The Best Outcome

Advising consumers on transferring out of a defined benefit (DB) pension to a defined contribution (DC) scheme is an area that has come under considerable scrutiny from the FCA. Transferring has been a popular choice, due to the size of the transfers available from DB Schemes, allowing pension scheme holders to take advantage of pensions freedoms. A total of £92 billion has been transferred since the introduction of pension freedoms back in 2015. Last year saw £33 billion transferred (down slightly compared to the £36.9 billion in 2017) but there are real concerns about the suitability of the advice being given and the potential for customer detriment.

A recent FCA review of 18 firms (which had advised 24,919 out of 48,248 clients to transfer since 2015) found unsuitable advice was given in 51.9 percent of cases, suggesting that advice failings are systemic.  This followed the publicity around the advice given to members of the British Steel Pension Scheme which saw 8,000 out of 44,000 DB pension scheme members transfer to DC arrangements. Many of the firms who provided this advice are now in administration with FSCS picking up the complaints from the British Steel members.

In light of this, the FCA was compelled to issue new rules and guidance in the form of PS18/6 and PS18/20 published in October 2018. As well as laying out the need for advisers to work together to assess risk and prepare a suitability report with immediate effect, perimeter guidance on triage was introduced from 1 January and the bar will be further increased with the introduction of a new qualification. This will require all pension transfer specialists to “obtain the same qualification as an investment adviser” by 1 October 2020. So those holding a Certificate in Pension Transfer Advice will need to undertake further study (although those holding the CII Diploma in Regulated Financial Planning or a Diploma in Financial Planning will not need to requalify).

Stepping up investigations

In an open letter to pension product providers in March, the FCA explicitly stated its requirements. It wants to see processes for reviewing DB products that show customers are taken into account; Management Information used to identify targets markets and any weaknesses in customer support; adviser firms giving accurate and unbiased messaging to distributors; and, for TCF and good customer outcomes to be placed uppermost. Providers should also attend to adviser permissions post review and check to see if they have changed; seek to use Management Information to capture customer/adviser behaviour including negative trends ie scheme churn and notify the regulator of these; use qualitative as well as quantitative factors to the assess quality of service; carry out second and third line reviews of DB activity, with systems and processes in place to mitigate risk while follow-up actions should become embedded; and keep tools and documentation up-to-date to give a balanced view of the pros/cons of the transfer. Suitability is now therefore the prime consideration.

In addition to this receiving schemes, under the retirement outcomes review, may also be caught through the ‘duty of care’ by accepting transfers in.  Some SIPP providers have, as a result of this, stopped accepting DB Pension Transfers in.

Proving best interest

The general rule of thumb is that advisers should assume that a transfer from a DB Scheme is not in the consumer’s best interest. DB pension schemes offer guaranteed benefits and an assured income for life and if this is the only source of retirement income, a transfer is unlikely to be suitable. By transferring into a DC arrangement and drawing down income over the years, funds may well be exhausted over the course of retirement, for example, so the consensus is that for anyone with one or two DB pensions the risk outweighs the albeit immediate benefits.

The Financial Ombudsman Service records numerous individual cases detailing instances of cases where advice given in good faith turned out to be poor. These include:

• A bank’s adviser who recommended a ‘medium risk’ customer transfer her eight years’ accrued pension in 1998. Her complaint was then upheld over 20 years later. The bank was ordered to reimburse her by paying into her personal pension or in the form of a lump sum.
• A financial planning firm advised Mr A to transfer to a SIPP in order to invest in an overseas property investment. When the development turned out to be fraudulent and his investment was lost, Mr A alleged he had been given bad advice. His case was upheld and the firm ordered to bring his pension benefits up to what they would have been on his final salary (although the firm was found not to have caused the losses relating to the second property he had invested in).
• A wealth management company advised Mr W to transfer from an occupational pension scheme into a SIPP which then substantially underperformed and was deemed a high-risk investment. The investment portfolio was undertaken by another fund manager and so the company was not held accountable for this but they had a “duty to act in his best interests” and he did “not appear to have any great investment experience” so it was ordered to calculate the redress on his £300k pension pot.
• A borderline case ruled against a financial planning firm despite the fact it had done its due diligence and provided the necessary documentation to client Mrs S. She was repeatedly advised not to transfer to a SIPP but the ombudsman upheld her complaint because there was deemed to be a conflict of interest (The firm received a payment from an overseas company if the transfer went ahead) and because it was deemed to have known this was not in the client’s best interest but still went ahead and processed the transfer.

Financial advisers need to be mindful of the rise in legal cases being brought against them not just by individuals but in class action cases.

Good advice

Yet with the large sums involved and consumers keen to cash in, we will undoubtedly continue to see transfer requests. Advisers therefore need to assist customers to assess their short term and long term objectives, their risk appetite, and the potential gains and losses, in order to reach a decision. They need to ensure their systems and processes are above reproach and most importantly that the decision can be shown to  meet the customer’s needs as well as their objectives and clearly set out the customer’s financial goals and how the advice meets this.  If the advice can’t meet this, this also should be clearly explained too.

When dispensing advice, the following criteria should be considered, evaluated and recorded:

• Technical failings: such as inputs to TVAS software which did not match scheme specifications leading to material disclosure failings and unfair comparison. Or the customer indicates early retirement preferred but scheme early retirement factors not obtained.
• Flexibility and Control: customer stated their objective but was unable to identify needs. Why were the benefits offered by the DB scheme not suitable? How would the customer use the increased flexibility? Was this modelled financially?
• Needs versus Objectives: the customer’s objectives are met by transferring e.g. inheritable asset for children but their own retirement needs not properly discussed or quantified.
• Options not explored: improved death benefits by transferring, but what was the need for this? If real, could this need be met by securing external life cover?
• Customers with lower ATRs: cautious customers recommended to transfer because cash flow modelling showed it to be advantageous. Significant risk that FCA/FOS would simply say that cautious customers should not transfer from DB no matter what the financial analysis shows.
• Capacity for Loss: Customers where the transfer represented the vast majority or all of their retirement savings – unless significant other investment assets FCA/FOS likely to say that customer should not be advised to transfer.
• Knowledge and Experience of Investing: Has the customer actually experienced poor investment returns in the past?
• Starting Assumption: FCA state that a transfer of safeguarded rights is unlikely to be in a customer’s best interests. How has the adviser demonstrated that this assumption has been communicated to the customer? How has the adviser demonstrated that this assumption is not valid in that case?
• Antipathy towards former employer: Customer instincts are to remove their pension as they were treated badly by their employer. Adviser did not challenge this objective or adequately explain protections in place or seek to remove this emotional response. If the customer would be significantly affected by the scheme moving to the PPF has this been explored adequately?
• Lifetime Allowance: Often transferring from DB to DC can increase a customer’s potential liability to LTA charges. This needs to be considered and explained carefully. Generally customers make great efforts to minimise their tax liability when using an adviser’s services, so strong rationale for the opposite needs to be built if applicable.

Exceptions to the rule

There are, of course, always the exceptions. DB transfer can often make sense if the customer has adequate other income to meet their retirement income needs, making the benefits of the DB pension less important. Or maybe the customer is in very poor health, and the benefits available from a DC pension with variable drawdown could outweigh the rigid benefits available from the DB scheme.

Even in these scenarios, advisers need to think carefully. There are several factors that can impact the true value of the transfer (or Transfer Value Analysis (TVAS)). TVAS has since been replaced by an Appropriate Pension Transfer Analysis (APTA) and Transfer Value Comparator (TVC), the latter of which is used to indicated “the value of the benefits being given up and the cost of purchasing the same income in a DC” and this can be hard to calculate. Then there are the costs to consider. Once transferred, the investment return not only has to get to the true scheme value, but also to overcome the product wrapper and fund management charges as well as the advisory charges. The analysis will be based on assumptions, and it is often extremely hard to prove that a transfer is equal to or better than a DB pension.

To demonstrate that the adviser has taken these factors into account, and to avoid falling foul of the regulator and CMCs, firms need to:

• Demonstrate suitability – that the cases being put forward for DB transfer are suitable and meet the FCA criteria
• Keep robust records – of all cases including those where the recommendation was that the customer should retain their DB scheme
• Assess borderline cases – where cases are not clear, the firm should have a strategy in place to assess the pros and cons with a view to achieving an outcome that is in the customer’s best interests
• Calculate redress – have procedures in place to help compensate those where DB transfer has been found not to be the correct decision, such as with respect to cases that pre-date the 2015 pension reform

The aim going forward has to be to embed these processes into the workflow so that financial advisers can demonstrate they have carried out the necessary pre-approved checks before DB advice is offered. Armed with suitability assessments and demonstrable proof that the investment was undertaken in good faith and in the customer’s best interests, the industry should then be able to stem the tide of complaints to FOS while protecting transfers that can and should go ahead in the right circumstances.