The decision by the Regulator to allow trustees to suspend applications for transfers places advisers on the frontline in the battle to secure a fair deal for clients whose defined benefit schemes are under threat
In an unprecedented move, the pensions regulator has given trustees permission to suspend applications for pension transfers. This change has been implemented while trustees await regulations from the Department for Work and Pensions that will allow them to impose a market value adjuster (MVA) on transfer requests.
This development will place advisers on the front line in the battle to secure a fair deal for clients who are members of defined benefit occupational pension schemes that are in danger of being wound up and cannot match their liabilities in full.
Taking a transfer out of a final salary pension scheme is a serious step and not one that advisers would recommend lightly. But the lack of security offered by certain schemes and the temptation for employers to wind up to avoid paying their liabilities in full cannot be ignored.
Under the current law, a scheme that achieves the wholly inadequate minimum funding requirement (MFR) can wind up, leaving the majority of active members with only a proportion of their promised benefits.
Martin Reynard, pensions manager at the London chartered accountant Blick Rothenberg, argues it is important to be clear about which members are comparatively safe and which are not under the law as it stands. 'Defined benefits are only guaranteed for as long as the scheme itself is in existence,' he says. 'Should the scheme be wound up only those in receipt of a pension have statutory protection.'
This minimalist approach to statutory protection requires a scheme that is winding up to secure any pensions in payment through the purchase of annuities. For all other members ' both active and deferred ' the statutory minimum benefit is the MFR transfer value. 'An MFR transfer value falls well short of the typical cost of a deferred annuity contract and may at best provide only 60% of the funds needed,' Reynard states.
In fact, for members under age 50, a 100% MFR transfer value would secure only about 40% of the pension promise. Nick Edmans, press spokesman for the Occupational Pensions Regulatory Authority (Opra), admitted that the current law was unfair and represented a 'sheer cliff' for active members. 'If you are retired you get favourable treatment but if you are close to retirement you get the same treatment as a 24-year-old.'
Taking a transfer from a scheme that it still in operation will not match the full benefit that would be paid if the member stayed to retirement. This is because the calculation assumes limited price inflation (capped at 5 %) rather than full earnings growth. Nevertheless it will be significantly higher than the MFR transfer value. However, the Department for Work and Pensions is currently pushing through regulations that will allow trustees to reduce transfer values where the scheme's funding position is weak.
These changes mean that trustees are in the equivalent position of a life office that imposes a 20% MVA on with profits policyholders who withdraw their fund early. In fact the MVAs likely to be applied by trustees could be far greater than anything we have seen from the life offices ' possibly as much as 50% for younger members. While trustees await these regulations OPRA has issued guidelines that allow trustees to suspend transfer requests where they think the remaining members will be disadvantaged. In other words trustees can now refuse members who try to get their full transfer values out of an underfunded scheme.
The pressure on defined benefits schemes is intense and can only get worse in the current economic climate. Any threat on the part of the Government to improve members' rights on wind up will encourage schemes to act ahead of the change to the law. Several major consultants have warned that employers who took the step to close a scheme to new members will not reduce their future liabilities as much as they originally thought and should look at other ways to control costs.
Peter Bowers, European Partner at Mercer Human Resources Consulting, says: 'With recent turmoil on the stock market, pension fund assets are shrinking. At the same time, with longer life expectancy, benefit costs are rising. This does not bode well for employers' balance sheets.' Mercer predicts that there will be a new wave of pension reviews and that DB schemes will be adapted to reduce employer risks or closed to existing members.
There is a bewildering range of options for employers keen to reduce DB costs ranging from a straight switch to money purchase to the more complex hybrids and career average revalued earnings schemes. In theory most employees will be anxious to avoid alienating the workforce and will seek out an acceptable compromise but there is no doubt that some will simply throw in the towel.
Dr Ros Altmann, an independent pensions adviser to the Treasury, says: 'It is currently possible and indeed entirely legal for employers to wind up their pension scheme and only be forced to pay a fraction of the pensions promised to those who have not yet retired. To their credit, however, not many employers have actually chosen to do this yet.' Yet being the operative word.
Back in October 2002, the Occupational Pensions Advisory Service (Opas) condemned the Danish shipping giant Maersk for setting a very dangerous precedent when it scrapped its UK final salary scheme, leaving members up to 60% short of full benefits. Opas chief executive Malcolm McLean said: 'This is a problem that could affect many thousands of people in the years to come, unless the law is changed. Now you have a situation in which a solvent employer is walking away from the pension fund. It just doesn't seem right.'
For all the criticism Maersk got away unscathed and the dangerous precedent might have been rather cheering to other companies that are equally cavalier about sacrificing their reputation as a caring employer. Altmann warns: 'There must be a major temptation for shareholders and finance directors to extract themselves from these mushrooming open-ended liabilities. In the many cases where schemes have become so large as to dwarf the size of their sponsoring employer, the cost of funding pensions has become dangerously high.'
A company with a market capitalisation that is worth considerably less than the pension fund would be hard pressed to make good a deficit in the pension scheme without allocating all of its profits to this black hole for the foreseeable future.
For advisers it is hard to say whether all of this bad news represents a major opportunity or a poisoned chalice. Even armed with a G60 and an ultra conservative approach to compliance, transfer business is potentially problematic, not least because professional indemnity insurers are likely to withhold cover where firms undertake controversial business. Nevertheless it will fall upon IFAs to advise many of the anxious members of occupational schemes who do not have expert pensions guidance from their trade union and who cannot afford an actuarial consultant's fees. Constructing a fireproof audit trail is essential.
Altmann argues it is also important to look at the individual's position for example by considering how close they are to retirement. If they have a choice between taking the pension now or in a year's time, the balance of risks may mitigate against waiting. The fact is that all members of DB schemes are vulnerable, closed or not. Employers can decide to wind up their schemes at any time.'
Trustees can refuse transfer values where a scheme is underfunded.
The DWP is pushing through regulations that will allow trustees to impose a market value adjuster on transfers from schemes that cannot match their liabilities in full.
Advisers should consider a scheme's financial position before advising a member to try to obtain a transfer out.
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