A presentation originally given at the Great Pension Debate by Alan Smith that helps explain how CETVs are calculated

1. Transfer Values-
Myths and
Misunderstandings
Henry Tapper
The Pensions Network
8th September 2017

2. Four questions
2
How are transfer values
calculated?
Are transfers out always
good for scheme funding?
Why can transfer values
for similar schemes
vary so much?
If you transfer to
a new scheme why do
you not get equivalent
service credit?

3. How are transfer values
calculated?
• The Transfer Value Regulations say:
“The initial cash equivalent is the amount at the guarantee date which
is required to make provision within the scheme for a member’s
accrued benefits, options and discretionary benefits.”
• In plain English, we say:
“The initial cash equivalent is the expected cost of providing the
benefits in the scheme.”
3

4. Initial Cash Equivalent
4
Pension at date
of leaving
Revaluation to
retirement
Annuity factor
Probability of
being alive at
retirement
Expressing in
‘today’s money’
(discounting)
Value of
death
benefits
Initial Cash
Equivalent

5. Example 1
Let us consider Jane, who is 45 years old, earns £40,000 pa and has 15
years’ service in her employer’s defined benefit pension scheme. The
scheme offers 1/60 accrual and a retirement age of 65.
Jane has just left her employer and started a new job elsewhere. Her
pension at date of leaving is calculated as:
15/60 * £40,000 = £10,000 pa (payable from age 65)
To estimate the pension at age 65 we need 20 years’ revaluation. If we
assume inflation is 2% pa Jane’s pension at age 65 will be:
£10,000 * (1.02)^20 = £14,860 pa
5
Pension at
date
of leaving
Revaluation to
retirement

6. Example 1
To get the value of this pension, at age 65, we need to multiply by an
appropriate annuity factor. If this factor is 25, then the value would be:
£14,860 pa * 25 = £371,500
Next, we need to allow for the probability that Jane lives to 65. This is around
93%, so the value is now £371,500 * 0.93 = £345,495
Then, we work out how much we need now to end up with £345,495 in 20
years’ time. Let us suppose there is mix of growth assets and bonds in the
scheme, giving an average expected rate of return of 3% pa.
So the money needed now to provide this pension will be:
£345,495 * 1/((1.03)^20) = £191,292
6
Annuity
Factor
Probability of
being alive at
retirement
Expressing in
‘today’s money’
(discounting)

7. Example 1
But what happens if Jane dies before her pension starts?
Suppose she gets a refund of her contributions and these amounted to
£15,000.
If we assume Jane dies halfway between now and retirement, in other
words in 10 years’ time, then the value of the death benefit is:
£15,000 * 0.07 * ((1/1.03)^10), i.e. £781
So total transfer is £191,292 + £781 = £192,073
7
Value of
death
benefits
Initial Cash
Equivalent

8. Four questions
8
How are transfer values
calculated?
Are transfers out always
good for scheme funding?
Why can transfer values
for similar schemes
vary so much?
If you transfer to
a new scheme why do
you not get equivalent
service credit?

9. Transfer to another scheme
Jane joins a new employer who runs a defined benefit scheme identical to
the one she has just left.
Jane asks what added years benefit would be secured by a transfer value
of £192,073?
We have £191,292 to provide pension at age 65. Using the same
assumptions as the old scheme Jane will get a pension of £14,860 at 65.
So what is this expressed as added years of service in the new scheme?
9

10. Transfer to another scheme
Added years of service will be linked to Jane’s salary and salaries are
assumed to increase at a higher rate than inflation.
Suppose the salary increase assumption in the new scheme is 2.5% pa.
The pension now to give £14,860 at age 65 is:
£14,860/(1.025)^20 = £9,068
The extra service granted satisfies (n/60)*£40,000 = £9,068
So n = 13.6 years
This compares to 15 years of service in Jane’s old scheme.
10

11. Transfer to another scheme
If Jane’s salary had increased in her new job to £44,000 then the
difference is greater as the formula becomes:
(n/60)*£44,000 = £9,068
So n = 12.4 years
Key point is that added years will be lower even if salary does not
increase because salaries are assumed to increase faster than inflation.
11

12. Four questions
12
How are transfer values
calculated?
Are transfers out always
good for scheme funding?
Why can transfer values
for similar schemes
vary so much?
If you transfer to
a new scheme why do
you not get equivalent
service credit?

13. Example 2
Let us stay with Jane and suppose her pension scheme adopts a more
prudent investment strategy, with an expected return of 2% pa rather than
3% pa.
Remember we need to work out how much we need now to end up with
£345,495 in 20 years’ time.
If investment return is 2% pa, the money needed now to provide this
pension will be:
£345,495 * 1/((1.02)^20) = £232,508
13

14. Example 2
But don’t forget Jane might die before her pension starts
The value of the death benefit is:
£15,000 * 0.07 * ((1/1.02)^10), i.e. £861
So total transfer is £232,508 + £861 = £233,369
This is 20% higher than in the previous example (£192,024)
simply because the scheme holds different assets
14

15. Four questions
15
How are transfer values
calculated?
Are transfers out always
good for scheme funding?
Why can transfer values
for similar schemes
vary so much?
If you transfer to
a new scheme why do
you not get equivalent
service credit?

16. Usually, but not always…
• The Transfer Value Regulations say:
“The initial cash equivalent is the amount at the guarantee date which
is required to make provision within the scheme for a member’s
accrued benefits, options and discretionary benefits.”
• The Regulator’s Guidance says:
“Only those options which would increase the value of benefits may
be included within the benefit for CE purposes”
16

17. Impact of option to take cash
17
10000
15000
20000
25000
30000
50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65
Liability(£'s)
Age
Liability of £1,000 Pension payable at 65
Valuation Liability Transfer Value

18. Four questions
18
How are transfer values
calculated?
Are transfers out always
good for scheme funding?
Why can transfer values
for similar schemes
vary so much?
If you transfer to
a new scheme why do
you not get equivalent
service credit?

19. Questions
19