A Defined Benefit (final salary) pension transfer valuation can increase (or decrease) for two main reasons.
- Decisions the Trustees make on the long term strategic direction of the pension
- The impact of financial and economic factors (discussed in detail elsewhere on this blog).
To understand why a pension Trustee may wish to increase transfer values it is first important to understand the role of Trustees and those they rely upon for support.
What is a Trustee?
Workplace pension schemes in the UK are set up as trusts to ensure pension assets are held separate from the assets of the employer. A Trustee is an independent person (or company) whose role is to oversee the pension fund and ensure funds are secure. They must always act in the best interests of the pension schemes beneficiaries (those retired and those still to retire).
Pension Trustees take advice from a wide range of professionals and make decisions on the best way forward for the pension fund. The activities of Trustees are controlled by the Pension Regulator
What Is A Pension Manager
The key duties of a Pension Manager are investing the pension fund to deliver the best return while managing risk. They are also responsible for reporting on the pension funds financial performance and managing a team of pension administrators.
What Is An Actuary
The key responsibility of an Actuary is to advise Trustees on the value of a pension fund and its liabilities. Actuaries are also responsible for ensuring pension transfer valuations are fair and calculated in accordance with scheme rules and regulations.
DB Pension Scheme Organisation
Final salary pension schemes have three groups of members, active members, deferred members and members in retirement and receiving a pension.
Active members remain in the sponsoring company employment and continue to pay contributions to the pension scheme. Deferred members have left the employment of the sponsoring company and are no longer allowed to pay into the scheme. Deferred members have a right to a pension when they retire based on their (and the sponsoring companies) contributions while they were in employment.
Pension Scheme Objectives
The objectives of the scheme are simple, they are to manage the pension fund to the benefit of the membership and deliver the pension each member is entitled to when it becomes due.
An individual’s final salary pension entitlement is a function of salary (final or some average), years service, any additional contributions and some predefined multiple. A calculation must be made on the level of contribution required by both the employee and employer to deliver the promised pension.
The real value of money potentially many years into the future must be accounted for and that means some growth of the pension fund is required to cover the impact of inflation. Most defined benefit pension schemes tend to invest in relatively low risk, relatively low return investments such as Gilts.
Market forces driving down the returns on Gilts have pushed many final salary schemes into deficit. A pension scheme in deficit has sufficient funds today to pay what is due to its members in future. With many employees and deferred members yet to retire this is not necessarily a problem provided the shortfall can be made up at some point.
The DB Pension Transfer Calculation
Valuing liabilities, the amount to be paid out from the scheme over a number of years is a complex calculation based on a variety of assumptions. The calculation must factor in future inflation rates, interest rates, economic prospects, investment returns and longevity rates. There is, therefore, no one correct answer.
If a pension scheme has a deficit there are a number of potential ways forward. There may be evidence that economic factors will change, improve investment returns and therefore reduce the deficit. Alternatively, the sponsoring company may decide to pay more into the pension fund to address at least part of the deficit. Finally, the scheme may choose to reduce the membership of the scheme by incentivising deferred members to transfer out.
From the three membership groups listed above, there is nothing that can be done about those already taking pension benefits. There is little that can be done about existing members. Even if the sponsoring company is planning a dramatic cut to its workforce any worker leaving employment becomes a deferred members and remains a liability. The only group open to review are deferred members.
The calculations are complex and based on several assumption but the Trustees in discussion with the actuary may decide to remove some of the long term fund liability by offering deferred members of the scheme a attractive pension transfer valuation in an effort to encourage them to transfer out of the scheme. However, the Trustee must be careful to ensure the numbers of transfers out do not put benefits due to the remaining members at risk.
Ultimately setting a transfer value is a matter of judgement based on the information available on a range of factors at a specific point in time. It is not an exact science. Any one factor changing significantly will require a re-assessment of the situation which may lead to pension transfer valuation movements (up or down). At present transfer values on a number of defined benefit pension schemes are at an all time high but that situation could soon change.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances. Past performance is no guarantee of future returns. The value of your investment is not guaranteed and you may not get back the full amount invested.