Pension transfers in news

[XFool]

I'm posting this here because there doesn't really seem to be a better place on TLF, lacking a Pension Policy board.

The high multiples sometimes reported in valuations for cash transfers out of DB pension schemes is currently in the news. What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

TIA

Moderator Message:
Moving to Pensions Practical board. Shadow left so you can find it! (chas49)

[Alaric]

I What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

There's a set of rules which would use the return on indexed and conventional gilts and current estimates of longevity. If you assume that you cannot earn a real rate of return on amounts invested, the value placed on liabilities becomes extremely high.

It's all part of the general crisis around defined benefit schemes. They don't work terribly well unless it's possible to get a decent return on the assets. Solvency rules can prevent the obvious and historic solution of sticking most of the assets into equities or property. Once the investment risk is transferred to the individual as in a defined contribution scheme, there's only the beneficiaries' attitude to risk.

[Urbandreamer]

What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

TIA

Well it's an opinion thing.

Pensions, especially DB pensions, are the ultimate in crystal ball bets. Who knows if the money set aside will cover the liabilities? In the dim and distant past employers could both over fund AND use pension pots to reduce their risk. Those of a certain age may remember a time when GEC had a pension war chest and General Motors could be described as a pension fund that happened to build cars!

Well the government got involved, with all too many good intentions. First there was the aspect that these pension funds were "distorting" the economy. The UK governmant (Thatcher government if anyone wants to date it), dictated that either extra benefits were provieded to use up scheme surplus or "pension holidays" taken. Then we had Maxwell!

OK so now we are in a stuation that companies both can't overfund pension schemes and also can't benefit from having a DB scheme in surplus. WORSE, they are STILL required to meet any short fall in an uncertain world. Why wouldn't they offer a good deal to reduce their liabilities? HMRC assumes that a pension is worth 20 times the income when calculating the life time allowence, but does that reflect the liabilities? It's gone a bit off the boil (as the crystal ball shows new things), but some companies were willing to offer 30 or more times the income as a lump sum.

Now to the opinion part. OF COURSE ADULTS CITIZENS CAN NOT BE TRUSTED TO BE ADULT. We need to protect them against deciding to converting their DB pension into a DC scheme and then buying a fast car. CLEARLY ADULTS ARE ACTUALLY CHILDREN! They certainly can not be allowed to judge risks just like children we must prevent them crossing the Rubicon, that's just too dangerous for them.

Sorry for shouting, especially at my fellow Fools. However I can't help but shout. Not that it makes a difference. You can't convince anyone that you and your age group should be treated as adult by shouting.

I'm 55, and I suspect that many/most who hold DB schemes left childhood quite a while ago. Oh and I doubt that I'll convert my frozen DB scheme, it's worth more to me as bonded income. It diversifies the risks that I take with my DC scheme, that may have both greater upside and downside.

If I were cynical I would suspect that the concern is that those with little pension provision and that have the mathematical aptitude to recognise that cashing the pension in then living off benefits would not affect their old age one jot, but cost HMRC quite a bit.

[XFool]

Well the government got involved, with all too many good intentions. First there was the aspect that these pension funds were "distorting" the economy. The UK governmant (Thatcher government if anyone wants to date it), dictated that either extra benefits were provieded to use up scheme surplus or "pension holidays" taken. Then we had Maxwell!

Yes, I'm aware of these factors. Unfortunately, the Maxwell effect seems, one way or another, to have had a long tail.

OK so now we are in a stuation that companies both can't overfund pension schemes and also can't benefit from having a DB scheme in surplus. WORSE, they are STILL required to meet any short fall in an uncertain world. Why wouldn't they offer a good deal to reduce their liabilities? HMRC assumes that a pension is worth 20 times the income when calculating the life time allowence, but does that reflect the liabilities? It's gone a bit off the boil (as the crystal ball shows new things), but some companies were willing to offer 30 or more times the income as a lump sum.

So why isn't there agitation to get theses things CHANGED? Things with pensions seemed to work best when nobody knew anything about them. When nobody knew of the so called 'tax breaks'. When they were boring and out of sight. Ever since they have been brought into the light and made better and safer things just seem to have been going downhill. Or am I just naive?

Now to the opinion part. OF COURSE ADULTS CITIZENS CAN NOT BE TRUSTED TO BE ADULT. We need to protect them against deciding to converting their DB pension into a DC scheme and then buying a fast car. CLEARLY ADULTS ARE ACTUALLY CHILDREN! They certainly can not be allowed to judge risks just like children we must prevent them crossing the Rubicon, that's just too dangerous for them.

No here I feel I am on the 'wrong' side, I'd go for 'paternalism', as in the past. When pensions worked(?)

It's not a matter of people being "CHILDREN". It is, or ought to be, a matter of who knows what. I don't know how reliable all those surveys are that invariably turn up that the average UK citizen doesn't know what 'APR' means or can't work out what 20% VAT is on a purchase of £200 but, if they are halfway true how CAN the average person manage be in a position to understand and allow for the life risks inherent in their own individual pension? Pooled systems (whether DB or Annuities) did that by being pooled. Even then it involves actuarial calculations...

I never expected to live long enough to witness the problems waiting to come to light following the err... 'Pensions Freedom' legislation. Apparently I was wrong, given the increasing bleatings calling for government protection against 'transfer scams'.
Imagine my surprise. No, really!

If I were cynical I would suspect that the concern is that those with little pension provision and that have the mathematical aptitude to recognise that cashing the pension in then living off benefits would not affect their old age one jot, but cost HMRC quite a bit.

Judging by some of the comments in such as 'This is Money', that bit of mathematics is known to the more cynical of the UK population.

[StepOne]

I'm posting this here because there doesn't really seem to be a better place on TLF, lacking a Pension Policy board.

The high multiples sometimes reported in valuations for cash transfers out of DB pension schemes is currently in the news. What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

Yes, it's the pension schemes that offer the multiples, and they won't be being generous. They will be based on the amount of capital they have to tie up to pay an individual's pension. With annuity rates low, they need to tie up more capital for each pound they need to pay out. This means they can afford to increase the payout multiples to encourage people to leave the scheme. If they offer an individual 300k to leave the scheme, then you can bet they are releasing more than 300k capital from the deal.

StepOne

[StepOne]

No here I feel I am on the 'wrong' side, I'd go for 'paternalism', as in the past. When pensions worked(?)

Pensions worked back then because people didn't live as long. Either we reduce life expectancy across the board by a decade or two , or we start contributing much more to our pension schemes.

That's my limited understanding anyway.

StepOne

[Alaric]

Pensions worked back then because people didn't live as long.

Assuming you imply (defined benefit) pensions.

It isn't the only factor.

There's also the issue that guarantees and accounting rules have become more onerous, forcing assets out of shares and property and into lower yielding fixed interest or indexed securities. Not to mention QE driving those yields artificially low.

Then there's the greater fairness of the benefits awarded to those who leave the pension scheme well before retirement age.

You can chuck in Gordon Brown's abolition of the dividend tax credit which wasn't helpful to those funds holding equities.

[SalvorHardin]

The high multiples sometimes reported in valuations for cash transfers out of DB pension schemes is currently in the news. What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

The multiples are calculated using discounted cashflow calculations. There's nothing suspicious about the method, which is standard actuarial mathematics. Generally the valuation rates are standardised but there should be some leeway for the scheme, if only to use industry-specific mortality and morbidity data (I'm a bit rusty having not worked as an Actuary for 15 years!).

What caused transfer values to rise in recent years is the combination of rising life expectancies (so pensions are paid for longer) and the dramatic fall in medium and long-term gilt yields (i.e. interest rates) which increases present values.

Consider a pension scheme which pays a lump sum of £10,000 in 30 years time with an 85% chance that the person will survive to claim it. The value of this payment in today's terms (the "present value") would be the basis for calculating the transfer value (the scheme would use present value minus something for costs).

At 6% interest the present day value is 10,000 x 0.85 ÷ 1.06^30 = £1,480

At 2% interest the present day value is 10,000 x 0.85 ÷ 1.02^30 = £4,693

So a 400 basis point fall in the valuation interest rate increases the transfer value by approximately 217%. The maths is obviously more complex with regular pension payments (an annuity) but the principle remains the same.

In theory the increase in the liabilities of a pension scheme caused by falling interest rates should be offset by an increase in the schemes' asset value caused by rising gilt prices (and other assets due to falling interest rates). Sometimes theory and practice diverge, particularly when you have "aggressive accounting" with the finance director getting the actuaries to use the most favourable assumptions

[XFool]

No here I feel I am on the 'wrong' side, I'd go for 'paternalism', as in the past. When pensions worked(?)

Pensions worked back then because people didn't live as long.

That's my limited understanding anyway.

Mine too, plus the significant effect of much reduced inflation figures and all that that implies. I don't know the comparative magnitudes of these two factors on pensions.

Either we reduce life expectancy across the board by a decade or two , or we start contributing much more to our pension schemes.

Yes. Of course we can't reduce life expectancy as such but we can, much the same thing, reduce the duration of life as a pensioner. This is what has happened in recent years by increasing pensionable age (certainly with the state pension). A "decade or two" sounds intuitively excessive to me - between five to ten years? As for more expensive pensions, yes it would be unpopular but, as a pension is ultimately for the long term benefit of the employee, surely not an impossible 'sell'?

It still surprises me that more effort was not put into 'saving' our past pension systems, which used to be considered excellent. The approach taken seems to me too often to have effectively farmed out the risks to pensioners themselves who, whatever people claim (and they do!), are really not in a position to properly understand and still less to manage and control. IMO.

This has also been 'sold' to people under the wonderful slogan of 'Pension Freedom" - who can possibly be against 'Freedom'?

[Alaric]

Mine too, plus the significant effect of much reduced inflation figures and all that that implies.

Reduced inflation means that even a non-indexed benefit better retains its purchasing power. That and the introduction of revaluation of deferred benefits removed the lottery effect that someone working twenty years for one employer and twenty years for another got much lower retirement income than someone working forty years for the same employer. If it made providing pensions more expensive, they were previously a con.

The real killer was the effect of much lower returns on government and similar bonds coupled with solvency and accounting rules preventing or inhibiting pension funds investing in property or shares with more volatile market values.

[XFool]

The high multiples sometimes reported in valuations for cash transfers out of DB pension schemes is currently in the news. What puzzles me is nobody seems to be explaining why such high multiples are ever offered? Who decides the multiple, are there rules? Could it be the pension scheme itself? If so, why would they offer "over generous" multiples and risk future harm to their own pension fund? Anybody here able to throw any light on this apparent mystery?

The multiples are calculated using discounted cashflow calculations. There's nothing suspicious about the method, which is standard actuarial mathematics. Generally the valuation rates are standardised but there should be some leeway for the scheme, if only to use industry-specific mortality and morbidity data (I'm a bit rusty having not worked as an Actuary for 15 years!).

What caused transfer values to rise in recent years is the combination of rising life expectancies (so pensions are paid for longer) and the dramatic fall in medium and long-term gilt yields (i.e. interest rates) which increases present values.

So, in summary, the answer to the original question seems to be that, using the appropriate rules, these high multiple payouts are fair - to the transferring pension holder - even if they appear to be immediately to the disadvantage of the pension fund (as was reported). On the other hand presumably, on a long term view, they currently appear no more disadvantageous to the fund than continuing to carry said pension holders liabilities?

So it could all be a case of oversimplified or even uninformed reporting? Wouldn't be the first time!

[Alaric]

On the other hand presumably, on a long term view, they currently appear no more disadvantageous to the fund than continuing to carry said pension holders liabilities?

That's about right. There's a caveat though as to whether the pension liability is funded by assets currently invested or by hypothetical future employer payments. So if a scheme is declared to be 80% funded on the accrued benefits, it should be cautious about offering transfer values assuming 100% funding or higher.

Another consideration which may influence some Trustees is that defined benefit schemes can be treated by politicians and lawyers as a bottomless pit. The employer might fund spouse pensions on the basis that only x% of members will be married, only to find their liabilities extended to include partners and other near dependants.

[XFool]

On the other hand presumably, on a long term view, they currently appear no more disadvantageous to the fund than continuing to carry said pension holders liabilities?

That's about right. There's a caveat though as to whether the pension liability is funded by assets currently invested or by hypothetical future employer payments. So if a scheme is declared to be 80% funded on the accrued benefits, it should be cautious about offering transfer values assuming 100% funding or higher.

Another consideration which may influence some Trustees is that defined benefit schemes can be treated by politicians and lawyers as a bottomless pit. The employer might fund spouse pensions on the basis that only x% of members will be married, only to find their liabilities extended to include partners and other near dependants.

Yes. This is why I rather cautiously wrote:

on a long term view, they currently appear no more disadvantageous

Anyway, thanks for all the helpful replies.