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How the FCA’s new DB transfer valuation works

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How the FCA’s new DB transfer valuation works

The Financial Conduct Authority (FCA) has proposed an overhaul of the way advisers assess the value of a defined benefit (DB) pension when advising on transfers. 

In a consultation paper the regulator put forward plans to move away from transfer value analysis (TVAS) report to a new method called appropriate pension transfer analysis (APTA).

What has changed with the new proposal?

Firstly APTA is designed to place suitability and holistic advice at the centre of DB transfer advice. This means that elements of financial planning such as cashflow modelling will possibly be included. 

It will also require advisers to consider all options for how the money will be used: will the client be better off if they pay for an annuity? Or will they be able to sustain their lifestyle if they plan to invest the money from a transfer before going into drawdown?

The FCA also said APTA should consider the underlying investments the client will be placed in, and the retirement vehicle used as well as other ways of achieving the client’s goals for example meeting death benefits through life insurance.

Annuity comparator

Under the regulator's proposals the current use of critical yield to determine the value of the benefits being given up will also be changed. 

In brief, the critical yield was the rate of return required to ensure the safeguarded benefits from the DB scheme that are being given up can be replicated. This has traditionally been based on the assumption that an annuity will be purchased at some point. 

The FCA pointed out in its consultation paper that the concept of critical yield 'is not widely understood by consumers'. So how has the regulator decided to address this?

Although the critical yield is being effectively moved away from in the client-facing advice process, the FCA said it was still important to get across to the client the value of giving up a guaranteed income.

‘Without this analysis it will be difficult for many consumers to put the implications of transferring their safeguarded benefits into financial context,’ the FCA said.

So the FCA has come up with a transfer value comparator (TVC) as part of APTA. 

The first two parts of the TVC are essentially the same as the current TVAS system. Where it differs is that advisers using the TVC will not be able to just present the rate of growth needed to replicate the value of the safeguarded benefits being given up after a transfer. 

Instead, the FCA has proposed a system where advisers apply a 'discount rate' to the value needed to buy the same protected benefits on the market. Under the FCA’s proposals, the IFA must also present this information in a ‘prescribed format’ whereby the CETV is matched up against the size of the pot needed to buy the equivalent income through an annuity. 

Les Cameron (pictured), head of technical at Prudential, said this means that advisers will have to take into account clients' attitude to risk when advising on DB transfers, which was previously not there with the critical yield.

'It is about taking away these percentages, with critical yield, and trying to get a grasp on the value of the client is giving up. The regulator is making it more personal, because every person could have the same critical yield, but everyone has a different attitude to risk. You get a cautious client, a balanced client and an adventurous client, all things being equal they will get the same critical yield,' he said.

Cameron said the change should mean that clients receive different advice depending on their circumstances and attitude to risk. 

‘In the new world they will get a different starting point because the amount of money they need today to match what they are getting is determined by what their journey is going to be like. Your cautious client will need a much higher amount today to get there, but your adventurous guy today would not,' he said.

Ex-FCA technical specialist Rory Percival said as a result of the proposals the critical yield would be seen as a ‘footnote’ in the process and the capitalised value (the amount required to buy an annuity) ‘should be at the front and centre’.

 

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