Gilt yields are low, transfer values are high and more people are taking them – I think we can be sure everyone has read enough articles about the increased volume of transfers from DB Schemes (not to mention our previous two, excellently written, blogs!).
So, here we are writing another! But wait, a lot of coverage has been focussed on the benefits to scheme members and trustees. Are sponsors winning too? The obvious ‘wins’ for sponsors are that transfer payments extinguish liability and reduce risk within the scheme and typically represent a cost saving against more prudent measures such as solvency and funding. However, is it an absolute winning scenario for sponsors? What are some of the crucial considerations?
- Transfer terms – With gilt yields at historic lows, employers should quite rightly be concerned about crystallising liabilities at this time. One thing that is clear though is that sponsors should be engaging with trustees with regards to their transfer terms since, unlike funding assumptions, the terms agreed here represent ‘real’ cash, now more than ever, leaving the scheme. The Pensions Regulator determines that the basis for transfer values should represent at least a best estimate of the cost of providing the benefits and also should be underpinned by the scheme’s Investment Strategy – both areas where the sponsor can provide significant input.
- Significant cashflows – An increased volume of transfers, together with the associated costs, can represent an issue for the overall cashflow management of a scheme. Significant cashflows will require an increasingly liquid asset allocation. An increasingly conservative asset allocation, producing lower expected returns, will with both feed into the discount rate methodology at formal valuation discussions and has the potential to increasing the cost of pension provision going forward.
- Selection risk – Especially when offering enhanced terms, sponsors should be aware of selection risk – unmarried members transferring out ‘joint-life benefits’ or members with impaired life expectancy transferring out on ‘normal’ life expectancy terms. This can mitigate some of the benefits of enhanced transfer value exercises (ETVs) and lead to additional costs for sponsors.
- Journey to buyout – We have recently had conversations with clients and illustrated that, even in current market conditions, transfer values and even ETVs could serve to improve solvency positions. However, rather perversely, an issue we have recently encountered with a scheme securing quotes for buyout is that an insurer was wary of ‘anti-selection’ with regards to recently completed ETV exercise. The insurer explained, the Company may have picked off the impaired life members and left all the healthy members in the Scheme to be insured on ‘normal health’ rates. As a result, the insurer threatened to increase the insurance premium to reflect this selection risk.
Our View: Whilst there are many positives from a sponsor’s perspective of increasing numbers of members transferring out of schemes, it is important to consider a breadth of factors, including those described above, as large numbers of transfers out may not be the optimal solution for all schemes and at all times.