Understanding the TVC

In October 2018, the FCA made the provision of an appropriate pension transfer analysis (APTA) mandatory. One of the elements which the APTA needs to contain is the Transfer Value Comparator (TVC).

Traditionally pension transfer reports utilised the critical yield, however, after much criticism for lack of understanding, and the over reliance on the critical yield to a transfer/not, the TVC has now been made mandatory in all APTA reports.

The TVC is nothing more than a fictitious CETV, used to compare the obtained CETV from the ceding scheme to a CETV (the TVC) based on FCA dictated assumptions. As may well be known, the CETV is calculated using 3 various assumptions (rates of inflation, gilt yield rates and investment returns). To understand how these are used in calculating the CETV, please visit this blog post.

The assumptions which the FCA stipulate can be found in the conduct of business sourcebook (COBS) section 19 Annex 4C. The rules state that the deferred benefits should be revalued using the schemes method of revaluation (RPI or CPI), however, it stipulates these rates as 3.0% (RPI) and 2.0% (CPI). Benefits should be revalued up to the normal retirement age using the formula FV=PV(1+r)^n where “r” is the rate of RPI/CPI.

The future value needs to be capitalised using the gilt yield rates to provide a future capital value which at normal retirement age, could secure an annuity which would provide equal benefits to those being surrendered under the ceding scheme.

The capital value is increased by 4% to illustrate the cost of purchasing such annuity at some point in the future (normal retirement age).

The future capital value is then discounted back to the date of calculation using the formula PV=FV/(1+r)^n where “r” is the coupon yield for the applicable term as per the FTSE actuaries index. This is reduced further by 0,75%. This reflects the risk free rate of returns, reduced by the expected advice expenses.

The result of the above two charge assumptions (increasing capital value by 4% and reducing returns by 0,75%) tend to have the effect of ballooning the TVC in relation to the CETV. Furthermore, it is extremely arguable whether it is a true reflection of the future cashflows. Purchasing an annuity does not cost 4%, and investment returns should be higher than the risk free rate as stipulated.

Therefore, whilst being a fictitious CETV with pre-determined assumptions, the FCA argue that it is a suitable comparison as it reflects the risk free nature of the deferred benefits the member currently holds in the ceding scheme. On the other hand, everyone knows that the benefits are not relinquished in the ceding scheme, only to purchase the exact same benefits elsewhere. That would be like selling your watch to a second hand dealer, and then buying the exact same watch at a different dealer. These are two very plausible arguments; and as is so often the case, reality probably lies somewhere in the middle.