Pension fund being wound up ?

[Usjes]

Hi,

I participate in a pension scheme organized by my employer, it gave the option of 4 different funds and being risk averse I decided to contribute to the one advertised as 'Low risk' and that guaranteed non-negative returns. About 6 months ago we were notified that in future contributions to this fund would only be accepted from existing participants, ie no new members but existing contributors could continue. Also l noticed that the declared return would be zero for 2009, obviously not a great absolute return but still very good compared to other riskier fund which could have returns up to -70%. Last week however we were informed that no new contributions would be accepted even from existing members and that anyone wanting to move there existing balance in this fund to another fund would have to pay a withdrawal penalty of 32%. So basically it looks to my admittedly non-expert eye that my contributions to date are essentially being held to ransom.
So I have two general questions:
1. Are there any conditions that would apply to all pension funds in general which would allow me to transfer my funds without loosing the 32% and if not
2. Can the pension fund hold this zero return rate indefinitely to extract their de facto 32% loss while still technically not breaching their 'guaranteed' non-negative return ?
- Basically what I am wondering is, does the rate of return have to be related in any way to the actual performance of the fund, because as I see it the incentive to offer a good return was that they would attract more subscribers and thereby earn more commisions, but since they have effectively abandoned this fund, this incentive no longer exists and so they can maximize their profits (or minimize losses) by offering zero return indefinitely. Would this be legal?
- Similarly are the returns from this fund ring fenced, assuming they had managed the fund properly to generate returns in accordance with their 'guarantee' could they now be taking these returns and using them to prop up some of their more risky funds which have collapsed? Again would this be legal?

So if there are any experts on this subject out there who can answer these questions let me know, or if anything about this scenario jumps out as being less than above board I'd like to hear about it.
Please no responses to the effect, 'You should have read the fine print.' I didn't read the fine print because the people selling the funds provided the helpful short desriptions 'Low risk' etc. had they not I would have read the details, ultimately I think it will be up to the Pensions Ombudsman to decide if I have a case from this point of view, but before going down that potentially acrimonious route I am wondering if the answers to the above questions might let me side-step this problem. eg if there is some requirement that the declared return to the subscribers be somehow related to the actual fund return then the rate should start going non-zero again in which case remaining in this fund might not be a bad investment.

Thanks,

Usjes

 

[Marc]

Hi Usjes,

It sounds like you have invested in a "With Profits Fund".


This post covers many of the issues (although it relates to a lump sum investment, the principles are the same) http://www.askaboutmoney.com/showthread.php?t=86566

I used to advise on winding up these things many moons ago......

The 32% reduction you refer to is a "Market Value Adjustment".

In a nutshell this means that provided you remain in the fund, the value of your investment does not fall. However if you move out, usually under any circumstances, you will receive the "real" value of the underlying investments in the fund which in your case is 32% less than the "face value".

If you stay, you avoid the 32% loss but as you point out, your bonus rate is now 0%.

As the fund is closed, this means that the Insurance Company now have no new contributions but still have guarantees to meet. Remember that the "face value" of your policy is 32% above the underlying value of the fund.

In these circumstances, the fund is usually required to switch into extremely safe assets to back-up these guarantees. Consequently the prospects for future investment returns for a fund in this position are usually very poor. There is no hope that the fund might recover and suddenly offer better returns. It is a regulatory requirement that a fund in this position meets the guarantees promised and so the fund will always persue a defensive investment strategy. Nothing can change this.

Investors in this position are therefore faced with the tough decision to stay or go.

The way to approach this is to consider what the guarantee might be worth to you.

Let's say for example that you have 10 years to go to retirement then the 32% is worth a little under 3%pa to you.

If you switched out, you would take a 32% hit, but you would only need to achieve an annual growth rate of just over 3%pa to be better off. If you were prepared to take some investment risk, this would be a reasonable assumption even over 10 years but you would need some competent investment advice. If you are not prepared to take any investment risk then on balance most investors typically decide to stay put since they perceive the guaranteed current value to be more valuable than an unknown future value.

If your term to retirement is 20 years, then the guarantee is almost worthless from an investment perspective and under nearly all circumstances you should be better off taking out the money and investing elsewhere, subject to the proviso that you would be willing to at least take some risk and could obtain appropriate investment advice.

I usually suggest in these circumstances that you ask your employer to arrange a seminar and for the employer to pay for an extenal consultant to make a presentation to all effected employees explaining the issues and the options. There is no point in getting the scheme provider in, you would never obtain an objective assessment.

All the best,

Marc
Head of Wealth Management
GoldCore Ltd

 

[Usjes]

Hi Marc,

Thanks for the reply. Interesting, the -32% was termed a 'MVA' so it sounds like we are
talking about the same thing however a few points remain unclear:
- Can they keep the return at zero indefinitely, you seem to be saying that they will be
obliged to move the assets into very conservative investments so the prospects of making
back the 32% even in 10 years is very slim so the return will likely be zero for 10 years,
but assuming they did recover the 32% in 10 years could they still hold the rate at zero
after that point and pocket any further gains for themselves? Remember they are
no longer trying to attract new subscribers.
- Why are regulations suddenly kicking in to ensure they invest in such a way to guarantee
to meet their obligations ie. the MV of the fund is now -32% => clearly they need to do
something drastic but was this not just as true when they were -20%, -10% or even -5%.
- What is to stop a fund guaranteeing non-negative but in actual fact putting it all on a
horse for 4.5 years and then coming back to the subscribers 5 years later and saying oops
the MVA is -99% and the return will be 0% henceforth ? I mean why the sudden requirement
that the fund be managed correctly in line with its advertised returns.
- In fact the situation you describe sounds perverse, from my personal investents over the
last five years, one in particular tripled in value, then with the credit crunch fell back
to almost its initial value but now has already doubled again, but from what you are saying
the pension fund may now be forced to avoid such investments that could recover the fund
from the losses due to the mismanagment to date.
- Is there any way for me to find out whether or not my fund in particular will be required
to follow any particular investment strategy, are these legally binding regulations you
describe definitely applicable simply by virtue of the fact that the fund has been closed ?
- Also is there not some requirement that the returns be in some way related to the true MV ?
Or at least the true MV be disclosed somewhere ?
I mean I don't pay much attention to the annual pension reports we get but I'm sure the return
was > 0% and has been for a number of years, is it really credible that the true MV suddenly
went to -32%, is it not very probable that it had already fallen by 10% or whatever last year
when they reported a return of 3% or whatever? I mean even if I watch all available infromation
like a hawk can I still be kept completely in the dark about the true performance of my funds
until it is too late and the losses have already been made ?
A meeting has been arranged with our pension provider on Friday, my understanding is that
my employer pays these people on my behalf but at no cost to me so I would have though they
should be reasonably impartial. Although there wasn't a peep out of them when the fund was
closed to new subscribers 6 months ago when they surely must have known what was happening and
that every additional € I invested since then was effectively immediately loosing 32%.

Thanks,

Usjes.

 

[Marc]

There are two issues here:

The 32% relates to the past. The value of investments has already fallen, therefore the MVA simply reflects that fall in value. It is the "real" value of the fund if you like.

However, you have not "suffered" this fall on paper. Your notional fund value is 32% higher than the real value of the investments.

Imagine a situation where there are say 5 people invested in the fund and they all have a fund value of €10,000. So, the total value of all the policies is €50,000.

However, the investments backing these policies have declined in value by 32% and therefore the real value of the underlying investments which support the fund is €34,000.

The insurance company has contractually promised each and every investor the full value of €10,000. What would happen if the first investor were to cash in and was paid the full €10,000?

The fund would have liabilities of €40,000 (the remaining 4 investors) but assets of just €24,000.

The way the MVA works is to ensure that everyone in the fund gets their fair share of the total value of the fund should they decide to cash in. If you were the last person in the queue you wouldn't want to find out that there was no money left at all!!.

In this respect the MVA is ensuring that everyone gets their fair share. Remember that these investments do not work in isolation. Markets have fallen around the world therefore these funds will have suffered exactly the same losses as everyone else. The only real difference is that, on paper at least, you have been protected from the nominal falls in value.

Now let's consider the future.

In the example above the fund has liabilities of €50,000 already promised but assets of just €34,000.

In this rather extreme example, the fund would be insolvent.

With Profits funds are therefore required by regulators to operate a positive "free-asset ratio" i.e. an excess of assets over liabilities. Historically, and I mean back in the 1990s, this ratio was very strong and it allowed With Profits funds to invest into equities and offer investors the possibility of capital security (the unit price not falling) plus a good bonus each year.

This seemed like a perfect investment. High returns each year but without the volatility. Well, it turns out that isn't really possible.

2000-2003 hit, and these funds hit the rails. MVAs started to be applied and to be honest, in reality these funds ceased to be as popular as they once were (especially in the UK) but in Ireland, I was suprised to see that they are still to this very day being sold to investors.

Many of your questions relate to investors being "in the dark". This is simply the nature of this sort of investment. The future bonuses (if any) are at the discretion of the acturary. They are extremely opaque and hardly anyone really understands how these things work.

So what are the prospects for the future. They are exactly as I describe them.
It is not the case that the bonus rate will be exactly 0% but its is possible, if not probable, that the future returns will be poor.

Remember what is going on here. The fund has guarantees that it has to meet now and this is always going to be at the expense of the possibility of future profits.

 

[Usjes]

Thanks again, there is just one final question and that is:
Is there anything to force the fund to pass on any future gains to the subscribers ?
i.e. If your assessment is correct, as it stands the fund knows it is currently 32% below its legally binding
obligations, it knows the number of subscribers and it knows their age profile so it would be a reasonably
trivial exercise to figure out what rate of compound interest they need to earn to meet their obligations.
For arguments sake let us assume (as is probably realistic) they won't simply take out a cash deposit at the
required interest rate but rather make conservative investments. Supposing one of those investment happens to
win the lottery, as far as I can see it I would still not benefit in ANY way from this. My point is I can not
see ANY incentive for the fund managers to pay me a single penny above the current MV they have now declared
no matter what happens.
i.e
1. they are not trying to attract new subscribers.
2. As this fund is now closed presumably they can bury it as though it never happened ie. it wont show up
as a black mark against them on fund league tables no matter how poorly it performs because effectively
it doesn't exist any more.

The reason I ask is because I am at least 20 years from retirement so I'm fairly certain that over 20+years it
would be very difficult NOT to do better than +32%. So the obvious conclusion would be, as you stated previously,
withdraw from this fund the +32% nominal value is more or less worthless to me. My confusion arises because the
company who manage the pension for my employer has sent me a written recommendation that I not withdraw from
the fund due the the large current MVA. I have looked into it and the company in question are actually our pension
scheme administrators and so should be completely independent but more importantly I don't believe they should
be advising me at all, so again this just makes me more suspicious that there may be something untoward going on
here although maybe they are just grossly incompetent and exposing themselves to potential liability by offering
me advice when they aren't even being paid to do so.
So I'm just wondering, could they be looking at this from a different angle, thinking the fund could recover well,
and that the fund would be required to pass on these gains to the subscribers. Or could the fund possibly be
reopened in future, is the closing of a pension fund final ? This is why I think the question boils
down to: Is there any realistic reason why they would decide to, or any way in which they are obliged to pass on any
future gains ?

Thanks,

Usjes.

P.S. I still haven't got around to reading your original link (too busy at work!) so sorry if it contains the answers I'm looking for , I will get around to reading it shortly.