It’s one of those situations that sounds great in theory.

OK Mr Jones, so here’s what your pension is on an annual basis.  Here’s what we’ve calculated that it is worth as a lump sum. But guess what, because we’re such nice guys, we don’t want to give you that (with apologies to Chris Tarrant). Oh no, we’re going to put a whacking great 20% extra on top. There, how can you refuse?

And there lies the problem.

Since the advent of the pension freedoms in 2015, there has been a huge rise in the number of members transferring away from defined benefit schemes. Attracted by the huge sums of cash on offer, particularly in a climate of low interest rates and gilt yields. Yet a significant number simply do not understand that the sum needs to be placed in the context of having to last for the remainder of their lives. I have spoken before of the ‘everyone else is doing it’ culture which anecdotally is hitting defined benefit right holders. When the average man in the street is told that this huge lump sum is significantly more than the actual value of his pension savings, the urge can quickly become irrepressible.

The rush to transfer out of defined benefit savings is to an extent symptomatic of the ‘live for today’ culture in modern society. We are all too aware that the freedoms can carry significant benefits in the right context – ability to leave death benefits to non-dependants being a big one. If you don’t last too much longer after the transfer then the next generation are (metaphorically) laughing. But with life expectancy on the increase, what happens if you live to 90? 95? 100? Suddenly, that huge transfer value doesn’t look so huge after all, particularly if investment returns are poor.

The fundamental issue with defined benefit transfers is that the risk is transferred onto the client. This is why many schemes are willing to offer generously enhanced transfer values – it allows them to quantify their liabilities and plan ahead for the future. The same can’t be said of the client, who faces significant unknowns in the shape of inflation, investment returns, life expectancy etc… Where the investor is sophisticated, has significant other assets and is in a position to make an informed choice then the risk is acceptable. But for the average Joe or Josephine with average assets who is simply following the herd, the risk is huge.

Enhanced transfer value exercises (or ETVs for short) have been on the joint radar of the FCA and The Pensions Regulator since as far back as 2010 (for those who are interested, their thoughts at the time can be found here In a recent example, risk management firm Aon succeeded in managing its own risks, cutting its liabilities by more than £80m after around 22% of its 7,000 deferred members accepted an ETV.

Those of you who have been doing your background reading will know that ETVs, and incentive exercises in general, are subject to the governance of the Snowdon Code. This was launched in 2012 and the effectiveness reviewed in 2016. It also remains high on the examiner’s agenda, having been questioned in the December 2017 PTPA paper and come up in the case study for the June 2018 LIBF PETR exam. It is, at the time of going to press, unknown whether this was questioned in the exam, however, it goes without saying that the good people at Expert Pensions prepared our students thoroughly for this possibility via our comprehensive case study analysis.

Whilst it is not necessarily the role of the trustees to prevent ETV exercises, it is their responsibility to ensure that they are carried out in accordance with the code and in the best interests of the members. The Snowdon Code requires trustees to ensure that such exercises are:

  • done fairly and transparently;
  • communicated in a balanced way and in terms that members can understand;
  • available with appropriate regulated and  qualified independent financial advice that is paid for by the employer;
  • able to achieve high levels of member engagement;
  • provided with regulated access to the independent complaints and compensation process.

ETV exercises are also subject to principles set by TPR. In the main, these require the exercises to be clear, fair and not misleading (the sharp eyed among you might recognise this wording from FCA principle 7 and the financial promotion rules). The other principles provide that the exercise should be open and transparent, manage conflicts of interest appropriately, engage the trustees and offer access to independent advice paid for by the employer.

A little known technical point on the subject of ETVs is that they can result in a client who has Enhanced or Fixed Protection losing their increased LTA. The Pensions Tax Manual provides that when transferring out of a DB scheme, protection shall not be lost providing the transfer is a ‘permitted’ one. This includes the stipulation that ‘the rights in the new scheme are actuarially equivalent to the rights being transferred’ (basically a CETV). Where a transfer value is enhanced, the rights in the new scheme are greater than the value of the rights being lost and hence the transfer would not meet the ‘permitted’ criteria. This has the potential to result in significant client detriment if great care is not taken when advising on the point.

I am already aware of one large scale past business review of ETV cases due to commence over the coming months. Anyone studying for a level 6 exam or providing advice in this area would be well advised to monitor further thematic work.