Transfer value calculations require assumptions about discount rates, inflation rates and demographic assumptions, all of which apply many years into the future and so there is considerable uncertainty over how these factors will play out.
Discount rates are often based on long-dated bonds adjusted for the scheme’s actual asset mix. Currently gilt yields are at low levels, which results in lower discount rates and higher transfer values. At the same time, the long-term inflation rate outlook has risen, which also tends to increase transfer values in many DB schemes.
These higher transfer values attract more members to transfer out as they might expect that such a relatively high transfer values can be invested to provide a higher return and greater pension than the more prudent assumptions used by the scheme actuary.
The green line on the chart shows that gilt yields have fallen since the start of 2016 and the trend looks set to continue.
The other lines show the approximate cost of £1,000 a year pension for a 65-year-old with no dependents, valued on the same discount rates as the green line, to give a rough indication of the relationship between bond yields and transfer values. The orange line shows pensions with no annual increases and the purple line shows inflation linked increases.
There was a large fall in gilt yields over the period just after the Brexit vote. Although the fall reversed towards the end of 2016, it looks to be slowly falling again in 2017. Transfer values are likely to have followed an inverse path depending on the scheme’s rules.
This simple analysis suggests people requesting transfer values last autumn are likely to have done well. Experience suggests they may also have told their friends and colleagues about the size of their transfer values, encouraging more people to consider transferring.
Setting transfer values is a challenge to balance practical requirements against the needs of fairness – for the ongoing scheme as well as the transferees. It is equally challenging to assess whether someone taking a transfer value will be better or worse off in the future.
Tim Bateman is life actuarial partner and Katie Dawson is senior pension consultant at Mazars
Key points
Pension freedoms have encouraged more members to transfer.
The scheme actuary’s aim is to calculate the “best estimate” of the amount needed.
CETV calculations can be updated daily, monthly or quarterly.
