Transfers from defined benefit (DB) schemes are currently one of the most talked-about aspects of pensions. The numbers of people considering a transfer over the last few years has been one of the biggest trends emerging from the pension freedoms – and this behaviour has largely been driven by high transfer values and people looking to tailor benefits to suit their individual circumstances.
Yet transfers have also been encouraged following sponsoring schemes closing or re-engineering the benefits on offer. In the wake of the high- profile British Steel Pension Scheme, suspect and downright dodgy practices inevitably drew the attention of advisers, the media and, subsequently, regulators and politicians.
The Financial Conduct Authority (FCA) has issued various consultations over the last few years and, as a result, there are now many new rules in place for advisers who want to continue operating in this market or are looking to do so. The market potential is significant. The latest industry numbers show £34bn was transferred between pensions contracts last year, with an average transfer value of £250,000 for defined pensions. It is estimated more than six million pensions are eligible to transfer out from final salary schemes.
Make no mistake, though – this is a high-risk area of business. Despite the obvious attractions a transfer offers, many people are likely to be better off staying put. There are situations where a transfer will be appropriate advice, however, so it is important each case is judged on its own individual merits.
In doing so, it is crucial to consider the latest FCA position, and what it means for your business processes and clients, if you want to be safely involved in this market. But what does a good process look like? Should you even go near this market or treat any client interest with asbestos gloves?
Well, from a client perspective, many will focus on the benefits of moving so it is important they also consider the potential pitfalls. Some may have health conditions that limit their life expectancy and, while transferring means they are giving up a guaranteed income for life, they will gain control of the death benefits.
Or your client may be single, in which case the automatic spouse income from a DB pension simply is not relevant to them. The client may also want to control when they access their pension – including the income and any lump sum – and control how much tax they pay on income and on death.
The pitfalls are obvious – giving up a guaranteed income for life, which will usually increase each year in line with inflation. And, if death benefits are a key objective, advisers should consider alternative ways of providing these, such as a term assurance, rather than a transfer.
So where does all of this leave you as the adviser, in this potential market where clients are keen to understand the benefits of moving? Just how do you keep on top of the regulatory scrutiny?
It is important to remember this is an evolving market and we will no doubt see further regulatory intervention in due course. What we do know now is the FCA issued new perimeter guidance on what can be covered within a triage service in January. And, from April, updated assumptions will need to be used for revaluing benefits and calculating the assumed increases of pensions in payment. These build on the recent FCA policy statement, PS18/20, which makes clear the process it wants advisers to follow when considering transfers from final salary schemes.
The FCA has confirmed any triage service cannot cross the advice boundary. In my view, this makes any triage conversation almost impossible as it could very easily stray into discussing a client’s personal circumstances. Advisers will need to consider how to provide only generic information covering the pros and cons of transferring, whether that is via access to videos, written material or referral to an independent body such as the Pensions Advisory Service.
If an advisory firm provides clients with a transfer value comparator (TVC) during triage then the FCA believes this is likely to constitute advice. The regulator is, however, working with The Pensions Regulator to consider ways in which members can receive clear information from their scheme about the benefits they are considering giving up – hopefully helping clients as they initially consider a transfer.
The need for a pension transfer specialist (PTS) to have a Level 4 investment qualification by no later than October 2020 has also been confirmed. Many PTSs will already have that level but those who have not will want to consider taking a suitable exam as soon as possible.
When it comes to the advice process, the FCA expects the advice to take account of both the proposed destination scheme and the proposed investments in that scheme. The regulator’s rules do not prevent two different advisers being involved but it does expect very clear processes in place to demonstrate the two advisers are working together and it is obvious to the client who is doing which aspect, and their respective charging structures.
Attitude to transfer risk
Advisers should also incorporate risk-profiling of any client. Considering attitude to investment risk is commonplace but, alongside that, advisers need to assess the client’s attitude to transfer risk. Some of the FCA’s supervisory work has found this has either not been sufficiently detailed, or PTSs have oversold the benefits of flexibility and death benefits without considering the risks involved – so it is a crucial area to review your process.
The new rules for a TVC and an appropriate pension transfer analysis (APTA) came into force on 1 October 2018. The TVC compares the transfer value with the estimated value needed to replace the client’s DB income but it is not personalised in any way and so does not take into account personal circumstances.
In most cases the replacement value will be higher than the transfer value offered, and this is likely to be a larger gap the further the client is from the scheme’s normal retirement age. The APTA can then consider the client’s personal circumstances. Another new requirement means where advice is not to transfer, the FCA now requires advisers to provide a suitability report setting out the reasons why.
Given the regulatory scrutiny, I expect the numbers of transfers to fall back from the numbers we saw in 2018. Overall, though, the genie has been well and truly let out of the bottle as far as clients are concerned, so transfers will continue to be an area where advice is much sought after.
For those advisers who are going to be involved in final salary transfers moving forward, then, these papers from the FCA offer some clear guidelines – as well as the opportunity to review existing processes to make sure they meet the new requirements.
Andrew Tully is pensions technical director at Canada Life