All final salary pension schemes in the UK are regulated. The formal body who regulate all company pension schemes, including final salary or DB schemes is called The Pensions Regulator (TPR):
The Pensions Regulator (TPR) is the UK regulator of workplace pension schemes so any company pension scheme that is not a SIPP (Self Invested Personal Pensions) or GPP (Group Personal Pensions). These schemes are regulated by The Financial Conduct Authority.
The types of schemes that come under The Pensions Regulator include:
- Final Salary Schemes also referred to as Defined Benefit or DB Schemes.
- Average Salary Schemes often referred to as CARE or career average schemes.
- Defined Contribution or Money Purchase Schemes
- SSAS (Small Self-Administered Schemes)
There are a small number of rare schemes classed as ‘hybrids’ and a few other obscure arrangements but the above covers most of the Workplace Pensions covered by The Pensions Regulator.
The Pensions Regulator make sure that employers put employees into a pension scheme either one of the above or into a pension scheme regulated by the FCA (usually a GPP or Group Personal Pension). They also make sure that workplace or company pension schemes are run properly and dictate how final salary schemes calculate their transfer values or CETV’s for deferred members.
What is very important to understand is The Pensions Regulator dictate that there are two Methods of calculating a transfer value (CETV).
Method one ~ Best Estimate
Method two – Alternative Method
Calculate your CETV Free
From The Pensions Regulator web site :
“The legislation provides for two methods for calculating CETVs:
a method based on a best estimate of the expected cost of providing the member’s benefits in the scheme; and
an alternative method where trustees want to pay CETVs which are above the minimum amount.”
It is very important to know and understand these two methods and which one your scheme trustees are applying. The reason is simple. The best estimate is the legal minimum a scheme must pay. The alternative method is voluntary where the trustees want to pay more “ above the minimum amount “.
So, if your scheme is applying the alternative method this can be removed at any time for any reason because it is voluntary.
Why would trustees revert back to best estimate ?
For this we need to know a little more about how Final Salary Schemes are paid for/funded. Back to basics:
Prior to William Beveridge and The National Insurance (NI) Act passed in 1946, there was no state pension, in fact there were not really any pensions at all. You worked to age 65-70 and then probably died a few years later. This is why pre-war generations had so many children: your children were your pension.
Post 1946 we had, for the first time, a state pension. This was the Basic State Pension that has stayed with us to this day, in one guise or another, supposedly paid for by ‘National Insurance’, although in reality tax and NI is all really lumped into one pot. So, the concept of ‘Pensions’ started to become popular or ‘superannuation’ as it was sometimes called. Government employees started to be superannuated and the birth of the final salary scheme occurred.
Post war Britain was in turmoil. If, or when you retired, or you could no longer work, or had no family to support you, it was off to the poor house. Retired life was pretty miserable and young working men saw the misery of their parents in retirement. Combine this with the full employment of the 1950s and employment with a superannuation scheme, it was a precious thing. To a degree, the best way for private companies to attract staff away from public sector was to offer them a superannuation scheme, hence the creation of the Final Salary Scheme in the private sector.
For decades Final Salary Schemes ruled the roost and were a fantastic tool for large and smaller businesses alike. However, that is when the rot started. To a degree it is possibly true that some businesses did abuse the system, using their final salary scheme for the companies’ benefit, disadvantaging HMRC of which the Treasury wouldn’t have approved. Under Maggie Thatcher the attack on final salary schemes started. Only a few remaining pillars of the final salary world have managed to keep strong.
The purpose of a final salary scheme was to attract and retain staff. And the cost of this is born by the principal employer or employers. If the principal employer is going well (BP) then it’s likely that CETV’s will be calculated on the alternative method and likely to be quite generous. There is something associated with this called de-risking.
De-risking is where employers and the Trustees look to actively transfer out deferred members. And to encourage them to transfer they may apply a de-risking premium to the CETV calculation, and this de-risking premium can be significant. This article explains in more detail
This is the primary reason why CETV’s can vary so widely from schemes who apply the legal minimum Best Estimate which may provide a transfer value (CETV) of circa 15-20 times the pension at normal retirement age. LGPS may be a good example here.
To blue chip employers doing very well whose CETV calculations on the alternative method may well generate a transfer value (CETV) of 40 times or more of the pension at normal retirement age and again BP may be a good example here.
Aside from the politics and regulation what else may affect a CETV.
The main factors that will determine the value of the CETV which will apply to either Best Estimate or Alternative Method are:
- The amount of deferred pension
- How much the deferred pension will increase (be revalued in technical speak) up to the scheme’s normal retirement date
- The benefits attached to the pension once in payment such as spouses’ pension and escalation
- Age and gender
- And, critically, the underlying economic interest rates / gilt yields. Contrary to what most people think as interest rates rise transfer values will fall
What is very important to know that where, according to Mercer, more than 70% of schemes are looking to de-risk so all these schemes / employers will be using Alternative Method, but this will be driven by how well the principal employer is doing. Bottom line is de-risking costs and as much as the employer and the Trustees may have a desire for de-risking they may not have the resources. One can conclude from this that at least 70% and probably more, of DB/Final Salary Schemes are using Alternative Method which can be removed at any time should the principal employer fall on difficult times.Calculate your CETV Free