At the end of my previous post, I was keenly awaiting the written report on my enhanced transfer value (ETV) consultation, after feeling some concerns about the process up to that point. What arrived earlier this month came in three part harmony:
1. A Transfer Suitability Report, which summarised the conversation I had had with my adviser, and the recommendation which I had rather wrung out of him not to transfer (a red traffic light illustration next to the summary reinforced the point), and included the modeller output that suggested a 9 in 10 chance of receiving a higher income at retirement (weather symbol: sunny).
There was nothing more for me to read on the assumptions here while I waited at the red light in the sunny weather but, instead, a new concept to anyone not working in pensions for a living which had not been mentioned in our previous conversation: critical yield. It explained that this was “the estimated investment return you would need to achieve year on year, if you were to transfer to a personal pension, in order to match the benefits provided by the Scheme at retirement”. It was calculated at 6.4%.
This was a little confusing since, when put together with the sunny 9 out of 10 assessment of my chances of receiving a higher income at retirement, it might lead you to think that there was a 90% chance of at least a 6.4% pa average investment growth over the next 10 years based on my new medium risk tolerance (which only reduced my equity allocation from 90% to 85%). But in fact 9 out of 10 was based on needing no spouse pension (they thought this reasonable as I am currently separated, but my Scheme benefits will include a spouse pension provided I have a spouse at retirement) and lower pension increases than are provided by the Scheme (these are indexed to the Retail Prices Index (RPI) rather than the Consumer Prices Index (CPI) assumed after the transfer, CPI tending to be lower). So 9 out of 10 was not replacing like with like, and the probability of achieving the critical yield over the next 10 years was more likely to be in the cloudy-with-a-chance-of-rain category.
2. Additional Information. This must contain the assumptions used, I thought. But no. It was instead an overview of how they had selected Aviva to be the pension provider, what the pension protection fund and financial services compensation scheme did and a glossary of terms. The glossary, interestingly, included lifestyling. “Lifestyling”, it said, “is an investment approach in which funds are gradually switched from more volatile asset classes, such as UK and Overseas Equities, to lower risk investments, such as Fixed Interest and Cash, in the period leading up to retirement. The aim of lifestyling is to reduce the risk of large fluctuations in your fund value as you approach your chosen retirement age. The reason for this is that, if markets were to fall significantly immediately before you retire, this would lead to significant reduction in your retirement income.” Lifestyling had not previously been mentioned as being assumed to be taking place over the next 10 years in any of my illustrations. This eagerly awaited report appeared to be raising more questions than it was answering.
3. Transfer Value Analysis Report. This gave more details about the benefits I was currently entitled to and that the projections of future income were based on CPI increases of 2% pa. And then finally, in the final appendix of the final report, there were notes on the assumptions underlying the calculation of the critical yield. Unhelpfully this included an annuity interest rate and annuity expense assumptions, but no mortality assumption. You would obviously need to know how long you were expected to live to work out how much they expected the annuity to cost. Or they could just have told me. Unfortunately, how much the annuity was expected to cost seemed to be on the list of things the member was not expected to need to know.
So, at the end of the process, I was still no wiser about the annuity rates assumed, or what high, medium and low meant in the years leading up to retirement. I didn’t think that the adviser I had knew either. And on this basis I was being asked to make an irrevocable decision about a third (more if you considered the cost of purchasing an equivalent guaranteed deferred annuity rather than the transfer values offered) of my pensions wealth.
I reflected on the times in the past when I had advised trustees to ensure as a minimum that transferring members in such exercises received independent advice, and on how inadequate that now seemed to be to support a decision in this case. As far as I could see everyone involved was doing their job in the way the regulatory regime intended them to. It was, in many ways, a model process:
- The sponsor was making an offer to members, and paying for independent advice to those members. If the advice was not to transfer or the member decided not to take any advice, the transfer was not allowed to proceed.
- The independent adviser had made a modeller available to members, and had carried out an assessment of each member’s attitude to investment risk. However both of these were seen as guides only, and they were prepared to be influenced in their advice by the attitudes presented to them directly by the members.
- The Trustee Board had made it clear that it was up to the members to decide and that members should consider any information provided carefully before opting for a transfer.
However, if I had accepted the original risk assessment, and let large parts of the information provided go over my head as too technical, I could well have been both advised to transfer and left with the impression that I had a 9 out of 10 chance of being better off as a result. This would not have been a remotely accurate impression. However, even if I had avoided that particular banana skin, I would still not, at the end of this totally professional and, at first sight, thorough process, have had enough information to decide whether I agreed with the advice given. This meant that, despite everyone’s best efforts here, it would still have been possible to have been missold a transfer.
That that should still be the case after all the regulatory activity in this area suggests to me that there is a limit to what regulators can achieve when it is seen as enough for the regulated to merely follow codes of practice and guidance. To aim higher than this requires both trustees and their advisers to do more than play the referee.
And my pension is staying where it is.
A couple of weeks ago, I had a session with Beaufort Consulting. They had been selected by the Phoenix Group to provide independent financial advice to members of the Pearl Group Staff Pension Scheme who had been offered an enhanced transfer value (ETV).
The aim of an ETV is simple. The sponsors of the scheme are looking to reduce the uncertainty and cost (the ETV is normally considerably less than the cost of purchasing an annuity with an insurer to an equivalent level to the pension given up). I have been the actuary to schemes in the past where the sponsor has carried out such exercises and, beyond advising the trustees to press the sponsor for certain minimum standards (for example independent financial advice, communication of risks and making sure the security of the non-transferring members is maintained), it has been frustrating to watch members seeming to give up the security of their benefits in many cases with rather little to show for it. I was curious to experience the process from the member’s perspective.
I had been warned by the Trustee Board of the Scheme that an exercise was going to be taking place in February. Then last month I received a transfer value quotation from the Phoenix Group, indicating that not only would the current reduction to transfer values of 10% be removed, but that an enhancement of a further 10% would be added. I had six weeks to register for advice with the Beaufort Group, and a further six weeks to accept the offer before it was withdrawn. I was directed to the modelling tools on Beaufort’s website and my attention was drawn to the Code of Good Practice and the Pension Regulator’s guidance on such offers. An “important additional information” booklet, in the form of questions and answers on the overall process, was also enclosed. From Beaufort consulting I received a client agreement, a key facts document and log in details for their website (referred to as the “Member Advisory Platform” or MAP).
Whew! So I went on the website and answered the 15 questions designed to assess my risk profile. I was interested to note, despite indicating that I tended to disagree with accepting the possibility of greater losses to achieve high investment growth and rating the amount of risk I had taken in the past as medium compared to other people, that I had been categorised as having a risk rating of medium/high. The suggested asset allocation was 90% in equities and 10% in corporate bonds.
On the basis of this, a requirement to provide a 50% spouse pension and annual pension increases in line with CPI increases capped at 2.5%, and with no lump sum taken, the modeller told me that I had a 6 out of 10 chance of getting a higher income from the transfer at retirement (in 10 years’ time at age 60). Taking out the spouse pension increased this to a 9 out of 10 chance. In fact, out of the high outcome, mid outcome and low outcome shown, only the low outcome led to a lower income from the transfer. The thick black line of certainty of the Scheme benefits was placed beside the alluring diamond of possibilities from the transfer (see diagram above). None of the financial assumptions or assumed cost of buying an annuity were spelt out. I decided this would benefit from further discussion and clicked to arrange an appointment. My slot for a telephone meeting with an adviser was quickly arranged and the afternoon arrived.
The adviser was very polite and unpushy. I explained my surprise at the outcome of the risk profiler, on the basis of which he agreed to reduce my profile risk level; from medium/high to medium.
He explained that Beaufort were not incentivised to get people to transfer and that the same offer was being made to everyone more than five years from retirement.
I asked him what assumptions had been made in the modeller. This took a while to get a response to, during which time I got an interesting account of a stochastic process (this is where you let the various outcomes be chosen randomly but according to an underlying probability distribution, then run the model lots of times to show the relative likelihood of different results. Throwing dice lots of times is a very simple stochastic process). I persisted, saying that the darker area in the middle of their diamond must be based on an average level assumed for investment returns and annuity rates. The response, after a moment when I thought he was going to put the phone down on me due to some noise on the line that I couldn’t hear, was that the assumptions were standard and he thought the low one was 5% pa. I felt that he was telling me all he knew about the modeller.
We moved on to what I thought of the strength of the Phoenix Group, what my preference was on death benefits, etc, before he ran a few modeller examples to illustrate how my income following the transfer would be greater until age 81 (all stochasticism had been abandoned at this stage).
I decided to move my adviser back onto risk. I said that, as my Pearl pension was about a third of my (non-state) total pension benefits, and all my other pensions were per force defined contribution (DC – see my previous post for explanation of defined contribution and defined benefit), it seemed a good idea to diversify my risks by keeping some in defined benefit form. If equity returns over the next 10 years were like those of the last 10, I might be very glad I had.
To his credit, he accepted my argument, and said that he would not recommend I transferred. I thanked him for his time and for a helpful discussion and checked that I would be receiving a final written report, which he confirmed.
I put down the phone and reflected on what had happened. I realised I had some concerns about the process:
- The adviser had been courteous, and had not pushed me in any particular direction, but had been unable to provide any information to assess the plausibility of the modeller at the heart of the advice.
- I had had to introduce the idea of the risk of having all my pension benefits in DC form.
In particular, after reading a fair volume of paperwork and spending the best part of an hour on the phone, I was, as a pensions actuary, unable to recreate (even approximately) the modeller calculations from the information provided. I awaited the written report with interest.
To be continued…