Transfer values: new regulations published

The Occupational Pension Schemes (Transfer Values) (Amendment) Regulations 2008 ("the Regulations") were published on 11 April 2008, and are due to come into force on 1 October 2008.

The Regulations establish new arrangements for the calculation and verification of cash equivalent transfer values and cash transfer sums, and withdraw mandatory Guidance Note (GN11), which was previously used by the actuarial profession to determine transfer values. They follow a government consultation on this issue, which was instigated by the actuarial profession's call for a revision to GN11.

Summary

The Regulations largely reflect the approach already taken in actuarial guidance note (GN11) for calculating the cash equivalent transfer value of a member's benefits being transferred out of a scheme although, the balance of responsibility has shifted.

Key features in the Regulations include:

• The requirement for the initial cash equivalent to be calculated on an "actuarial basis" taking into account the member's accrued benefits, available options and any relevant discretionary benefits
• A procedure for calculating the minimum basis for initial cash equivalent transfer values
• Trustee responsibility, on actuarial advice, for setting the assumptions used to calculate the initial cash equivalent
• Increased disclosure obligations on trustees to members considering a transfer
• The ability to reduce the initial cash equivalent to reflect scheme underfunding
• Consequential amendments to other sets of regulations that make use of the cash equivalent methodology, such as regulations dealing with pension sharing on divorce.

How are Transfer Values calculated?

Under the Regulations "initial cash equivalent" is used to refer to the cash equivalent as calculated prior to any deductions to reflect scheme underfunding. "Cash Equivalent" is used to reflect the net amount after such reductions.

The Regulations define the minimum level for calculating the initial cash equivalent, but do not prevent trustees from paying out higher than the minimum level, provided they are permitted to do so in their scheme rules (Regulation 4(2)).

For salary related benefits, the responsibility for deciding the financial, economic and demographic assumptions upon which the initial cash equivalent will be calculated lies with the trustees, acting on actuarial advice. (Regulation 7B).

The assumptions that trustees use to calculate the initial cash equivalent must be a "best estimate", and should take into account the main characteristics of members of the scheme, as well as the scheme's investment strategy (Regulation 7B).

What reductions can be made to the initial cash equivalent?

An initial cash equivalent may be reduced to reflect underfunding in a scheme (Regulation 7D and Schedule 1A). This is done on the basis of an "insufficiency report" prepared by an actuary. In essence this remains broadly similar to the "GN11 report". Indeed, the trustees may treat the actuary's last GN11 as an insufficiency report provided it meets the requirements set out in Schedule 1B to the Regulations.

The initial cash equivalent may also be reduced to reflect any reasonable administrative costs incurred by the scheme, although this must be offset against administrative savings attributable to the member leaving the scheme. (Schedule 1A, paragraph 15)

What about disclosure requirements?

The Regulations introduce a requirement for a greater disclosure of information to members who are considering whether to transfer out (Regulation 7(b)). Trustees will have to tell such members that the Financial Services Authority and the Pensions Regulator provide information that may help them in their decision. Trustees must also recommend that members take financial advice before making a decision about a transfer from one pension scheme to another.

What about transfers in?

The Regulations only apply to outgoing transfers, and so the requirement for consistency between outgoing and incoming transfers is removed. In relation to incoming transfers, it will be for trustees to decide how to award benefits, although the DWP noted in its consultation paper on the Regulations that it expects trustees to make those transferring in aware of any differences in calculations.

What next?

The Pensions Regulator has welcomed the publication of the Regulations, and has stated its intention to publish guidance before the Regulations come into force in October in order to "help trustees understand the different considerations and new requirements in relation to transfers". The Regulator has also stated an intention to publish guidance for scheme members to help them compare the key risks with any potential advantages associated with taking a transfer.

Comment

The Regulations are a welcome and expected clarification on the process for calculating transfer values as the Regulations are intended to define a minimum level for cash equivalent transfer values. The Regulations do not prevent the trustees from paying out higher amounts if they consider it appropriate and where scheme rules and trust law allows.

However, the Regulations place the responsibility on the trustees for deciding what assumptions are used to calculate the transfer values. In making these decisions the trustees will need to balance the needs of existing members with those members that want to transfer. Whilst trustees will no doubt be guided by the scheme actuary on this, it also hoped that the guidance from the Pensions Regulator will assist them.

It is welcomed that the coming into force of the Regulations was put back until October in order to give trustees and advisers time to consider the impact of the Regulations and to enable a smooth transition to the new procedure.