Dr. Ros Altmann highlight of Response to Treasury Consultation on Freedom and Choice for pensions

by Dr. Ros Altmann

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Summary of response to questions relating to DB-DC transfers:

• Transfers should be permitted from funded DB schemes to DC schemes
• Some schemes could benefit from members transferring small entitlements due to the savings in administration and ongoing liabilities
• Government should allow any funds transferred to be withdrawn flexibly from DC after age 55, without restriction
• It might be necessary to control transfers if demand is too high, for example if too many members try to transfer or one or two very large entitlements want to leave which account for the majority of liabilities
• Trustees should be given powers to restrict or refuse transfers, which should only be permitted with trustee approval
• There may be times when market conditions prevent transfers, or trustees may be unable to realise illiquid investments quickly so might need to restrict or impose timing constraints on transfers – like ‘gated redemptions’ or lock-up periods
• The amount transferred could be capped or reduced to reflect underfunding of a scheme, in order to protect the integrity of the scheme and the future pensions of other members – rather like ‘Market Value Reductions’ imposed on with-profits funds
• The situation in future will be different from that which prevailed in the past. Until now, employers tried to encourage workers to leave, however with the new pension freedoms it could be that members themselves will want to transfer
• Past concerns about transfers were based on feass that members might be enticed to give up guaranteed benefits and end up in inflexible and insecure DC schemes instead. Now that members themselves may wish to transfer in order to cash their pension rights in, consideration could be given to requiring those who request to transfer (whether it is the employer or member) to pay for independent financial advice before doing so
• Government might consider the possibility of permitting members to request that their GMP rights are transferred back to the state pension system, this could help scheme funding and also ensure a faster move to ensuring more people do receive the full flat rate state pension

Question: What are your views on the following options for DB scheme transfers?

• No transfers allowed, as per public sector unfunded schemes
  I would not be in favour of preventing transfers. In some cases, members do need to transfer, for example if they are ill, or if they have urgent need for some funds and transfers can be in the interest of both members and the scheme itself. It would seem unwise to allow full freedom to DC members without permitting at least some private sector transfers from DB to DC. The funding of many defined benefit schemes could benefit from transfers especially of very small entitlements which are expensive to administer, although some controls on timing or amounts may be required.
• Allow DB-DC transfers but then impose restrictions on the funds transferred to DC as now
  I am not in favour of this option, it is difficult to see the point of permitting this. It would not be consistent with the desire for freedom and flexibility in pensions and is unlikely to be taken up. It seems to leave defined benefit members in a much worse position. If they do transfer, it may well be because they need the funds or are seriously ill. Thus, preventing them from withdrawing that money would be particularly unfair when those in DC are permitted to do so.
• Cap the amount of DB to DC transfers allowed each year
  It might be necessary to cap the amount of pension benefit members are permitted to transfer each year. Controls could be placed on the maximum amount of pension entitlement that can be transferred out (a little like the small pots or trivial commutation rules under the previous DC regime). The purpose of this would be to protect the integrity of DB schemes which could be compromised if too many members try to transfer out of schemes all at once. I would be in favour of allowing trustees to limit transfers, if they feel they need to in order to mitigate risks to other members of the scheme and to the scheme’s survival.
• Transfers have to be approved by the trustees
  I would be in favour of requiring trustees to approve transfers, so that trustees can carry out their duties to protect the scheme and its members. Trustees may need to take advice on the impact of transfers, but they should have the power to stop transfers, or to encourage transfers, albeit ensuring they can justify any decisions. Members should have the right to apply to transfer benefits from DB to DC, but the trustees need the right to refuse such a request, or to cap the amount of the transfer, or to adjust the timing of the transfer. It is not possible to establish a one-size-fits-all rule that would cater for requirements of all DB schemes. Therefore, the principle of freedom and choice in pensions can be offered, but it should not be imposed on schemes which would be damaged as a result – and whose remaining members could be negatively impacted.
• Full flexibility with no controls on the transfers from DB to DC
  I would be concerned that full flexibility could be too risky. I do think that powers to impose controls in the interest of financial stability may be required – either because of risks to markets, or to the scheme itself. These could be triggered by trustees of schemes and their advisers, or imposed by the Regulator if considered necessary. Providing full flexibility runs the risk of mass transfers of large entitlements which could compromise the future survival of some schemes with large deficits. It might be necessary to only permit transfers at reduced values – below the actuarial equivalent of full benefits – if schemes have large deficits. This would be rather like the market value reductions in with profits fund. It might be necessary to delay transfers if investments cannot be sold to raise funds for the transfer. It might be necessary to limit the size of transfers each year.

I also have some suggestions for further options relating to DB to DC transfers:

Pay for an IFA – I would suggest requiring members to pay for full financial advice before requesting to transfer, to ensure they understand the risks of doing so. If members take advice and then decide to transfer, that is their fully informed choice. Up till now, the issue of pension transfers has been from a very different perspective under the previous regime. Until now, the issue stemmed from employers trying to entice members to leave, offering them enhanced values to transfer out of the scheme. Under those circumstances, it was important to protect members from transferring out and then losing guaranteed benefits, in exchange for DC benefits with annuity restrictions. The fact that employers were willing to enhance the transfer value is a clear indication that permitting transfers could improve scheme funding. Under the new rules, however, it is quite possible that members themselves will want to transfer, due to the ability to take cash, rather than having to annuitise or use capped drawdown. In future, therefore, permitting transfers could be in the interests of both members and schemes, however it will still be vital to ensure members’ interests are protected. This could include requiring any member who applies to transfer out to have proved they have taken independent financial advice. At the very least, they need to sign and confirm that they understand the risks of transferring and the guaranteed benefits they are relinquishing.

Capping the maximum percentage of scheme assets that can be transferred each year without regulatory approval – this would be designed to protect the scheme and possibly the PPF if there were some large transfers that jeopardised future scheme funding.

Only allow those near scheme pension age to transfer out – for example only from age 55, the same as is allowed in DC. This would limit the amount of people transferring, although over time as schemes mature, increasing numbers of members will fall into this category.

Transferring the GMP element to the state – this could be a significant radical reform that would have a number of benefits for schemes and possibly for members. Firstly, by transferring GMP rights back to the state, the new flat-rate state pension would be received in full by far more citizens, since there would no longer be a contracted out deduction. The Government could consider allowing members the option of transferring their GMP rights back to the state pension system if they want to receive the full flat-rate state pension. The assets transferred from the schemes would be a cash boost to the Treasury and removing GMP rights from the schemes could result in higher pensions if schemes would otherwise end up in the Pension Protection Fund.

Requiring the funding level of the scheme to be considered when assessing the permission for scheme transfers – It might be necessary to only permit transfers from DB to DC for schemes which have funding above a prescribed level. The aim would be to encourage improved scheme funding, with employers increasing funding and then the scheme being able to transfer members out as funding levels increased. On the other hand, it might be helpful to permit transfers from very underfunded schemes, but with an allowance for the underfunding, so that transfers are at less than actuarial equivalence of full scheme benefits, if such transfers would actually help the funding position and prevent entry into the PPF.

Restricting transfers if there is too much demand – ‘gated’ redemptions – It might be necessary to introduce powers for either Government, the Pensions Regulator, or scheme trustees to impose restrictions on transfers if markets become disorderly or too many members want to transfer all at once. There could also be a case for considering whether there is a risk to scheme funding and investments, or a risk to the Pension Protection Fund, for example if large entitlements are transferred out which exceed the PPF cap.

Allowing the value of a transfer to reflect the underfunding of each scheme – like market value reductions – If a scheme is perceived to be in trouble and the employer covenant is in doubt, it might be necessary to allow transfer values to reflect the underfunding of each scheme. Again, if members are required to receive full financial advice before transferring out, they would have someone to explain the risks to them and if they still choose to leave that is their fully informed decision.

Question 9. Should the government continue to allow private sector defined benefit to defined contribution transfers and, if so, in which circumstances?

If the member has paid for full independent financial advice and has still chosen to transfer their benefits out, then the government should not need to specify particular circumstances or restrictions from the member’s perspective. There may be legitimate reasons why a transfer is considered advisable for that member. For example, if they are in very poor health, if they do not have a partner, if the scheme is very poorly funded and the employer is in danger of bankruptcy, (fears of large benefit reductions in the PPF) or indeed perhaps if they need the money very urgently and there is no other source. There will also be circumstances in which the transfer could be detrimental to the scheme, rather than the member, so the scheme integrity needs to be considered when deciding whether to permit DB to DC transfers. If a scheme is very poorly funded, has illiquid investments that will not generate sufficient funds in the near term to meet the redemptions, or if the scheme has cash-flow constraints that may already be hampering ability to meet pensions in payment, then members’ rights to transfer out should be curtailed.

Question 10. How should the government assess the risks associated with allowing members of private sector defined benefit schemes to transfer to defined contribution under the proposed tax system?

The risks are relatively easy to identify but very difficult to quantify. There are risks to scheme members – if they give up rights to a guaranteed, inflation-linked lifetime pension they could end up poorer in retirement. The member needs to understand what is being given up when transferring, preferably after receiving independent advice to explain the risks.

There are risks to the schemes themselves, if too many members try to transfer out all of a sudden, the pension fund’s investment allocation could be compromised and some schemes are struggling with cash flow requirements as liabilities for pensions in payment increase, so sudden demands for pension transfers could be problematic. Schemes often have illiquid investments, whether small cap stocks, infrastructure funds, private equity, hedge funds or real estate, which can all be difficult to sell quickly.

There are also, therefore, potential risks for financial assets, if schemes were to have to liquidate investments rapidly and force the asset prices down in order to sell, at times when market circumstances proved unfavourable. Each scheme will be in a different position and the impact on the schemes themselves and the impact for the financial markets will depend on which members do transfer, when, how much is moved and what investment position the pension fund itself is in, as well as which assets the funds are moved to – or whether they are simply taken as cash. On balance, allowing transfers is likely to be favourable for scheme funding, especially if smaller deferred entitlements are transferred. Small accrued rights are costly both to administer and to pay, so if many of those with very low pension accruals decide to take their funds out, rather than waiting to receive just a few pounds a week in pension, the scheme funding position should improve. The terms on which transfers are made will also be important when assessing the impact on the scheme. If members are allowed to transfer to DC from under-funded schemes with sums equivalent to less than their full entitlements – in order to reflect the scheme underfunding in some way – then there would be a benefit to the scheme overall in the long-term. However, if members have to transfer out only with full value, then the position of underfunded schemes could worsen.

To assess the risks, it would be important to survey schemes and their funding levels, as well as surveying members to try to gauge attitudes to transferring small entitlements. Ultimately, there is probably an argument that transfers should only be permitted after taking independent advice, to ensure that the decision to transfer out has been understood by the member.

There could possibly even be risks to the Exchequer if people use defined benefit funds to generate extra tax relief in recycling. This could be a significant issue.

As regards defined benefit schemes, the flows into gilts and bonds are likely to depend partly on how many schemes are considering or undertaking bulk annuity purchase, either in the form of buy-ins or buy-outs. It is likely that increasing numbers of bulk deals will be done in coming years and either pension funds themselves or the insurance companies will increase demand for bonds as a result. If transfers out of DB schemes are permitted freely, then the impact will depend on size of assets transferred, age of those transferring (the older those transferring, the more likely their liabilities were backed by bonds anyway) and what those who transfer actually do with their assets.