminology. So to keep us all on our toes: "GN11 reports" (which enable trustees to reduce transfer values if their scheme is underfunded) are to be called "insufficiency reports"; "initial cash equivalent" is now defined as the transfer value amount before adjustment for items like expenses and underfunding; "cash equivalent" is defined as the transfer value amount after these adjustments.

Cosmetic changes aside, the main change introduced is to place the responsibility for determining how transfer values are calculated firmly on trustees' shoulders; the actuary will no longer be required to certify the assumptions or methodology used.

Fortunately, and in line with the new Statutory Funding Objective (SFO), trustees are not expected to rely solely on their "knowledge and understanding", grab their calculators and start calculating transfer values themselves; trustees are still expected to seek advice from their scheme actuary.

Unfortunately, and also in line with the SFO, the proposed legislation contains terms that are not strictly defined - for "prudent" in the case of the SFO read "best estimate" in the case of the draft transfer value regulations. Consequently, trustees are (following advice from their scheme actuary) left to decide what "best estimate" really means. The question is, will it be possible for trustees to use their interpretation of this to penalise members choosing to transfer from their scheme?

The days when all schemes calculated transfer values on a single set of standard assumptions (making it easy for advisers to compare figures on a like-for-like basis) are now long gone. Transfer values will now be calculated on a scheme-specific "best estimate" basis, taking into account the scheme's existing asset mix and with the trustees determining the extent of any allowance for discretionary benefits.

The draft regulations have raised concerns in some quarters regarding their inconsistency with other pensions legislation. Unlike their role under the SFO, where trustees are required to at least consult with the employer when setting assumptions, employers are to have no say in how transfer values are calculated. Another inconsistency appears to be in relation to transfers-in to a final salary scheme, where there is no longer a requirement for the benefits from a transfer-in to be determined using a basis consistent with that for determining outgoing transfer values. A further reason for advisers to express their concerns to clients who seek to transfer benefits to another final salary scheme!

How does this affect me and my client?

The Government's emphasis on disclosure (designed to ensure members are able to make fully informed decisions) has led to a raft of information being made available to members. This includes copies of the statement of funding principles, statement of investment principles, schedule of contributions, recovery plan, annual pension scheme accounts and the annual/triennial actuarial reports. This information is in addition to a summary funding statement and annual benefit statements. Advisers should now be able to form an early opinion on the value and safety of members' benefits far more easily.

However, whether or not the Government achieves its ambition to make cash equivalents fairer remains to be seen. Guidelines currently in place already attempt "to ensure that members of retirement benefit schemes exercising a right to a cash equivalent can be assured that it fairly reflects the benefits otherwise available". The new explicit requirement to use a "best estimate" basis to calculate transfer values might not result in increased transfer values in many cases.

Further, it is possible that the increased focus on fairness and disclosure combined with the introduction of the PPF (which provides increased security for those who retain benefits in a final salary scheme) could result in even fewer members taking a transfer value from their final salary scheme.

So whether this will offer members an escape route from a scheme in trouble remains to be seen.

What happens next?

Implementation of the new transfer value regulations, in whatever form they may take, has been delayed until October 2008. A number of consultation respondents asked for more time to prepare, presumably as most trustees have delayed making any decisions in respect of transfer values for the last few years until a conclusion was reached.

It isn't entirely clear if this extra time will be available solely for implementation. It may be that the DWP and Treasury will also use it to refine the proposed legislation, assuming they can make it to their offices past the line of naked protesters!