Since it was first announced members of private sector defined benefit (DB) pension schemes would be allowed to transfer out into defined contribution (DC) pots, and advice would by and large be required, IFAs have been worried about the potentially large liability such advice will entail for their firms.
The discovery by New Model Adviser® that DB transfers have been assessed by the regulator in two separate reviews has pushed this issue back into the spotlight, offering advisers a timely reminder that serious thought needs to be given to the consequences of giving this type of advice.
There is a nightmare scenario over DB transfers, which goes as follows: A seemingly innocent client asks an IFA for help cashing in their final salary entitlement into a DC pot. The diligent adviser carries out research, and finds the client would be better off without a transfer. But the client is adamant they want to transfer, so the adviser fulfils their wish. Lo and behold, the IFA is hit with a complaint a couple of years down the line. Alternatively, they do not acquiesce to the client’s request, and still end up being hit with claims their advice was wrong.
Knowing whether or not your DB transfer advice will be safe down the line is causing plenty of headaches among IFA firms brave (or foolhardy) enough to offer the service.
One IFA firm providing transfer advice is Guildford-based IFA firm HFS Milbourne, which has devised a process that includes multiple reporting stages involving final salary pension experts and compliance managers, and requires board approval before a consultant can move towards transacting a DB transfer with a client.
HFS Milbourne will under no circumstances transact against their eventual advice however.
‘We are quite black and white about that,’ said joint managing director Rod Milne (pictured below). ‘Sometimes it can be a case of saving the clients from themselves.
‘I know we can do it, but the risk is too high. Some advisers say “sign these forms” thinking it’s a get out of jail free card and they are not taking any risk. We don’t because there’s pretty high regulatory risk, mainly due to advice from our professional indemnity insurers.’
Earlier this year, the Financial Conduct Authority (FCA) reviewed DB transfer advice given by a number of firms who had increased their level of DB to DC transfer work in the wake of the pension freedoms. The regulator visited firms and gave them feedback on the suitability of their advice.
But that is not the only review of DB advice the regulator has been carrying out. New Model Adviser® understands the FCA has also collected files on DB transfers to conduct a wider review of advice suitability, which was launched last month as part of its 2016/17 business plan.
An FCA spokeswoman said the regulator was aiming to ‘be more proactive in identifying risks and good practice across a large and disparate sector to ensure good consumer outcomes are achieved.’
Judging best interest
The FCA’s default position on pension transfers is explicit: assume they are unsuitable.
In a factsheet for advisers (number 35) the FCA said: ‘Where the advice includes a pension transfer, conversion or opt-out, there may be additional requirements such as ensuring the advice is provided by or checked by a pension transfer specialist, comparing the DB scheme with the DC scheme and starting by assuming the transfer is not suitable.’
In a consultation entitled ‘Pension reforms – feedback on CP15/30 and final rules and guidance’, the FCA asks: ‘Should we be reviewing the starting assumption for those over minimum retirement age that a pension transfer will be unsuitable unless it can be proven to be in the client’s best interests?’
So far the starting assumption is unchanged. However, a debate starts to arise when the client is adamant a transfer really is in their best interests.
The FCA’s guidance states IFAs are well within their rights to advise on but not transact a pension transfer if it is not in the client’s interest. But advisers are still free to carry out the transaction even where they judge it to be against the client’s best interest, and charge for the service.
This leaves room for insistent clients to complain either way: that an adviser should not have allowed them to transfer or that they should have.
The FCA has also not offered input on how the Financial Ombudsman Service will interpret insistent client claims.
That is a problem for the likes of Milne. ‘Not all advisers are going to be whiter than white about this. They will see an opportunity to reach their monthly target in one case,’ he said. ‘If it’s a 50/50 call they will look hard for reasons to do it and overlook reasons not to. That’s where some mis-selling will occur.
‘It’s something that could go wrong if [transfers] are not regulated clearly enough,’ Milne said. ‘I’m not sure the regulator has done enough work to make it clear to advisers the importance of what they should be doing: properly working in clients’ interests.’
Points of contention
In April, a senior associate in the FCA’s communications team and manager of the regulator’s Live & Local adviser outreach project said the regulator’s position on advisers facilitating pension transfers against recommendation was clear as it stood.
To be fair, a factsheet released by the regulator last June offered some examples of good and bad insistent client practice. The former included capturing the client’s rationale for insistence in their own words, while the latter included basing advice solely on the suitability of the transfer itself, rather than considering the client’s wider financial circumstances. However, the regulator has stopped short of any guidance more prescriptive than that.
A smaller, but no less confusing point of contention, was whether firms holding appointed representative (AR) status were allowed to conduct pension transfers. This looks to have been clarified by the recent passage of the Bank of England and Financial Services Act 2016, which explicitly stated transfers could be conducted not just by an ‘authorised independent adviser’ as the original rules had it, but also firms ‘acting as an AR’.
Jack McVitie (pictured above), chief executive of national IFA LEBC Group, said: ‘When it drafted the permissions the FCA made an error in drafting, which meant when you read it, it might have excluded ARs from giving DB transfer advice.
‘[The regulator] openly said this was a mistake it was going to put right and it did so in this piece of legislation.’
To some extent or other, the future suitability of pension transfers will rely on the results of adviser’s transfer value analysis (TVAS) reports, which are used as a starting point to gain an idea of the critical yield from such a move.
Some experts, including pensions guru Steve Bee, believe it is possible to achieve useful measurements on whether or not a transfer is suitable through this method.
‘If a transfer combines complex benefits with complex guarantees you can still put a value on it,’ he said. ‘In 2016 you can determine the value of a DB pound compared with a DC pound.’
IFAs anecdotally report that transfer values can vary widely between different firms, however, depending on which adviser is conducting the process. Crucially, though, if the FCA chooses to focus solely on this headline figure when assessing suitability in years to come, it runs the risk of overlooking wider factors that might actually make a transfer a good decision, despite a vastly reduced pay-out.
Association of Professional Financial Advisers (Apfa) director general, Chris Hannant (pictured above), said: ‘You have to follow the conduct of business rules, but that might be irrelevant to the clients’ objectives.
‘A transfer is suitable if it follows on from the clients’ objectives. It might be important for a client to consider flexibility and inheritance. Taking a hit may be exactly what they want.
‘Following the pension freedoms, if a client is drawing sufficient income from elsewhere; if they want to pass all the pot down; if they don’t have good death benefits; or they are looking at their sponsoring employer and thinking they aren’t going to last much longer, those are all valid reasons for wanting what they want, not looking at the final salary TVAS report.’
Apfa has already called for a radical change in the way TVAS reports are used, as they are currently the most important determinant in retirement saving decision making.
Nonetheless, Hannant recommends if an IFA has a policy of refusing to transact against advice, this should be spelt out to the client from the outset, long before a decision has to be made, so they are less likely to complain the adviser did not see the whole process through.
Sting in the tail
The FCA’s rules on the suitability of DB transfers remain fairly embryonic. It may decide in the future that IFAs should not transact against their judgement or advise to the contrary.
The regulator may introduce additional suitability requirements given the potential consumer detriment at hand and IFAs should be ready for such an eventuality.
However, will IFAs be able to fully protect themselves if significant numbers of clients conclude their DB transfers were unwise, when the money runs out?
Director of suitability assessment company Harbour, David Roberts, said: ‘I would never be so audacious as to say “yes” [to that question] but [advisers] have to be better protected. They have to be sure they have recorded the facts correctly and the client has agreed to everything else.’
Milne agrees: ‘Otherwise there will be a witch-hunt in two or three years when clients start complaining and advisers will face another review.’