We have seen a very large number of pension transfer suitability reports since the introduction of the pension freedoms that came out of the Pensions Act 2015.

Many of these displayed two common threads running through the recommendation. First, many of the clients apparently wanted ‘flexibility’. Second, those same clients wanted ‘control’. These two drivers for transfer were arguably formulaic in many cases. The need for flexibility was often not supported by any credible documented need or client specific objective. For example, justifying a transfer because it gives the option of taking cash or income at age 55 is flawed if there is no indication that the client actually intends and needs to do so. And the need for control was rarely, if ever, even defined. What control did clients think they would be achieving? Both of these ‘needs’ fell into the category of what the FCA calls statements of preference rather than genuine client specific objectives.

We tended to view these as product feature led ‘objectives’. Many firms used flawed questionnaires that specifically asked whether the client wanted ‘flexibility and control’ – why would a client say no? It was not only ATEB that noticed, or had concerns about, these common themes. The FCA also made explicit mention in Finalised Guidance FG21/3:

“Features of the pension freedoms are not client objectives.
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.

If your firm gives advice based on objectives such as ‘flexibility’ or ‘control of my pension’, these are unlikely to be sufficiently personalised to enable you to provide a suitable personal recommendation, without further detail. You should challenge vague statements like these and identify the underlying reasons why your client needs or wants these features.”

In any case, even where there was a genuine need for either or both of these features, transferring to a drawdown plan was not necessarily the only way to achieve them.

A third common thread frequently ran a close race with flexibility and control – namely the client’s apparent desire to leave a legacy to children or others. The ability to do so is obviously yet another feature of a drawdown plan so again consideration is always needed as to whether this is simply a feature of a drawdown plan that carries some level of attraction for the client or a genuine need that is supported by other information and evidence gathered. There are undoubtedly situations where access to a residual capital fund instead of a dependant’s pension is clearly a sensible strategy and a strong driver for transfer, for example:

• Wealthy clients for whom pension is simply not of importance and where the transferred fund is an IHT planning opportunity
• Clients in ill health
• Clients with no dependants or divorced with adult children or spouse who does not qualify for the spouse’s pension (some schemes define the spouse as the one the member was married to at the time of joining the scheme AND at time of dying – this excludes second spouses, or third!)

But where these obvious scenarios are not in play, the apparently attractive option of a residual fund being available needs a closer look – is it meaningful in practice – is it possible to achieve the same result without having  to accept the downsides of transferring out from a safeguarded scheme?

Death benefit misunderstandings

Unless the technicalities of the scheme are explained in an understandable and balanced manner, many clients will struggle to understand that comparing 100% of a transferred fund against 50% dependant’s pension is comparing chalk and cheese. Yet we have seen many reports where that is exactly how the comparison of death benefits has been presented to the client! We do not dispute that, for many clients, the prospect of a capital sum immediately available will have more appeal than a dependant’s pension payable over time. If that is the case, so be it, but only if the client actually understands how to compare the benefits and the limitations of each approach. And that brings us to another of the more common issues around how the death benefit issue is handled. An approach that deals with the matter in a purely mechanical and lip service manner. Firms adopting this approach would appear to believe that it ticks some compliance box – it doesn’t! We are referring to life cover.

There is a long standing truism that life cover is sold not bought but we don’t see a lot of positive persuasion going on when firms deal with life cover in connection with transfer advice. Quite the opposite in fact. More typically, a suitability report will have a compliance tick box paragraph that starts along the lines of:

“Of course it would be possible to cover the transfer value with a whole life policy …”

The first problem with this rather reluctant and hesitant opener is that the proportion of people who would eagerly answer ‘Yes!’ when asked if they want more insurance is roughly the same as the proportion of people who would say they do not believe in motherhood and apple pie! The second issue is that it is presented as ‘insurance’ that will carry a cost rather than as a valid strategy for retaining a safeguarded benefit while at the same time addressing a genuine concern about legacy or protecting a sizable capital fund.

The third issue is when this option is not explored in understandable detail with the client. The sum that should be covered is almost never the full amount of the CETV. Of course it is possible that a client could die soon – accidents happen. But unless there is some reason to be concerned about foreshortened life expectancy (in which case life cover could be prohibitive or even unavailable), the approach taken elsewhere in the advice process – particularly in the use of cash flow projections and data sources giving some indication fo life expectancy, moderated by knowledge of the client’s age and state of health – would be appropriate. So, rather than simply quoting for the full amount of the CETV, the following should be factored in as is appropriate to the circumstances:

• Given that the life cover is an ALTERNATIVE to transferring, the dependants benefits that would be available from the scheme in the event of death should be offset as appropriate from the CETV.
• Based on the client’s age, health and expected withdrawal pattern, how much residual fund might there be on death, based on realistic assumptions. In many, if not most, cases the residual fund could well be much lower than the headline CETV starting figure. Not only does this mean that the sum assured for a whole life quote would be significantly lower but also that the strength of the legacy aspect as a driver for transfer is also substantially reduced.

Instead, the quote for the full CETV is generally presented in one of two ways:

• “I obtained quotes and the cover would cost around £X per month but we discussed it and you don’t want it.”
  So, if it has been discussed and discounted already, why get quotes at all?
• “I obtained quotes and the cover would cost around £X per month which is expensive / too much from your net income / other.”
  This would appear to be the adviser’s conclusion, the client not having had the opportunity to see the suitability report or to decide what is too much. In addition, the option is presented as a cost yet, if the client were to transfer, the ongoing charges on the transferred fund are not presented in that way or contrasted against the, often lower, cost of the life cover.

Why now?

There are cases where all the indications are that the client’s needs in retirement could well be suited best by transferring to a drawdown plan. But, if the intended retirement is several years away, say five plus, then the question remains why transfer now instead of leaving that irreversible decision until closer to the event when a much clearer picture of current needs and market conditions could lead to a better informed decision. Arguments for deferring include avoiding several years of ongoing charges on transferred funds and not missing out on several years of continued benefits escalation in the scheme. An argument for transferring now would be the fear of the transfer value reducing. It might do – or it might not – but it is worth remembering that there are many actuarial reasons why transfer values tend to increase as members get closer to scheme pension age. This discussion needs to be had with the client when required and clearly documented.

That only leaves the argument of a concern about the client dying in the interim. If this is a genuine concern, and everything else points to not transferring, it can be addressed by life cover. Not a whole life plan, but a term assurance. Similar thought processes around what the sum assured should be apply, but, in any event, term cover would be significantly lower cost than a whole life plan and again any cost should be considered in the context of the costs that would be incurred each year in the drawdown plan prior to such a plan needing to be in place.