At what point should schemes begin to limit transfers?

As the consequences of the US subprime mortgage crisis hit the UK, consumer confidence was rocked, and the more financially rocky than average Northern Rock suffered a run – a fortunately rare but terrible event when a self-fulfilling loss of confidence causes a bank to run out of money.

The current historically low gilt yields, themselves a distant consequence of the 2008 crash, are causing a huge upsurge in interest in cash equivalent transfer values from defined benefit schemes. This has prompted some to ask whether this is the equivalent to, or an actual, run, and if it is, how long can a DB scheme survive?

Although financially a CETV 'run' could be tolerated, as a fiduciary, it would prompt me to ask some other questions

First things first. A CETV is usually an actuarial assessment of the amount of money needed to give someone an evens chance of replicating the value of their benefits elsewhere – the key word in this definition being “evens”.

DB schemes have to be funded to a prudent level or have a plan, agreed with the sponsor, to get it to that level. In other words, a DB scheme must have a more than evens chance of hitting its funding target. An evens chance would be a 50 per cent chance. A more than evens chance would be a 60 per cent chance.

It can be seen from this that the payment of a CETV actually releases surplus value to the scheme – CETVs are healthy for scheme finances. As a consequence, a scheme could tolerate losing all of its liabilities to CETVs without harm.

The exception to this would be if a scheme was not yet funded to at least the evens level – that is, it has a funding deficit. In such cases, trustees can pay out full CETVs, provided they are happy that the sponsor is [making?] good for any resultant financial strain as it arises.

If they are not happy, they can, by having their actuary produce an Insufficiency Report, reduce CETVs by up to an amount equivalent to the funding deficit – thus ensuring the scheme would not run out of money. As a consequence, again, a scheme could tolerate losing all of its liabilities to CETVs without harm.

Ask questions beyond the finances

Although financially a CETV 'run' could be tolerated, as a fiduciary, it would prompt me to ask some other questions.

I would ask whether our CETV basis is too attractive. Are we being too generous and in turn, influencing for better or worse, the members’ decision and paying out too much of the sponsor’s money?

I would also ask some questions about the liquidity of our assets. In an ideal world, cash out would be matched by cash in, but where that cannot be achieved I would want to avoid becoming a distressed seller of assets.

Ensure members make an informed decision

The secondary driver of interest for CETVs is freedom and choice: a member can transfer their DB benefits to a defined contribution scheme and then cash them out. This is attractive to many members, and there are reasons why it might be a good idea.

I would, however, want to check and make sure the members understand what they are giving up, that they are not being scammed and that they understand the level of security implicit in the DB scheme – in other words, I would check that their decision to transfer is a properly informed one. All members with a CETV worth more than £30,000 are required to take financial advice although they are not obliged to follow it.

Pension schemes are not like banks, but they could conceivably be subject to a run. There are, however, control mechanisms that, combined with sensible and prudent governance, should protect those schemes and the members they have a responsibility to.

Richard Butcher is managing director of professional trustee company PTL