Crystal Risk Consulting : Independent Actuarial & Risk Management Consultancy
Emerging Risks Blog
How exposed are life insurers to enhanced transfer value misselling ?

1 comment

Patrick Kelliher

My previous post touched on how asset managers could be exposed to 3rd party misselling under the FSA’s PS07/11 on provider / distributor responsibilities [1] which places an onus on product providers to ensure their products are suitable for target markets and that marketing literature and other sales support is sufficient for customers and their advisers to understand risks involved. I think PS07/11 could now become a critical issue for life insurers as it may expose them to misselling liabilities in respect of enhanced transfers values (ETVs).

By way of background, ETV exercises were often undertaken by employers to reduce pension scheme liabilities or reduce their exposure to pension scheme risks. They typically involved deferred members who had left employment and were no longer accruing benefits but had still to reach retirement age. These were given incentives to transfer their benefits to a personal pension, thereby extinguishing the scheme’s liability. The incentive was either in the form of cash and/or an enhancement to the transfer value on offer from the scheme.

Notwithstanding any enhancement, the TV was often less than the value of benefits on the IAS19 accounting value so the transfer would lead to an accounting gain for the employer which is why employers were keen on these exercises. I would contend that the IAS19 is a reasonable proxy for the fair value of the pension [2] and therefore the pension scheme member was losing out if the TV was less than this. Furthermore there would be a transfer of risk from the employer to the member who would now be exposed to varying investment returns both before and after retirement as well as the longevity risk of living longer than expected. To my mind some if not most members who availed of ETV offers will have lost out significantly.

Misselling losses stem not just from customer losses but also from poor advice, and the evidence is that there was widespread advice failings associated with ETV exercises. The FCA recently carried out a thematic review of ETV advice, looking at 300 cases advised between 2008 – 2012 [3]. They found that advice was suitable in about half of these, but unsuitable in a third of cases (it was not clear cut for the remainder). Furthermore in roughly 75% of cases there were disclosure failing such as failure to disclose annuity risks associated with converting personal pension pots into income at unknown annuity rates.

I do not find this surprising. Typically ETVs were assessed on the basis of a “critical yield” – the investment return the member would need for the enhanced transfer value to replace benefits foregone. If the yield was greater than a certain level (say 9% p.a., consistent with the upper projection rate for pensions at the time), then it was judged very unlikely the ETV would replace benefits and the advice should be to stay. However the critical yield only covered the risk relating to fluctuating investment returns pre-retirement. If the member transferred they would also be subject to the risk of fluctuating annuity rates which depend on bond yields and life expectancy i.e. they would be subject to longevity and interest rate risk once they retired [4]. The critical yield calculations I have seen did not address these risks.

Perhaps the only saving grace for advisers is that in ca.60% of cases, the member proceeded with the transfer despite advice to stay (I suspect there is a large overlap between these cases and the cases where advice was suitable). This may be because of cash incentives offered. Even that may not be protection against misselling claims. I have seen pension review cases where advisers had to pay misselling compensation to customers who insisted on transferring against advice, as the adviser did not explain the risks fully.

Given the significant customer detriment involved and the extent of misselling uncovered, I would not be surprised if the FCA followed up on this and mandated wide scale reviews of ETV advice. This is likely to give rise to significant misselling losses for advisers. The compensation liabilities will lead to many firms going bust, with the FSCS having to step in to meet compensation claims and higher levies for other advisers – even those not involved in ETV advice.

I don’t think the losses will stop there however. I believe advisers will try to pass some of the loss on to insurers, and I think they may be successful in this. For one thing, I believe life insurers are complicit in advice failings. Being the recipient of transfer values, they often provided support to ETV exercises in terms of producing critical yield calculations but as noted these did not address annuity rate and related longevity and interest rate risks. Furthermore the literature they provided may not have properly explained the extent of these risks.

I think this is where PS07/11 could come into play. It places a responsibility on providers like life insurers to ensure distributors have sufficient information to understand the risks associated with the products they sell and to advise customers properly. I think a case could be made that they have failed in this regard, particularly in relation to annuity risk. Providers are also obliged to consider their target market and stress test the impact on customers. I find it hard to imagine that any stress testing would not have highlighted the potential for severe losses for scheme members who would become their customers if they transferred. I do wonder why life insurers became involved with such business – notwithstanding any profit on writing transfer business, the reputation risk of being associated with transactions leading to employers gaining at the expense of pension scheme members should have put them off.

As it is, if the FCA deems insurers to have contributed to advice failings on ETVs, I don’t think it is beyond the realms of possibility for insurers to be asked to pick up part of the tab. This may be on an “ex gratia” basis like the compensation schemes for split-capital investment trusts which cost £144m [5]; or the £54m [6] set aside for investors in Arch Cru. The sums involved could run into billions for life insurers given the size of losses that can arise with defined benefit transfers and the extent of advice failure.

It would also set an unwelcome precedent. Long after most life insures ditched their own direct sales forces and appointed representatives, and with it their direct exposure to misselling, this may find themselves exposed to losses in respect of 3rd parties they sold business with. ETVs could be the start of another painful chapter in life insurance misselling losses….


[1] FSA PS on provided / distributor responsibilities can be found at:
[2] Financial economics suggest that pension scheme obligations can be viewed in the same way as corporate bonds issued by the same employer, albeit with the added protection offered by a ring fenced pension fund and the guarantee of up to 90% of benefits by the UK Pension Protection Fund (PPF). So while the employer may not be highly rated, with the added protection, pension scheme obligations could be viewed as high grade corporate bonds and so the IAS19 value of benefits – which is based on discounting at high grade (generally AA-rated) corporate bond yields – is a reasonable basis for assessing the value of assessing the value of the pension scheme obligation.
An alternative argument may look at the value of the benefits covered by the PPF perhaps on an IAS19 basis (the PPF is not formally guaranteed by the UK government so it should perhaps be looked at in a similar way to a high grade corporate bond). However is many exercises, even the enhanced transfer value was less than 90% of the IAS19 value which may be a proxy for the value of benefits guaranteed by the PPF.
[3] See while the full review can be found at:  
[4] If they opted for drawdown instead of an annuity, they would be exposed to fluctuating investment returns on their fund and the risk of living longer than expected leading to their fund being exhausted.
[5] See for example:  

Send to friend
Home About Us Our Services Papers & Articles Links Emerging Risks Blog Contact Us
Crystal Risk Consulting Limited
Sitemap  |  Privacy
Website Design & Hosting
by Edinburgh Websites
Crystal Risk Consulting Limited
Crystal Risk Consulting Ltd Edinburgh : Bookmark & Share