The challenges of DB transfers

Over the last year there has been a more than 50% increase in the volume of transfers out of defined benefit (DB) schemes, according to a recent survey of 800 financial advisers by Royal London.

Ultra-low interest rates have pushed defined benefit transfer values to exceptionally high levels while freedom and choice legislation has made it possible for members to access their assets.

This surge in transfers is creating potential problems for occupational pension schemes, pension providers and scheme members. Neither the regulator nor the industry anticipated this sudden surge in transfers and so options and protections are not as complete as they could be.

While a scheme member cannot transfer more than £30,000 out of a pension scheme without taking financial advice, there is no compulsion for them to follow the advice, nor are they compelled to take advice on investing the settlement or to take ongoing advice afterwards.

Governance

Royal London director of policy Sir Steve Webb says: "The bit of the jigsaw that is still missing is to ensure that scheme members transfer their funds into something that provides some level of governance."

If the member were to transfer their funds into the company's defined contribution (DC) scheme, governance would be provided. And it could be provided for a personal pension if they were to pay for ongoing advice, he added.

At the moment most transfers are going into individual products rather than occupational DC schemes. Webb says: "Most people want ownership of their money and view a personal plan as the best way to achieve this rather than being part of a collective scheme."

But it's not only the behavioural aspect that is driving these decisions - some argue that a lack of response from occupational DC schemes has driven many scheme members to personal pensions.

Julian Lyne, global head of distribution at Newton Investment Management, says: "There is currently a reluctance among many [workplace] DC schemes to put in place the type of flexible retirement options that members who have transferred out of DB will want."‎

Both trustee-based and contract schemes are questioning whether it is up to an occupational pension to provide the level of flexible retirement income wanted by both members who have transferred out of a DB scheme.

Lyne says: "They are debating whether it is appropriate to provide advice and a range of post-retirement options."

It's more than simple reluctance, however - many occupational DC schemes are not able to pay out income. Lyne says: "Many administrative systems used to run these schemes are not set up to make monthly income payments."

To deliver the type of functionality to enable a seamless transfer from a DB pension scheme to a occupational DC scheme will require a considerable IT investment.

Lyne says: "Schemes have cold feet about making such a sizeable outlay when they are not sure whether this trend is large and sustainable enough to justify the expense."

But such an expense could be justified if they looked further into the future and recognised that DC will replace DB. Lyne says: "As the pot size grows, there will be an increasing demand from plan sponsors to provide this level of support and service."

At the moment, however, most members transferring out of DB schemes have to transfer into a personal pension as there is simply no other option.

This means that members are effectively forced into a more expensive plan - there is no charge cap for personal pensions as there is for many workplace DC schemes. Nor do personal pension plans always provide the same level of governance as an occupational DC scheme.

Lyne says: "There could be ramifications for the industry once members realise they are being charged much higher fees in their personal pension."

Shifting attitudes

But these attitudes could shift if the UK develops in a similar manner to the more mature US market. Companies will start to get comfortable with the idea of providing advice and flexible post-retirement options.

The 2017 DC trends survey carried out by Callan ‎in the US showed that 85% of plans offer investment guidance and advice to their members. Lyne says: "More than a third of firms offer advice."

Lyne says: "In the US companies actively try to keep members in their plan rather than encourage them to go elsewhere." This is driven by a concern to ensure members are given the appropriate support by their employees.

"They are conscious that, because of their scale, they are best placed to deliver that at the right price with the correct level of governance," he adds.

But that is not the only factor. Part of the motivation for US companies for this paternalistic approach to post-retirement is driven by organisations' desire to manage their workforce effectively, adds Lyne.

While UK companies might adapt a similar approach to their US peers over time, policy changes could encourage the process.

Lyne says: "If the government indicated that DB schemes could not simply hand off members from a scheme with good governance and fee cap to a personal pension, this would force DC schemes to offer post-retirement products to those transferring out of DB."

The introduction of a charge cap in the post-retirement market would provide further impetus for DC schemes to develop this product range, he adds.

Mis-selling fears

But some argue that current guidance from UK regulators is not helping master trusts or DC schemes to offer options to members who have transferred out of DB schemes.

A recent consultation by the Financial Conduct Authority on DB pension transfers put its emphasis of the advice and the role of the advisor at the heart of this process.

SEI director of institutional investor solutions Ashish Kapur says: "There was very little discussion of the responsibility of the transferring scheme trustees or those at the scheme that receive the assets."

Neither the trustees from the DB pension from which members have transferred out of nor those in the scheme they switch into can see the advice given to the member. Kapur says: "They can only get confirmation that the member has obtained that advice."

The trustees at the receiving scheme want to understand why the member has made the decision to transfer into their fund. Kapur says: "Without this knowledge of why a transfer has been made, schemes are worried that they could risk a mis-selling scandal."

If the regulator were to allow trustees of both DB and DC schemes access to the advice received by the members, it would help to encourage an easy transfer between different occupational schemes.

Transfer delays

But other practical barriers also have to be removed and many administrators are struggling with the high demand.

Mercer partner Deborah Cooper says: "The service level agreements they have with their clients are being stretched because of the number of transfers."

When these agreements were made, it was not envisaged that such a high number of employees would request quotes on the value of their transfers. Cooper says: "Many members considering taking advantage of the pensions freedom have requested a valuation of their pension pot."

While the number of quotes is much higher than the actual transfers, this still creates a headache for administrators, she adds.

Employers are also becoming concerned about the number of their employees transferring out of the company pension scheme.

Kapur says: "They know little about these employees' financial plans and are worried they might not be in a position to retire as planned. This could make it much harder for companies to manage their workforce, he adds.

It might seem that the high level of pension transfers would be welcome by DB schemes as this reduces the long-term liabilities they need to pay. However, for some schemes the short-term challenges could threaten to overwhelm the short-term benefits.

Lyne says: "There are investment repercussions for DB schemes experiencing high levels of transfers, particularly for those which are cash-flow negative." A different strategy may well needed to cope with these challenges, he adds.

The double whammy of high transfer levels along with negative cash flows will change the way that both consultants and trustees look at the risk profile and the time scale of those plans, he adds.

Lyne says: "Trustees and their consultants may need to adapt to the challenges presented by the combination of high levels of cash flows needed to pay pensions and pension transfers and change the investment strategy."