The plight of former members of the British Steel Pension Scheme (BSPS) who were advised to give up their defined benefit (DB) pensions in favour of individual defined contribution (DC) pots is well documented.
Almost 8,000 members were advised to transfer out of the BSPS rather than choose between two other options. They could have moved their pension to the new British Steel Pension Scheme (BSPS2), which would have provided slimmed-down BSPS benefits. Or they could have remained in the BSPS, which at the time was expected to enter the Pensions Protection Fund (PPF).
The FCA believes that many of the transfers were based on unsuitable advice.
The consumer redress scheme launched by the FCA last year has resulted in much lower compensation payments than was originally expected. This reflects the methodology used to calculate redress, whereby the value placed on a DB pension correlates closely with the cost of an annuity.
Given the FCA’s original suggestion that average redress would be of the order of £60,000 per person (later reduced to £45,000), it came as a shock to steel workers when updated calculations showed that no redress was due in most cases.
As a specialist in pensions transfer redress, I believe there are two key points to note.
Firstly, the ‘no loss’ result generated by redress calculations means that affected individuals should now have sufficient pension funds to secure the pension they would have received had they not transferred out.
Secondly, as these individuals have forfeited their right to a DB pension, the risk that they’re unable to attain equivalent benefits now lies with them. This is the key difference between DB and DC pensions: individuals whose investment choices turn out to be suboptimal will suffer the consequences.
Crucially, they will also lose out if the cost of annuities increases before they reach retirement. This is a particular risk for those who are farther from retirement.
To protect themselves from the risk of movements in annuity prices, steel workers would need to invest in assets that increase in value when annuities become more expensive, such as government bonds. This is implicitly assumed within the redress calculation methodology.
This sort of investment strategy is commonly adopted in occupational pension schemes, but individuals tend to invest their personal pension pots in growth-seeking assets such as equities.
Indeed, the reason why people who received redress a few years ago seem over-compensated is because they applied this sort of ‘mismatched’ investment strategy and their gamble paid off.
However, if the goal is for people to have a pot at retirement that is sufficient to secure the same guaranteed pension income for life as would have been provided by the BSPS2 (or the PPF), then it’s problematic that individuals may adopt investment strategies that are inconsistent with the underlying assumptions of redress calculations.
What’s the solution? Ideally steel workers would be able to secure benefits by purchasing a deferred annuity – a product which closely replicates a DB pension. However, these are currently unavailable in the retail market, with annuities only available for individual consumers at the point of retirement.
The key to resolving this issue therefore lies with the insurance company that has taken on the BSPS2 liabilities. Deferred annuities have been secured with Legal & General for many members as part of the scheme’s journey towards buy-out; adding a few individuals to the policy should not prove prohibitively difficult.
Modelling by First Actuarial shows that the minimum personal pension pot required under the redress calculation methodology is comparable with current bulk-annuity pricing. This means that if Legal & General were to agree to former BSPS members being added to the existing bulk annuity policy, it would be possible for many steel workers to exchange their personal pension for secure BSPS2 benefits.
Modelling reflects a BSPS pension at date of leaving of £7,000 pa accrued between 2006 and 2017
This solution would not work for everyone, as many steelworkers have already spent a portion of their DC pot (this is factored into the redress calculation so they aren’t compensated for any such spend). But even if some individuals faced a cut to their BSPS2 benefits, the advantages of a secure income promise might still be attractive.
Sarah Abraham leads the pension redress team at First Actuarial and has extensive experience of calculating redress in relation to non-compliant pension transfer advice.