PPF outlines what advisers should do when a client comes to them from a defined benefit (DB) pension scheme in deficit
In a recent report into the pension advice received by British Steel DB pension holders, Sara Protheroe, chief customer officer at the Pension Protection Fund (PPF) stated: ‘We are worried that for some the default position when confronted with a deficit is that ‘the risk is in staying put’, and this is leading members to make poor choices about their futures.
“Seven and a half years to close shortfalls”
At the PPF we track the deficits in DB schemes through our monthly 7800 Index. The index monitors how well funded schemes are if they had to get an insurer to pay the equivalent of PPF benefits. At the end of October the aggregate shortfall was just under £150 billion, down from the peak of over £400 billion at the end of August 2016.
On average schemes are planning to take seven and a half years to close those shortfalls. In general we believe that is affordable and realistic. Most employers with DB schemes will remain in business, and gradually eliminate their deficits. While they do so, they will continue to pay full benefits to scheme members.
The presumption of the Pensions Regulator and the Financial Conduct Authority (FCA) has been that, even in the context of deficits, members are best to remain in their DB schemes. The FCA’s June consultation was very helpful in thinking further about the scope of that presumption.
So why do we share that presumption against transfers? Why are deficits not a cause for alarm for 11 million members of DB pension schemes?
Before April 2005 and the existence of the PPF they would have been. There was no minimum level of benefits that members could expect in the event of employer insolvency: members simply received their share of the assets in the scheme, with pensioners being prioritised. Some members found themselves left with nothing.
“an industry funded lifeboat”
Hence the creation of the PPF as an industry funded lifeboat to ensure members would be compensated if their scheme was insufficiently funded when the employer became insolvent.
If a pension scheme can afford to pay better than the PPF then it does. If not, members still receive a substantial proportion of their total promised benefits, paid as an income for life. The average scheme transferring to the PPF since 2005 has only been sufficiently funded to pay members 60% of their promised benefits. Without the PPF that would have meant substantially less than they were promised and less than they’re receiving from us. Of course those underfunded schemes are also likely to have reduced their transfer values to reflect their poor funding position.
We have all seen the media reports of a jump in DB transfers. We have also all seen it reported that some members’ decisions are being driven primarily by ‘greed and fear’.
It is frustrating to see the protection we provide mischaracterised and misrepresented, seemingly to create that ‘fear’. The PPF does not ‘slash’ member benefits and, particularly given schemes only come to us if underfunded, is not a fate to be avoided. Scheme members who are over the scheme’s normal retirement age, or receiving an ill-health, spouse’s or dependent’s pension get 100% of their accrued entitlement, others get 90%.
Increases are likely to be less than members expected and some members may see their benefits capped. It is worth remembering though only around 0.2% of current PPF members have capped benefits. PPF commutation factors may also be much better than their previous scheme offered.
We know that for some members and their advisers, considering a transfer from a DB scheme might be the right thing to do. This obviously depends on their circumstances and that of the scheme.
We know that the vast majority of IFAs take their responsibilities seriously. We have already seen with the British Steel Pension Scheme (BSPS), good IFAs are providing good advice that can help members make hopefully good choices, even with the challenges of managing a lump sum over an uncertain lifespan, given fees and uncertain investment returns.
However, there is evidence of poor advice. My PPF member services teams regularly receive transfer value requests from advisers of behalf of our members. This is surprising given it is a very clear part of the law that members cannot transfer their compensation entitlement.
With the BSPS in particular we have seen some concerning behaviour: the reported ‘feeding frenzy’ of advisers. My colleagues attending the scheme’s roadshows have seen, as members have described it, ‘vultures’ hanging around outside the events.
So, what are we doing about this? We want to ensure that we help members, and their advisers, in the schemes we protect better understand the value of our protection. For their sakes we also want to help stop the bad practice that we see. We are already engaging with the FCA around DB transfers and welcome what they’re doing about poor advice and the wider issue of scams. We are also looking at what more we can do to help and equip the majority of good advisers to give their clients a balanced view of deficits and the PPF.
It is in no one’s interest, particularly that of members, if they transfer but would have had a better retirement if they had have stayed in their scheme, including if that scheme had come to the PPF.
Deficits do matter and we want schemes to close them as quickly as possible. But given we expect that most schemes will pay their benefits in full, deficits should not mean members being led to make poor choices about their futures.