Pension Switches – a timely reminder

Most readers have probably seen, or at least heard of, the 1955 film, ‘The Seven Year Itch’. The widely-known premise of this film, whose title has passed into common usage, is that relationships hit a rocky patch after seven years. In the film, the itch referred to a married man being tempted to be unfaithful by the obvious attractions of a blonde neighbour, played by Marilyn Monroe. This was the film with the famous scene in which Marilyn’s skirt is lifted by the draught from a subway grating. It is said it took forty takes to get the shot as she kept fluffing her lines.

So, what is the connection with pension switches I hear you ask? We were reminded of the film when considering that it is seven years since the FSA published guidance on pension switching in February 2009, following reviews indicating that many firms were not dealing with switches adequately, leading to unsuitable advice. The guidance was accompanied by a switching template. The template was available in two formats, a PDF version and a spreadsheet version with more functionality.

From the work we do with clients, we know that pension switches are, if anything, an even more common area of advice now than they were in 2009. Regrettably, we still see switch advice that does not meet the standards expected by the regulator. So, we think it is the perfect time to revisit the whole subject of switching pensions in an attempt to prevent firms getting a seven-year itch and being tempted to be unfaithful to the regulatory guidance that applies today every bit as much as it did seven years ago! After all, regulations are here ’till death do us part!’

The four danger signs

The FSA found four key unsuitability outcomes that were the most likely causes of unsuitable switching advice. These are summarised below – you can read the detail in the guidance referred to above.

  • Key unsuitable outcome 1: The customer has been switched to a pension that is more expensive than their existing one(s) or a stakeholder pension (because of exit penalties and/or initial costs and ongoing costs of the receiving scheme versus the old scheme or a stakeholder pension) without good reason.
  • Key unsuitable outcome 2: The customer has lost benefits (e.g. guaranteed annuity rates) in the pension switch without good reason.
  • Key unsuitable outcome 3: The customer has switched into a pension that does not match their recorded attitude to risk and personal circumstances.
  • Key unsuitable outcome 4: The customer has switched into a pension where there is a need for ongoing investment reviews but this is not explained, offered or put in place.

A special word about with-profits

We regularly see switches where the ceding plan was in a with-profits fund. For a variety of reasons that we will not go into here, these funds have fallen out of favour with many advisers. However, there are particular requirements when advising a switch from a with-profits fund, the main one being that a proper analysis of the fund must be done. We can do no better than quote the following extract from the 2009 guidance.

“Where an adviser has recommended a switch out of a policy because it invests in a with-profits fund, we would expect the adviser to provide analysis of the ceding with-profits fund beyond simply noting the existence (or lack) of MVA penalties, terminal bonuses and the recent reversionary bonus history.”

The three ‘C’s

Forget the three ‘R’s. When advising a client in relation to a pension switch, you need to consider the three ‘C’s.

  • Cost comparison;
  • Client value;
  • Client’s best interest.

For a switch recommendation to be suitable, advisers must clearly demonstrate that the switch is in the client’s best interest and that the advice represents value for the client. A key component in achieving this is that a like for like cost comparison is done.

We should first define what is meant by the phrase ‘like for like’. Some firms compare the ceding plan against the proposed plan on a features, past performance and product charges basis in order to show the client how the products compare ‘like for like’. This comparison might have some theoretical incidental value but it is certainly not sufficient to demonstrate suitability.

Like for like requires a comparison of the before and after situations not just considering the products in isolation. This means that all charges that will apply after must be included in the comparison – plan charges, fund management charges and, possibly of greatest impact, initial and ongoing adviser charges.

However, to be fair and accurate, any ongoing adviser charges that apply to the ceding plan should also be factored in to the comparison. While advisers usually identify the relevant plan and fund charges relating to the ceding plan (available from the provider on production of a letter of authority), information relating to the ongoing adviser charges is often missing and usually only readily available from the client. Do you ask clients for this information?

When considering multiple ceding plans, a comparison must be done on each separately for each plan, using the full adviser charges against each plan, no matter how small. The logic of this is that it is possible the cost comparisons could result in only one plan being recommended for switch. If that plan is switched, it will carry all the initial and ongoing charges and so it is appropriate that the comparison is based on that assumption.

So, the general rule is that the cost comparison should include ALL charges that apply to both the before and after situation – but there is one exception …

Contingency plan

Most firms still charge adviser fees on contingent basis, only being paid if the client proceeds with the switch. We firmly believe that firms should charge for the advice and expertise they provide to clients rather than being paid only if the client acts on that advice. The implication for switches is that if the client is being charged on a non-contingent basis, such that part or all of the fee will be charged whether or not the client proceeds with the switch, then that element of the fee can either be added to both sides of the comparison … or omitted from both sides.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

ATEB Suitability provides report writing software for the financial services market.

Our View

While many firms have actually incorporated the Pension Switching Template into their advice and compliance processes, others might well have long since forgotten it ever existed. As pension switches continue to feature regularly, this should be a timely reminder of the standards required.

The comments made here refer only to pension switches, money purchase to money purchase. They do not apply to pension transfers from defined benefit schemes as a different set of rules applies for transfer advice. However, we believe that the standards do apply to any other type of replacement business, in particular, the need to do a cost comparison.

Non-contingent fees are undoubtedly best practice and we believe that there is likely to be regulatory and market pressure in the foreseeable future on firms to move in that direction. A non-contingent fee avoids the conflict of interest arising from the actual or potential incentive to recommend a switch in order to be paid. MIFID II is likely to require firms not only to declare all conflicts of interest but also to manage them.

Many research projects have tried to see if there is any evidence for the seven-year itch concept. There isn’t! It just is not borne out by any evidence examined by serious research. Perhaps not a surprise when you learn that the film was based around the fictional theory of a fictional psychologist. Furthermore, the original title of the book on which the film was based was the ten-year itch. The author only changed it because he thought the seven-year itch had a better ring to it!

Advisers involved with pension switches have to meet the required standard – we just want to help ensure that it doesn’t need forty takes to get it right! So, scratch that itch and read the action below!

Action Required By You

  • Read the switching guide to refresh your awareness of the switching requirements;
  • A cost comparison must be done when advising on pension switches (or any other replacement business);
  • Ensure that each ceding plan is considered separately;
  • Include all plan, fund management and contingent adviser charges that apply to the proposed plan;
  • Similarly, factor in all charges that apply to the ceding plan, including any ongoing adviser charge;
  • Any non-contingent fee can be included on both sides of the comparison – or omitted entirely;
  • Review your charging model and consider moving to a non-contingent basis;
  • For more assistance, contact your usual ATEB consultant, or click here.

 

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About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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