Pension transfer advice – assessing transfer risk

It has been well publicised that the FCA has aimed increasingly close scrutiny in the direction of firms that have been providing advice in relation to defined benefit pension transfers. Apparently caught off guard by the then Chancellor’s introduction in the Pension Schemes Act 2015 of what are generally called ‘pension freedoms’, the regulator has been running hard ever since to catch up with firms’ activity in this area, which it believes has led to a large number of defined benefit scheme members receiving unsuitable advice.

Starting in October 2019, several rounds of data collection from firms was followed by site visits to selected firms, many of which resulted in firms being asked to undertake past business reviews and, in some cases, a Section 166 Skilled Person’s Report was required.

ATEB have been engaged by many of these firms to work with them to improve their processes and help them in discussions with the FCA. As a result, we have seen a large number of FCA file reviews, all carried out using the infamous DBAAT tool. We wrote about that back in March – see here.

One of the key questions asked in the DBAAT is:

‘Has the firm obtained the necessary information regarding the client’s attitude to transfer risk?’

Transfer what?

Many firms do not appear to have been assessing clients’ attitude to transfer risk, certainly not in an obvious and structured manner. Arguably that is because they were unaware of the concept of transfer risk. A search of the FCA Handbook for the phrase ‘transfer risk’ will prove fruitless – it doesn’t exist. In fact, the concept did not feature at all until 1 October 2018 when COBS 19 included suitability guidance that firms must ‘take into account’ …

‘the retail client’s attitude to, and understanding of the risk of giving up safeguarded benefits (or potential safeguarded benefits) for flexible benefits’

A mere three days later the guidance was given more detail and became the transfer risk guidance that currently exists in COBS 19.1.6 and COBS 19.1A.11.

For the record, the aspects that should be assessed against attitude to transfer risk are as follows: 

(i) the risks and benefits of staying in the ceding arrangement;

(ii) the risks and benefits of transferring into an arrangement with flexible benefits;

(iii) the retail client’s attitude to certainty of income in retirement;

(iv) whether the retail client would be likely to access funds in an arrangement with flexible benefits in an unplanned way;

(v) the likely impact of (iv) on the sustainability of the funds over time;

(vi) the retail client’s attitude to and experience of managing investments or paying for advice on investments so long as the funds last; and

(vii) the retail client’s attitude to any restrictions on their ability to access funds in the ceding arrangement

Despite adding all this detail, the FCA still did not see fit to actually label this lot as ‘assessing transfer risk’!

How to assess transfer risk

In practice, we find that many firms do not have a clear process to assess transfer risk. Usually, some aspects of transfer risk are clearly discussed with the client but, in the absence until recently of clear guidance from the FCA about how this should be assessed and documented it was often difficult to see clear evidence of a transfer risk assessment or at least an adequate one, which satisfied the requirements. That lack of guidance has since been addressed with transfer risk not only being mentioned by name in the final guidance (FG 21/3) that was published in March 2021, but also covered with detailed guidance. The guidance opens with the following statement:

“When you find out your client’s attitude to the transfer risk, you are assessing the client’s behavioural and emotional response to the risks and benefits of giving up guaranteed benefits in favour of non-safeguarded benefits. You need to ask your client fair, clear and not misleading questions to understand what it means for them personally. You need to assess your client’s attitude to the features of safeguarded and flexible benefits and understand their attitude to managing money.”

The guidance makes the pretty obvious point that standard risk profile questionnaires usually only assess the client’s attitude to investment risk and, if advisers use these types of questionnaires, it is likely they will not have properly assessed attitude to transfer risk.

The guidance suggests that advisers should consider using:

  • A range of balanced questions so that you get a spread of responses from different clients. If most of your clients answer each question in the same way, it is likely that you need to review the questions that you ask.
  • Language that is not biased so that you do not steer the client towards answering in a certain way. If you ask, ‘do you want flexibility and control?’ you are unlikely to get enough information to understand whether your client is more suited to safeguarded benefits or flexible benefits.
  • Open questions that will provide detail. If you ask, ‘how would you feel if your pension pot didn’t grow as expected and you had to take less income from it so that it would last?’ your client is more likely to explain what is important to them.
  • If you use realistic examples of what might happen to their level of income or sustainability of income if markets fell, say 10% or 20%, you will get even greater detail about your client’s likely behavioural response to transfer risk.

However, the closing paragraph of the transfer risk section is less helpful, stating:

“A client is less likely to have the required attitude to transfer risk where they want certainty of income in retirement and/or do not want to manage their investments or pay for advice on investments. A client is more likely to have the required attitude to transfer risk where they do not want any restrictions on their ability to access funds and/or want to manage their investments or pay for advice on investments.”

While the accuracy of this statement cannot be faulted, it is in the category of ‘obvious’ and has the more fundamental flaw in that virtually every client that presents themselves for transfer advice doesn’t want restrictions on access to the pension pot.

Describe the features of a drawdown plan to most clients … access to a large pot of cash, dip in and out when you want, leave remaining funds to next generation etc. and it is a rare client who is not attracted to the idea. Mention the investment risk, that they might run out of money if they ‘live too long’ and the other downsides and many clients remain attracted to the idea of transferring, often due to ‘present bias’ – the tendency to value immediate gratification more highly than  a deferred benefit. That is where a robust transfer risk assessment process comes in as it provides a means by which the client’s feelings about all the key aspects of transferring or remaining with the scheme can be more thoroughly explored, beyond merely ‘selling’ the benefits of a drawdown plan.

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

Regardless of the fact that transfer risk as a concept is not clearly signposted in the rules, there is no doubt that the associated guidance gives a very clear steer to the relevant factors that are listed in COBS 19.1 and COBS 19.1A. Further, if challenged around the date (October 2018) from which the concept explicitly came into being, the FCA points to earlier rules and suitability guidance that essentially required advisers to identify the same set of factors even if that was not spelled out at the time. The FCA have been firmly applying the rule that states “if you don’t have all the required information, you should not make a recommendation at all” and attitude transfer risk is unquestionably an important part of the required information. Armed with knowledge of the FCA’s current thinking and concerns around pension transfer advice, ATEB can assist firms to create a compliant and effective transfer advice process, including how to assess transfer risk.

Action Required By You

Review you pension transfer advice process to identify whether you clearly capture sufficient information to address each of the seven factors in ‘transfer risk’. If not, consider how you can address this aspect.
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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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