The FCA’s recent consultation paper CP19/25 is the Regulator’s latest attempt to resolve the predominance of poor advice on pension transfers that, according to FCA research and thematic work over the past few years, has led to many people transferring out of defined benefit schemes when that was probably not in their best interests. You can read our analysis of the proposals here.
The paper makes a number of proposals, principal among which was the proposal to ban contingent charging. This is a long standing, much debated and complex topic, so it is unsurprising that most of the comment on CP19/25 has focused on this aspect and largely ignored other proposals and content in the paper.
However, as is often the case, the surrounding text and background described in the paper, provides some very interesting indications of specific things that the FCA is unhappy about. We take this opportunity to draw out and highlight a few of those that, in our experience, accurately reflect widespread practice in firms advising on transfers (and which have relevance to pension switches and other ‘replacement business’ too).
Reason for switch / or for not transferring to a WPS – insufficient fund choice
FCA rules already require firms to explain why the scheme they recommend is at least as suitable as a Work Place Pension (WPS) – (COBS 19.2.2R). This rule came in shortly after the introduction of stakeholder pensions. In December 2017, we wrote an article on our pet hates when reviewing client files. This was one of our pet hates! We wrote:
Stakeholder discounted because of insufficient fund choice
Stakeholder pensions started in 2001! Advisers were obliged to consider them. It took advisers approximately15.5 seconds to come up with this reason for not recommending a Stakeholder pension. To be honest, even in 2001 it was a bit of a lame cop-out … no client ever needed access to 4000 funds, and the client was then usually advised to invest in only one or two funds anyway! So, you would think that in the intervening sixteen years somebody would have come up with a more credible reason.
That this is still prevalent practice is unfortunately confirmed by the FCA in CP19/25:
“Our recent work indicates that many firms pay lip service to this requirement and recommend personal pension schemes on the basis that a WPS offers inadequate fund choices. Yet, in many cases, advisers are not able to articulate the need for a vast selection of funds.”
Reason for switching or transferring – access to our model portfolio and ongoing service
This is another very common reason used to justify a switch or a transfer. The FCA shares our concern over what is often a very weak justification.
“We have seen firms recommend more expensive schemes on the basis that the client needs the adviser’s ongoing advice service and so the charges for managing the pension are justified. When combined with multiple layers of charging such as platform charges, charges for discretionary fund management as well as product charges, advisers are not giving sufficient attention to value for money. The high cost of some recommended investment solutions contrasts sharply with the lack of charges incurred by members if they stay in their DB scheme.”
Focus on charges
The paper also confirms the FCA’s continued focus on charges and value for money for clients. Firms generally have a business model that is predicated on building up recurring income. This is a not unreasonable business objective given that the eventual sale price of the business tends to be largely driven by that metric – or at least business owners believe that to be the case. But firms may never have really questioned the value of their ongoing service to the client. The 1%, 0.75% or even the good old, yet rarely seen these days, 0.5% ongoing adviser charge is a significant drain on the client’s long terms returns, especially in these days of single digit investment returns.
The FCA paper puts some numbers around the issue.
“Total ongoing advice charges of 0.5% to 1% will reduce an average transferred pension pot of £350,000 by £145 to £290 each month in the period immediately after transferring. Similarly, ongoing product charges of 1% to 1.5% will reduce it by a further £290 to £440 each month. So the total deductions on a transfer value of £350,000 would range from £435 to £730 each month. A DB scheme with that size of transfer value might have a current income value of £1,000-£1,200 each month, so the charges represent between 44% and 61% of the current level of that value.”
The FCA’s point is that the need for ongoing service is often because of the over complex solution that has been recommended in the first place. There are lots of investment solutions with what could be called ‘shelf-life’ that would not require the same level (and so cost) of ongoing service and they are discounted, or more usually not even considered, because they are not the firm’s preferred platform/portfolio combo.
Reason for switching or transferring – ‘control’ and ‘flexibility’
The paper referred to transfers being justified by a client desire to gain ‘control’ of their pension.
“Some consumers mentioned a wish to ‘control’ their pension as a motive to withdraw their whole pension. For DB pension scheme holders, this motive is compounded further by a belief that money in a DB pension scheme is not within their control and, in some way, vulnerable to mismanagement.”
We see this justification in a very high proportion of transfer recommendations. It is flawed in several ways. First, it should have been explored and challenged with the client rather than simply accepted as read. Such a belief clearly indicates an inadequate understanding of the nature of the scheme and it is usually not clear exactly what is meant by ‘control’. The employer does not control the scheme funds. Control lies with the scheme trustees, who have a legal obligation to ensure that the funds are managed on behalf of and in the interests of scheme members. That the client will have any substantial control over transferred funds is arguably an illusion …
- HMRC rules and constraints still apply to when and how benefits can be accessed;
- Self-investors excluded, clients will usually simply accept whatever plan and funds the adviser recommends and will rarely move away from that or impose their own ideas.
Although not explicitly referred to in the paper, ‘flexibility’ is another reason to transfer that often appears in suitability reports. Again, unless it is clear what is meant by flexibility and it is demonstrable that a particular client has a credible need to vary income, this reason is a weak justification.