We have covered regulatory requirements around replacement business, more commonly referred to as switch business, before. As this appears to comprise a significant proportion of the source of many firms’ business, it is always relevant to revisit this from time to time.
You can link to our previous articles here.
It is particularly relevant to revisit the topic when specific queries arise, as they did recently. A firm asked the following questions.
“What is expected on file in terms of research? Mainly looking at pension switch cases.
As an example, if a prospective client came to us with five pension plans, a mix of personal pensions, old GPPs and platform based pensions …
- Would you expect there to be an analysis of funds available?
- Which funds would we have to analyse?
- If there is a small pension (e.g. £5k only), would you expect there to be any performance / fund analysis outside of basic comparison of costs/features?
- If the cost of a pension plan is high (e.g. 0.2%+ from our CIP) would you still expect an analysis of funds?
- If a client needs drawdown immediately and it’s not available on the existing plan, would we have analyse the plan at all?
One of our core investment philosophies is risk rated funds and is part of our standard CIP. I would expect to see a discussion with the client regarding risk rated approach. Do we need to look at all available funds? There could be hundreds, how could this be simplified?”
Taking the points in order, we would comment as follows …
There is a general requirement when considering any type of replacement business to undertake a ‘costs/benefits/features’ comparison that will enable the firm to satisfy the relevant rule requirements. These are as follows:
Switching: MiFID business COBS 9A.2.18 UK 01/01/2021
When providing investment advice or portfolio management services that involve switching investments, either by selling an instrument and buying another or by exercising a right to make a change in regard to an existing instrument, investment firms shall collect the necessary information on the client’s existing investments and the recommended new investments and shall undertake an analysis of the costs and benefits of the switch, such that they are reasonably able to demonstrate that the benefits of switching are greater than the costs.
Switching: insurance-based investment products COBS 9A.2.18A UK 01/01/2021
When providing advice that involves switching between underlying investment assets, insurance intermediaries and insurance undertakings shall also collect the necessary information on the customer’s existing underlying investment assets and the recommended new investment assets and shall undertake an analysis of the expected costs and benefits of the switch, such that they are reasonably able to demonstrate that the benefits of switching are expected to be greater than the costs.
It is worth stating what the costs comparison should cover. Many firms have been in the habit of only comparing the charges on the existing plan with the charges on the proposed plan. This is not sufficient. ALL costs relating to the proposed switch must be included, platform/plan/fund charges AND initial and ongoing adviser charges. The comparison should interpret and explain the potential impact of the charges for future returns. And the comparison must be done individually for each existing plan. Just because one is significantly more expensive than the proposed plan does not make it automatically appropriate to switch the other existing plans that have lower charges because the overall effect is to lower the average charges over all the plans.
Where a switch will result in lower overall costs, it is usually fairly straightforward to justify the switch. Unfortunately, in our experience, the reality is that a high proportion of the switch recommendations we see result in higher overall costs and, for these switches to be justified/suitable, there has to some other factors in play that provide benefits that clearly outweigh the increase in costs for the client. That is not always easy to achieve.
We have identified the most common reasons that firms give for recommending a switch and a common issue is a failure to consider rectifying any perceived failing in the existing plan by taking action within that plan. For example, ‘the existing portfolio does not match your ATR’ can usually be addressed by a switch/rebalance of funds within the existing plan. Similarly, ‘existing plan does not offer drawdown’ needs investigation as to whether it can be converted so as to offer this facility at no cost or at a cost that still means the existing plan carries lower charges.
Another commonly seen rationale is ‘your existing plan has limited funds available’. For this to justify a switch would require the firm to clearly demonstrate a need for funds of a type not available in the existing plan. The FCA comments on this rationale frequently and questions how many funds is ‘enough’ – why access to 3000 funds is any better in practice than 30 funds which cover all the main types and geography – the firm would need to evidence why the client is not catered for adequately with the existing funds.
The most common version of this rationale is where the existing plans are to be switched to the firm’s CIP. Many firms have a centralised investment proposition – complete with a preferred platform and model portfolios. That is fine, but it is important to remember that, just because you prefer it, does not make it an automatic no brainer right solution for every client. Sometimes, more often than might be thought actually, what the client already has is perfectly good.
So in relation to the specific question, we would expect the comparison to include an appropriate degree of analysis of the existing funds, more detailed in the event that the switch rationale will include a suggestion that there is a problem with the existing funds beyond merely not being funds that are within the firm’s CIP.
As indicated above, firms certainly need to analyse any existing fund that they are suggesting is problematic but remember that a simple ‘our fund has performed better than your fund’ over the past x years is no guarantee that the outperformance will continue and, in any case, if the switch involves an increase in overall costs, then the new plan HAS to work that bit harder to just match the existing funds, all things being equal. Note that special rules apply when a switch away from any with profits plan is under consideration.
The primary comparison is that relating to costs – features/performance/risk etc are all secondary but still part of any appropriate comparison and have to take centre stage and prove the value of a switch if costs are increased. The comparison is required for any and all proposed switches, there is no de minimis on plan value. Of course, a client is probably easily persuaded to ‘tidy up’ his or her portfolio by consolidating all the plans into one new easily tracked plan, especially so to get rid of the small pots that barely justify reading the annual statement! But that does not negate the comparison requirement. If there is an increase in costs the client has to clearly understand (and therefore be told in the suitability report) that the price for ‘tidying up’ is that he or she could well be financially worse off.
As already mentioned, the primary metric in the comparison is costs. Whether costs increase or decrease, care is also needed to review/compare the relevant features and, where there is a cost increase, specifically the other features need to be explored very carefully at an appropriate level of detail.
This is covered above. The firm would need to investigate the possibility of adding drawdown within the existing plan/provider. That option is often available and sometimes at little or no cost. If the existing plan has lower costs and would remain so after ‘conversion’ then it is difficult to see how a switch could be justified purely on the basis of achieving the options available from drawdown. Of course, a client ‘needing drawdown immediately’ is really a client who needs to consider the most appropriate way to set up his or her retirement income. An annuity would have to be considered as would taking benefits from the existing plan, drawdown or not. Drawing on some plans and not others would also be an option. And if drawdown could robustly be shown to be appropriate, it need not necessarily apply across the board to all plans. A combination of annuity, or drawing on existing plans together with a switch of some plans to a new drawdown arrangement could well be the most cost effective strategy even if it is ‘less tidy’ for the client and less attractive for the firm than simply moving everything into a new plan.
And finally …
Now to the final question raised:
“One of our core investment philosophies is risk rated funds and is part of our standard CIP. I would expect to see a discussion with the client regarding risk rated approach. Do we need to look at all available funds? There could be hundreds, how could this be simplified?”
This is probably answered by the comments above relating to CIP. All funds are risk rated so in practice there is no issue arising from that aspect in isolation. Clients generally have a number of funds comprising their portfolio and it is the how you would map that client’s risk profile to the risk profile of the existing portfolio and whether that mapping indicates any issue that would be the first step. Second step where the switch would increase overall costs would be, as indicated above, to assess whether any risk mismatch could adequately be resolved within the existing plan. It usually can. But considering that the existing plan/platform/funds as being unsuitable simply because they are not your preferred plan/platform/funds patently does not bear up to close scrutiny.
Note that there are additional considerations that apply when a switch of platforms is in play. These are summarised pretty well in our article from February this year. You can read that here: https://news.ateb-group.co.uk/platform-switching-is-a-suitability-report-required