As the economic downturn bites, we are likely to see an increase in transfers out of defined benefit (DB) pension schemes. Reports suggest there has already been an uptick in activity by fraudsters looking to prey on transferees.
Transfers-out are a matter for trustees first and foremost. But employers also have an interest. Transfers have implications for scheme funding. And there will be adverse implications if transferees fall victim to fraud: human costs, reputational risk, and possible claims against the transferring scheme.
In this post we recap on the transfer regime, and look at some recent developments.
Members have a statutory right to a transfer payment (CETV) in respect of their DB benefits, provided that they have ceased DB accrual and are at least one year away from normal pension age.
Legislation states that the CETV must equal the cost (best estimate) of providing the member’s accrued benefits within the scheme. This is sometimes said to equate to a scheme’s ongoing valuation basis minus the element of prudence.
In recent years, investment de-risking and falling bond yields have pushed CETVs to surprising heights. But bear in mind that paying a CETV may well improve a scheme’s funding position on a buy-out basis, and so reduce the employer’s potential “section 75” liability. Note also that if a scheme is underfunded and the actuary provides an “insufficiency report”, trustees may be able to scale down CETVs to reflect the underfunding.
Once a CETV has been calculated, trustees are required to pay it to the member’s chosen receiving scheme within prescribed time limits, provided that the receiving scheme meets certain basic requirements.
Therein lies a problem: the legislation does not allow trustees to veto a transfer merely because they feel that (due to fraud or otherwise) the member is making the wrong decision.
The Pension Schemes Bill currently before Parliament will enable the Government to extend the list of requirements which must be met by receiving schemes. But in the meantime, members have two main lines of protection:
- Where a DB CETV exceeds £30,000, the member can transfer only if he/she has first obtained advice from a suitably-qualified financial adviser.
- Trustees are expected to carry out appropriate checks and provide appropriate warnings before proceeding with a transfer.
Where trustees follow due process in this regard, the Pensions Ombudsman will generally absolve them from liability in the event that the member is defrauded under the receiving scheme. But where trustees fail to follow due process, the Ombudsman will sometimes order them to reinstate a defrauded member’s benefits; in effect the transferring scheme ends up paying out twice.
The safeguards mentioned above have not had the impact which regulators had hoped. In particular an FCA investigation last year raised serious questions as to the quality of financial advice. The FCA found that the proportion of cases in which transfers were recommended was much higher than one might expect – almost 70%.
Recent weeks have seen new moves for the protection of members:
- The FCA has announced a ban on contingent charging by financial advisers, plus other measures designed to improve the quality of advice.
- The Pensions Regulator has asked trustees to issue letters telling would-be transferees that, “in these times of financial uncertainty”, they should be “very careful” about giving up their DB benefits.
- In addition the Regulator has announced a partial amnesty for trustees who breach the transfer time limits. The amnesty applies where trustees wish to reassess the basis on which they calculate CETVs and perhaps obtain an insufficiency report. It applies also where trustees are flooded with transfer requests, and need more time in order to follow due process.
Employers may want to engage with trustees and their own advisers, so as to understand the level of transfer activity, the CETV calculation basis, and the implications for scheme funding. Employers may also want to do what they can to support trustees in combatting fraud. CETVs can be substantial, and it’s in no one’s interest for the money to end up in the hands of scammers.