The future of DB transfer advice - the FCA's policy statement
In part 3 of our blog series on defined benefit pension transfers (DB transfers) we look at the FCA's policy statement on changes to the DB transfer rules. The change that has attracted most press attention is the ban on contingent charging but there are other parts to the policy statement that are likely to have a much more substantive impact on the DB transfer market going forward.
The FCA's policy statement starts off by repeating the FCA's pension strategy – "… to reduce the risk of consumers not having adequate income, or the level of income they expect in retirement. We think most consumers are best advised to stay in their DB scheme…". The statement goes on to say "… both with individual firms and across the sector, we think the risk of harm from unsuitable advice remains unacceptably high. This Policy Statement … aims to improve the quality of future advice on DB transfers, reduce the incidence of bad advice, and so reduce the harm to consumers losing their guaranteed lifetime pension income and the high fees when doing so…". Later in the statement it says "… we estimate that 2 out of 3 consumers who no longer take advice (on the transferred DB pension) would not have been suited to a transfer. While 1 in 3 consumers may have been suited to a transfer and benefitted financially, they will not be materially harmed by remaining in their DB scheme". An implicit starting point, which perhaps we all appreciated anyway, is that the FCA does not look fondly on advice to transfer out of DB schemes – no doubt some of the changes are designed to make it harder to transfer.
The key changes to the DB transfer rules are:
1. Contingent charging
From October 2020 there is to be a ban on contingent charging for DB transfer advice, subject to two carve outs. The statement accepts that there is no data that contingent charging created a conflict of interest but it is said that the ban on contingent charging is a proportionate response to consumer harm. One of the reasons given is that "… as most consumers would not benefit from a transfer, we expect the ban to be effective in reducing both the numbers of consumers who proceed to a transfer following advice and the harm that unsuitable transfers cause…".
The effect of the new rules is that firms will need to charge the same amount for advice whether or not they recommend a transfer and as a result firms will need to set a total charge for activities. The ban also applies across 2-adviser models and so both firms (one providing the transfer advice and the other the investment advice) must levy charges that they collect whether or not the transfer goes ahead. Also a firm must charge at least as much in relation to pension transfer advice as if they were offering investment advice on funds of the same value. This latter proposal is designed to prevent firms from gaming the ban by charging a token fee for initial advice albeit this measure does not apply where charges are paid partly or fully by an employer or trustee.
There are two carve outs; first for cases of serious ill health and second for serious financial hardship albeit the application of the carve outs is limited and firms must report when they rely on these carve outs in terms of both the number of times the carve out is used and the revenue generated. The Guidance Consultation sets out some helpful examples of good and bad practice on the intended operation of the carve outs.
2. Triage and abridged advice
Triage is a non-advisory service intended to be used for an educational process so that consumers can decide whether to proceed with regulated advice. The difficulty with the triage service is if it can result in a binary decision – transfer or do not transfer – this raises the risk of providing advice. As a result the FCA has said that firms should not use decision trees or traffic light questionnaires for non-advised triage services so that the use of triage services does not result in a binary decision and with it, regulated advice.
The bigger change is the introduction of an abridged advice process. This is to enable advisers to provide the consumer with a lower cost personal recommendation not to transfer or to tell the customer that it is unclear whether they would benefit from a pension transfer on the information collected through the abridged advice process. The adviser must for these unclear cases check if the consumer wants to continue to full advice and check they understand the associated costs. This process involves a fact find and risk assessment but does not include an appropriate pension transfer analysis (APTA), transfer value comparator or consideration of any proposed defined contribution arrangement.
Following the consultation, abridged advice includes consideration of the benefits (notably not the downsides) of the existing DB scheme. Abridged advice must be checked by a pension transfer specialist and if a customer moves to full advice, the cost of the abridged advice must be taken off the full advice charge unless the customer uses different advisers. Firms can provide abridged advice free of charge but must not do so in an attempt to game the ban on contingent charging. The option of providing abridged advice comes in on 1 October 2020 and so can only be adopted after that date.
On abridged advice the statement says "… where clients proceed to full advice having previously received abridged advice where the outcome is unclear, we still expect some consumers to be advised not to transfer… where abridged advice results in a recommendation not to transfer, but clients proceed to full advice, with indications that they may become insistent clients, we have added guidance that, in most cases, we expect the advice to continue to be that the individual should remain in their existing arrangement.".
3. Managing conflicts – the presumption in favour of the workplace pension scheme (WPS) default fund
The FCA's issue with conflicts comes down in large part to ongoing advice charges. The statement says "… The default fund of a WPS should be appropriate for all members without the need for ongoing advice. Given the high-charging products that many consumers are currently transferred into, our proposed changes would also reduce the product charges for consumers who transfer in the future."
The FCA proposes that instead of an adviser having to show that a recommended defined contribution scheme is at least as suitable as a WPS the adviser instead must be able to demonstrate that the recommended defined contribution scheme is more suitable than a customer's current default arrangement in a WPS. The APTA analysis must also include the WPS default arrangement.
There are transitional provisions for the introduction of this new rule. This means in practice that where a suitability report is prepared within 3 months of the new rule, firms may omit the comparison with a WPS in APTA provided they can demonstrate that the advice process started before 1 October 2020.
4. "Empowering customers"
There are further changes to how charges are disclosed and referenced in documents. This includes that the engagement letter must set out charges for abridged and full advice as well as the charges for ongoing advice. There must also be a 1 page summary in the suitability report including charges, the recommendation, a statement on the risks of the transfer and information about ongoing advice to be provided. Firms must also be able to evidence that the customer can demonstrate they understand the risks of proceeding with a DB transfer before finalising the recommendation and keep a record of this evidence.
Alongside these key changes, there are also technical amendments to expand the definition of "arranging" a pension transfer, to the transfer value comparator in relation to the technical assumptions adopted and cashflow modelling.
The key change is likely to be the introduction of abridged advice and how that is used going forward by the market. It does appear to offer another tool for firms and customers to at least look at the option of a DB transfer in a cost effective way and for customers then to decide whether to proceed with full advice.
However, the tone and content of the statement does, in our view, once again emphasise the FCA's view on DB transfers – that they are not fond of them (to put it mildly). Whilst some of the changes appear to make it more difficult for customers to obtain DB transfer advice (such as the ban on contingent charging) the FCA is also conscious not to remove DB transfer advice as an option for customers where it might be the best option for them (hence the introduction of abridged advice). That said, both the triage service and abridged advice appear to be designed to warn off customers from DB transfers, emphasising the risks and the abridged service only results in a recommendation not to transfer or advice that the position is unclear. Further, the introduction of the rule requiring an adviser to show that a proposed defined contribution scheme is more suitable than a default arrangement in a WPS is hard to square with the comment in the FCA's guidance consultation. The guidance consultation states that a client is more likely to have the required attitude to transfer risk where they want to manage their own investments; if most (suitable) transfers will be recommended to those wanting to manage their own investments, why require firms to specifically use WPS default funds as a principle comparator and require the firm to prove any alternative fund is more suitable? It looks to us like yet another, high hurdle for firms to overcome to demonstrate positive advice to transfer is suitable in the FCA's eyes.
The core proposals in the statement are due to take effect in October 2020 and it will be interesting to see what shape the DB transfer market is in by that time and how these changes are then taken forward.