1. How DB schemes calculate transfers values
2. Whether transfer value analytics is still relevant
3. How the regulator will shape TVAS moving forwards
PRESENTER: DB transfers have soared as savers seek to take advantage of high transfer values, and to move their nest eggs into defined contribution schemes in order to access them via the pension freedom rules introduced in 2015. So in this Akademia session Vince Smith-Hughes, Director of Specialist Business Support at Prudential, will be answering some of the common questions and misconceptions surrounding DB transfers. Now, there are three key learning outcomes to cover. How DB schemes calculate transfer values, whether transfer value analysis is still relevant, and how the regulator will shape TVAS moving forward. But first to set the scene I asked Vince about the size of the market.
VINCE SMITH-HUGHES: Well I think the market’s very big. The Pension Regulator determined that about 80,000 transfers have been done over the last year, that was a few months ago, and we’re not seeing any decline in the number of transfers and transfer requests coming in. So I think we’ll see a very buoyant market for the next year or so I suspect.
PRESENTER: 80,000 transfers, that’s quite a large number; what would you say are the drivers behind this?
PRESENTER: VINCE SMITH-HUGHES: Well I think the drivers are twofold. The first one is obviously we’ve seen the introduction of pension freedoms coming in a couple of years ago, so people are now looking at their pension pots which are in the DC world, and are thinking to themselves well I can do anything I want with that. I can take an income, I can take lump sums, I can do a combination of both. So that’s obviously very attractive. But of course the defined benefit transfer market is also being driven by the fact that transfers are historically at very high levels. So, people are seeing a transfer value which is a very large sum, and potentially a larger sum than people have ever had before in their lives. So it’s not surprising that people want to investigate it.
PRESENTER: And we’re seeing a lot of pension companies release results which are showing a lot of inflows from DB transfers. Now, do you think, what role do providers have in policing the advice process; I think that’s something that comes up quite a bit?
VINCE SMITH-HUGHES: Yes, well clearly Prudential offer a defined benefit service, and clearly that’s our responsibility to police that. I’m not so sure it’s so much our responsibility to police independent advisers. What I would say I think we’ve got a responsibility to provide them with information tools and assistance to actually help them in the suitability process.
PRESENTER: Are there any perhaps conflicts of interest you think our viewers should really be aware of though in this area?
VINCE SMITH-HUGHES: Well I think there’s a classic one, which is when you talk about who’s actually analysing when a transfer should take place or not, and for example a lot of people talk about contingency charging for pension transfers. I think that’s probably OK as long as you’ve got people who are looking at the transfer, and then making a decision as to whether it’s appropriate to transfer or not, who are outside of the normal advice chain, i.e. they have no benefit to be gained from whether a transfer takes place or not. So I think that’s one conflict of interest to watch out for. As I say I think it’s not insurmountable, but it’s probably only the bigger firms that can really do that I suspect.
PRESENTER: Absolutely, well now the regulator is showing a lot of interest in transfers, do you think perhaps we’re in danger of a misselling scandal?
VINCE SMITH-HUGHES: I’d hope not. And the reason I would say that for is because I think we know so much more about all the ins and outs of transfers than we did last time there was a defined benefit transfer misselling scandal. And sadly I’m old enough to remember that, and some of the causes of it. So I think we’ve got a lot more information, we’ve got a lot more tools and calculators, we’ve got a lot more assistance for advisers now. So I’d hope that we could avoid that.
PRESENTER: But is there any advice for advisers, is there a checklist of how they can really advise, really not fall into any problems and this sort of thing?
VINCE SMITH-HUGHES: Yes, there’s lots of things out there. So for example we’ve got a defined benefit checklist, which we’ve launched now. It’s not the panacea; it really is only designed to help advisers to check their own advice process. And there’s numerous other things out there as well. For example you’ve got retirement modellers out there, which can really help both the adviser and the client to understand the implications of the choice they’re actually making if they do decide to transfer. So there is a number of things that can really help advisers.
PRESENTER: So moving on to then the main reasons for people wanting to transfer, what would you say they are?
VINCE SMITH-HUGHES: Well I think obviously there’s a lot of interest in it. And I think the reason is people like the idea that they can have a pension fund they can dip in and out of as it suits them. That clearly is going to be very attractive to a lot of people on face value because of the pension freedoms. But I think one of the other things that also is influencing people is they see it as a way of passing down a legacy to the next generation. So the pension rules are such now that it’s actually pretty simple, and it’s very effective to actually pass a pension fund not only to your spouse but also onto your children, potentially, and I think that’s influencing a lot of people as well.
PRESENTER: And is it obvious which clients this is not suitable for?
VINCE SMITH-HUGHES: Well I think there’s some real danger signs that need to be watched out for. So one of the ones for me which I think is really evident is if you’ve got someone who the transfer, whether you transfer or not is actually representing the client’s core income in retirement, I think you’ve got to be really careful there. Because what you’re saying is if you transfer it and let’s say there’s a fall in the markets, fall in your fund value, that client might not have enough income to manage just their essential spending in retirement. So for me that would be a real warning sign. And in those cases the majority of cases I would say don’t transfer.
PRESENTER: And insisting clients, I mean do they actually exist who really insist to do something when perhaps the advice is against them, and if that’s the case how is it best to deal with them?
VINCE SMITH-HUGHES: Well I think there are insisting clients, and whether advisers choose to deal with them or not is obviously down to themselves. All I would say is if they are doing insisting client type business, they really need to be following the pretty prescriptive rules that are in place. Personal Finance Society have got some excellent assistance in this particular area actually. What I would say is almost you’ve got to conduct your normal suitability process, but then if you’ve got an insisting client you almost need to do another suitability letter explaining all the reasons why it’s not the right thing to transfer before the actual transaction is completed.
PRESENTER: Well we’re going to be looking suitability letters a little bit later on. But just to recap then what are the main reasons then to transfer out and clearly the reasons not to?
VINCE SMITH-HUGHES: Well I think the main reason to transfer out is obviously you’ve got control of your own fund. You can take income and lump sums as and when you want to. Potentially you can pass a legacy down to the next generation. And of course clearly at the moment transfer values are historically pretty high. In terms of the reasons not to transfer, and there’s at least as many of those, clearly you’ve got things like you’re losing that essential guaranteed income in retirement. And I think you’ve got to be really careful about that particular point. It’s got to suit a client’s attitude to risk and capacity for loss. What I mean by that is if they’re actually transferring across, putting the money in drawdown, taking income from drawdown, they’ve got to be very aware of the fact that if they’ve taken too much income they could run out of funds, so that’s a real problem. And thirdly I think one thing just to say is that I mentioned about the ability to pass down a legacy to the next generation.
One thing I think that should be explored, and it won’t work in every case, but quite often it’ll be possible for an adviser to arrange life cover perhaps using some of the income from the scheme, and that actually may be a more attractive way of passing down a legacy. Instead of actually transferring because they say well I’ve got this large fund and I want to potentially use some of it to pass down to my children, why not actually look at exploring setting up life cover. You can put it in trust for the children, and actually use that as a mechanism of providing a legacy. So just one thing I think advisers should be thinking about.
VINCE SMITH-HUGHES: In terms of other reasons not to transfer, I’ve covered I think the main ones which are you may lose that ability to pay your core income needs in retirement, and I think for me that’s an absolutely critical one. And also quite simply is there a concern from clients that they may have a big pension pot, but it’s got to be invested somewhere. And we’ve seen the markets at pretty high levels now. It may be the case we see a fall in markets soon, it may not be, but at least it’s a possibility. And if that is the case that of course could mean that there’s a subsequent fall in the client’s fund value when they have transferred. One final thing I would throw into the mix is that be very aware of the dangers of negative pound cost averaging. If we do see a fall in markets, and clients are actually taking an income from the fund, what they’re effectively doing is crystallising their loss at the point they take that income. And that can really hurt a drawdown portfolio, so again it’s something to watch out for.
PRESENTER: So now I’m now going to put a question to you that was sent in to me from a viewer. So one argument against transfers might be that seeding schemes are offering high values for a reason: if they want an employee to transfer benefits away from them because it’s better for the company, doesn’t that mean that conversely it must be bad for the employee?
VINCE SMITH-HUGHES: I wouldn’t say necessarily it’s definitely worse for the employee; you’ve got to look at each case on its own rights. And whether it’s right or not for the employee is very much down to their own personal circumstances. So I don’t think you can make a black or white decision like that to be honest. I think you’ve actually got to look at the individual client’s circumstances. Yes transfer values are historically at high levels, and yes some employers may well be boosting those transfer values out of the scheme. All I would say is that in itself is not a good reason to transfer. You’ve got to think about the actual level of the guaranteed income you’re giving up.
PRESENTER: Now earlier you mentioned suitability letters, so let’s look at those a bit closer now. So what do you think is important to cover in a suitability letter?
VINCE SMITH-HUGHES: Well I think for me there’s a whole host of things, but I’ll break it down into three fundamentals, I think. So the first one is you’ve got to obviously lay out what the client’s needs and objectives are. That’s pretty critical. Secondly, if a transfer is then being recommended, you’ve got to explain why that is the right thing for the client, and how it’s meeting those needs and objectives. And thirdly and perhaps most importantly, you’ve got to spell out exactly what all the dangers are of transferring. There’s a lot of disadvantages as well as advantages, and that is absolutely essential that’s put across in the suitability letter, so the client knows exactly what they’re letting themselves in for.
PRESENTER: So to summarise this section then, what are really the pitfalls of advice in this area?
VINCE SMITH-HUGHES: I think the pitfalls of advice are first of all something called unconscious bias. So you’ve got to be careful that advisers aren’t reaching the decision that it’s right for a client to transfer because they may be thinking well look at all this money, the client’s keen on transferring, I’ll put in place a transfer because it’s the right thing to do. You’ve got to be careful about that sort of thing, and you’ve got to look at it very objectively in terms of whether it’s right or not.
So I think that’s the first thing. The second pitfall is is it absolutely right and meeting the client’s needs and objectives, or is there another way of doing it? So for example I mentioned about the life cover scenario earlier on. It might be that the client’s got a need for some short term funds. So let’s say for example they need to repay a loan, repay a mortgage, they want to build an extension on the house, could be anything. There might well be the opportunity to actually use other funds outside of the pension fund to actually pay for that particular need. It doesn’t necessarily need to come from the pension scheme in all cases.
So I think that’s a real one to watch out for. And thirdly it really is making sure the client understands that a transfer value of let’s say 30 times the value of their income may seem like a very attractive and large lump sum, but actually that income stream is exceedingly valuable in itself, and that’s why I’m firmly behind the FCA proposals in terms of the changes they’re making to transfer analysis.
PRESENTER: Another thing the viewers need to be aware with these FCA changes.
VINCE SMITH-HUGHES: Well the changes haven’t come into place yet, so they’re not the rules. I have seen one or two commentators talking about well there’s a softening of the stance in terms of that a transfer is not suitable and should be treated as not suitable in the first instance; in other words you’ve almost got to prove it is suitable. I’m not sure there is a softening in the stance. If you actually read the wording in the consultation, CP1716, it’s reworded, but actually I think it means the same: which is that treat these things with real caution. It may very well be the case that it’s not the right thing to transfer.
PRESENTER: Well, Vince, now we’ve had a question sent in via Pulse, let’s take a look.
RICHARD SHAPPARD: Hello Vince, I’ve got another question for you. It relates to the volume of DB transfers that we’ve seen in recent years. A whole host of reasons that we could suggest why clients are pursuing these towards transferring to DC arrangements, subject to of course the quality advice they’re receiving. But do we feel that there is a change on the horizon with the regulatory restrictions that we may well see? Also, with the additional exams that we’re seeing from the Personal Finance Society, and the number of advisors actually transacting business in this area, do we see that maybe there will be less of these going forward in terms of transfers completed? What do you think?
VINCE SMITH-HUGHES: Well I think there’s a couple of points in there. So, in terms of future regulatory changes, I mean clearly we have the consultation I referenced earlier, CP1716, that will fundamentally change transfer analysis. So if it does come in, and I certainly have no reason to believe it won’t, advisers will really need to help clients understand exactly how that’s working. And I think there’s a real positive there for me, because I think what it will do is it will hopefully make clients and advisers as well of course realise that that income stream is very valuable, because it will be demonstrating it as a lump sum if the changes come through. So I think that will really help, but there is a real onus on advisors there to make sure they understand all of the new mechanics of what the new analysis will entail.
In terms of examinations, I guess I would say that there is new examinations out there, I would always strongly encourage advisers to make sure they’re up to date with the latest examinations. But I think perhaps almost even more importantly if you are involved in the pension transfer space, it may be that some of those people have taken G60 many years ago for example, whether you choose to do the exams or not, and the exams are obviously a very good way of doing this, but just make sure your CPD is up to date. Just make sure your knowledge is completely up to date in terms of all the things you need to do, and know now when you’re actually looking at a defined benefit transfer.
PRESENTER: Well now if I take you back to something you said during a previous Akademia session. You said that DB transfer market was in part driven by this low rate environment. So if rates start to rise how will that impact the market?
VINCE SMITH-HUGHES: If we see rates start to rise we will see a converse effect on transfer values, and they will start to drop. And in actual fact I saw something fairly recently that suggested that this has already happened, although it was only one month’s data so certainly not a trend. But yes we will see transfer values starting to come off as those interest rates increase, which may or may not make it less attractive to transfer. But I would go back to the point that high transfer values in itself doesn’t mean it’s the right thing to transfer.
PRESENTER: And any other likely factors that will impact the sector?
VINCE SMITH-HUGHES: Well I guess if you take that one stage further and do start to see interest rates going up, it will make guarantees actually cheaper for clients. So whether that’s guarantees in terms of annuity values and annuity rates, or whether it’s guarantees in terms of guaranteed income rates in drawdown, that should start to bring the price down of those. So on the one hand clients will be having lower transfer values, but on the other hand it may actually be easier to purchase a guarantee in the defined contribution sector.
PRESENTER: Well we talk a lot about transfer values but quite a basic questions now, how do DB schemes actually calculate these?
VINCE SMITH-HUGHES: Well what they do is they look at the actual value of the underlying income guarantee. They then convert that into a lump sum, and then discount it back down again to arrive at a transfer value, so in other words what they’re trying to do is establish what a lump sum would be needed to pay that similar level of income.
PRESENTER: And capacity for loss, this is referenced quite a lot, but what exactly does this mean, and how does it fit into DB schemes?
VINCE SMITH-HUGHES: Well I think capacity for loss is critical when you’re looking at is the scheme going to be responsible for paying the client’s core income; in other words, if it’s responsible for meeting all the client’s core income needs in retirement, then I would say that suggests the client’s capacity for loss is actually pretty low. Because if they invest all of their money, let’s say they go into a range of funds, but then you start to see those funds falling in value, what of course that means is they may not actually be able to meet that income need, and therefore their capacity for loss is actually pretty low. And I would suggest that’s a pretty strong indicator that they should be staying put.
PRESENTER: Vince, so last time you were on Akademia we had a few people send in questions via Twitter, so I’ve got the best couple of those questions, and I’m going to put them to you. So the first one is should IFAs insist they maintain a client relationship for investment advice so the critical yield stands a chance of being achieved, so what’s your thoughts on that?
VINCE SMITH-HUGHES: Well in short I would say yes, it definitely sounds like good practice. And I’d also go one stage further, which is that if the adviser who’s arranging the transfer has had the client introduced from another adviser who has then taken the client back after the transfer has been completed, it’s also absolutely critical that those client’s details are factored into the actual transfer analysis. So for example what’s their attitude to risk, what’s their capacity for loss, you know, what sort of funds are they going into? So it can be determined whether the transfer is the right thing or not. But in short yes I think it’s a very good idea.
PRESENTER: So I want to look at transfer value analysis now. A big question I’m getting asked a lot is whether this is even still relevant. So what would you say to that?
VINCE SMITH-HUGHES: I think it absolutely is still relevant, but that’s not to say it can be improved upon. For example the proposals to change over to ABTA from the title of value analysis system I think is really positive, because I think does spell out to clients exactly what it is they are giving up, so I think there’s some real positives in there. But let’s not forget transfer value analysis at the moment is what we’ve got, and it is the compulsory tool, so we must use it, and obviously make everything, make sure we do everything we can to help clients understand it.
PRESENTER: So how then would you say is the best way to really approach it?
VINCE SMITH-HUGHES: Well I think one of the things to do is to, we talk about critical yield, so the transfer value analysis will throw out a critical yield, and it’s very easy to be a bit blasé, because we have had a run of a bull market, to say well you need 5, 6, 7, 8% to actually match the benefits. But those sort of numbers are by no means certain in terms of what we’re going to see for returns going forward. So it’s important to help clients understand that, I think. But it’s also important to actually use I think some of the tools that are out there to show clients the impact of what will happen if those yields aren’t met. For example I was trying to encourage people, and I think we used one of the charts the last time I was here, to say well if you’re taking this level of income but you actually receive this level of growth on average, the actual funds would be running out after 15/20 years or whatever, and really help explain that to clients – because no one wants to be in the position where a large income stream suddenly disappears.
PRESENTER: And looking at DB transfer files, how is the best way to manage them? is there a list of the top 10 things that you should consider perhaps?
VINCE SMITH-HUGHES: I think it’s always difficult to say there’s a list of the top 10 things, but there is an awful lot of guidance out there. There’s an awful lot of guidance from the FCA, and there’s also an awful lot of guidance from people like the Personal Finance Society, as well of course as people like providers like ourselves. All I would say is just make sure you've got an absolutely robust mechanism in place when you’re looking at suitability, looking at all the things we’ve talked about, capacity for loss, attitude to risk, giving not only the advantages but also of course the disadvantages. Make sure you’re listing out all the client’s needs and objectives. Make sure you’re thinking about is there any other way of meeting those needs and objectives other than transferring? So a whole host of things in there, lots of things to think about, but just make sure you’ve properly sat down and thought about all of those things in the overall suitability process.
PRESENTER: But there must be common mistakes in this area that people are making, and what should people really be avoiding?
VINCE SMITH-HUGHES: Well I think if you look at the FCA releases again. They had two this year. One thing that seems to be, they seem to be inferring hasn’t been the case in some of the files they’ve looked at, there’s not a clear explanation of those needs and objectives, and clearly that’s absolutely critical for advisors to make sure their files are going to pass as suitable. But the other thing I would say, and again I mentioned it earlier, just make sure that you’re also covering off is there any other way of meeting those needs and objectives, because quite often there may well be outside of transferring.
PRESENTER: Now, we’ve had another question sent in by Richard, so let’s take a look at that.
RICHARD SHEPPARD: Hello there, Richard Sheppard, an adviser from down in Surrey. I just have a quick question for the panel around the whole TVAS process. Bearing in mind where we are with the retirement options that are available to clients now, and the way that they are making their decisions based on the advice they’re given, is TVAS fit for purpose? Should we even look to amend what we’ve got, or is the best action to maybe even rip everything up and start again, or do we wait for the regulator to tell us what to do? Your thoughts.
VINCE SMITH-HUGHES: Well I think to be honest the FCA have actually made some pretty substantial changes, or proposals to changes I should say to TVAS, with this new CP1716 inclusion of the new analysis – converting it to a lump sum, the transfer value comparator, all of that is a pretty radical change. Now we did suggest a few tweaks to that when we replied to the consultation, but in general I think there’s some big improvements in there.
PRESENTER: And is it right to base comparisons on annuity purchase, or is there a better method giving the decreasing use of annuity is another question sent in there for you?
VINCE SMITH-HUGHES: Yes, and I think that is a good question. The only thing I would say is that by basing it on an annuity it at least hopefully helps the client to understand what the actual cost of a guarantee is. Because if you’re buying an annuity in the open market, and any adviser will tell you, it’s actually pretty expensive to buy that annuity at the moment. So guarantees are expensive. But I think that’s actually a positive in terms of saying well we’ll use annuities, but only because it actually will bring home to people what the real value of that income stream is.
PRESENTER: So then how do you think the regulator will shape TVAS moving forwards?
VINCE SMITH-HUGHES: I think hopefully many of the proposals from CP1716 will be introduced, so we’ll see the changes come through, including the introduction of the transfer value comparator. I think there’s lots of other useful information in there in terms of what else will need to be included within suitability reports. So again we’ll start to see that too. And one of the other suggestions they had was around cashflow modelling. I mentioned retirement modellers earlier, and essentially I’m talking about the same thing. I think cashflow modelling can really help clients to understand what it is they’re taking onboard. And yes, it will be the right thing certainly in some circumstances. But hopefully it will also help them to understand that actually that guaranteed income stream could be very attractive in others.
PRESENTER: And how would you say is the best way to prepare clients for these changes?
VINCE SMITH-HUGHES: Well taking the cashflow modelling one stage further, and I don’t think we can do too much as an industry until we see the introduction of this new transfer analysis service. But taking it one stage further I do strongly encourage advisers to use cashflow modelling now as a mechanism to help clients to understand exactly what it is that they’re actually looking to get into once they do transfer – because I think that can do a number of things. It can help them realise well what sort of growth rates do I need to make this work, and sometimes they’re reasonably high. But also it can really bring home to them the risk of either running out of money or alternatively having to reduce their income levels in retirement. And that’s clearly I think something clients need to understand.
PRESENTER: Well let’s draw your attention now to our final Twitter question that was sent in, and that was what is an acceptable level of fee charged by advisers who specialise in this area?
VINCE SMITH-HUGHES: I think it’s very much down to the individual adviser proposition. So I don’t think it’s easy for me to say that it should be £3,000, £5,000 etc. It may well be that an adviser is actually charging by the hour, and of course if that’s the case then that may well work for some advisers, it does away with the contingency charging aspect that I mentioned earlier. That can work for some advisers. If they are operating on a fixed fee, what they’ve got to be sure of is it’s actually appropriate in all circumstances. And what I mean by that is if they’re say operating on, and I’ll pluck a figure out of the air, a 2% fixed fee in terms of the actual transfer value, are they actually sure that they’re, there’s more work involved in doing £100,000 transfer as opposed to a £1m transfer. For example if they’re operating on 2% across the board, that’s a huge difference in fee. So they’ve got to be comfortable that the additional work is being justified. I’m not saying it isn’t justified, because it may well be that the client’s circumstances are more complicated, there’s more complicated investment mechanism. All I would say is they need to be comfortable that is the case.
PRESENTER: And what does the TVAS report tell us about adviser fees charges?
VINCE SMITH-HUGHES: It’s very diverse actually. So I mean we obviously have a TVAS service where we see a lot of requests going through. And there’s all sorts of models in there actually. So it’s a combination of some advisers who, there’s no fee shown on the transfer analysis at all. Maybe they’re charging the client by the hour and it’s paid for separately. Some are working on a percentage basis, so we’d see 1, 2, 3% models typically being used. Some are actually operating on a fixed fee basis. So I don’t think there’s an awful lot of continuity across advisers, but then I wouldn’t really expect it to because their propositions are often quite different.
PRESENTER: We are almost out of time, so what do you think then for advisers are the main takeaways from this Akademia session, and the main things they really need to be aware of moving forwards?
VINCE SMITH-HUGHES: I think the main things they need to be aware of are it’s a very large market. Clearly there’s a lot of interest and it’s often driven by clients themselves. So this isn’t very often advisers going out and trying to find clients with DB transfers; quite often the interest is actually coming from the clients themselves. And I guess all I would say is proceed with real caution. And one really good way, and I mentioned it earlier and I’ll say it again because I think it is worth repeating, just make sure that suitability letters are covering the aspects I talked about. So client’s needs and objectives, the reason why transfer is suitable, and the reason why, or sorry the disadvantages I would say of actually making that transfer. And as an aside to that just remember to actually explore whether there’s any other mechanisms for the client, any other financial planning which could be put in place, which can meet their short-term lump sum or income needs.
PRESENTER: Super, Vince, thank you.
VINCE SMITH-HUGHES: Thank you very much.
PRESENTER: In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this Akademia session you’ll be able to understand and describe how DB schemes calculate transfer values, whether transfer value analysis is still relevant, and how the regulator will shape TVAS moving forwards. Please complete the reflective statement to validate your CPD.