I have been pondering consultation paper 19/25: Pension transfer advice: contingent charging and other proposed changes and what this means for the future for defined benefit (DB)/safeguarded transfer/conversion advice.
The main issue with DB transfers is the current suitability rate of around 50% being deemed to be suitable, with the remainder unclear/unsuitable. This compares poorly to suitability across non-DB areas of financial advice when tend to be in the low 90% area. So, there’s clearly a need for something to be done to improve this.
In short, these changes may well be seismic for initial and perhaps, ongoing charges.
So, what is changing for charging?
In a nutshell, the proposal is to ban (most) contingent charging. While the paper is clear that a causal link cannot be proven statistically, one way or the other, the Financial Conduct Authority (FCA) believes that the conflict arising from contingent charging is a large part of the unsuitability rates seen. If you only get paid for business that proceeds, then consciously or unconsciously this adds bias to a recommendation to proceed.
Adding fuel to the fire were the figures for contingent and non-contingent charges using an average transfer value of £350,000. Consumers taking advice from firms that charge non-contingently typically pay £2,500-£3,500 on average, with contingent charges around £7,000-£10,500. So, paying contingently costs £4,500 to £7,000 more. The FCA mused on why everyone cannot do it profitably at the lower end. Likewise charging contingently means that there must be cross-subsidy for those advised not to proceed. Is this unfair on those that proceed contingently?
Perhaps the poorest statistic in the paper was the clarity of communications, where overall only 29.2% of firms’ disclosure and other communications, primarily the suitability reports, were deemed compliant.
With this in mind there is a proposed “one pager” to be included at the front of all suitability reports. This will summarise any initial charges and the first year’s advice and product charges in monetary terms and compare them to the amount of DB income that is being used up. It will also summarise the recommendation and risk being taken. The client will need to sign these as well as a section stating they understand the costs of ongoing pension management advice, they’re not required to take this service and can cancel it at any time.
Swapping one cross-subsidy for another
The paper details that the initial charging applied must include all costs of advice. The cost of transfer advice, investment advice and implementation will need to be rolled up into one cost. And it must all be charged whatever the recommendation. It will also apply across two-adviser models where transfer and investment recommendation come from different advisers. Both firms charges will need disclosed together and both must be taken regardless of advice.
It is recognised that by including implementation charges there will be cross-subsidy.
But this should be far less of a cross-subsidy than currently happens. Already I’ve heard discussions and queries about the cost of implementing advice and the time taken. It would appear the FCA considers implementation to simply be filling out forms and chasing up requirements. But while this can be time consuming for some cases to fill out the forms and chase the case through, the general feeling I get is that this may well be the bit that people remember the most and think it takes the most effort.
A simplistic analogy would be to imagine Sir Mo Farah running. Everyone will probably go to the impressive last lap sprint finishes (and the Mobot), but for the 10,000m race the forgotten part is usually the first 24 laps. Arguably the same thing occurs with transfer advice, all the hard laps (meetings, education, risk discussions, Appropriate Pension Transfer Analysis (APTA)/ Transfer Value Comparator (TVC), transfer advice, investment advice etc) occur far before implementation.
Can anyone still be contingently charged?
The proposed ban on contingent charging is to come into effect within a week of the FCA board making the final instrument. There’s a three-month transitional period to cover situations where engagement letters have already been issued detailing the charges will be on a contingent basis.
There are two other cohorts of customers that will be eligible for a “carve-out” on an on-going basis. Those in serious ill-health (which will require a medical practitioner to confirm the customer has an illness/condition that’s likely to reduce life expectancy to under 75) or serious financial hardship.
These cohorts are, by their very nature, vulnerable customers, so extra care and work is needed here.
Bear in mind, for those in ill health a transfer could have inheritance tax implications, although the advice may still be to transfer if death benefits are a driver, as a percentage of something may be better that 100% of nothing depending on the rules of the ceding scheme.
The FCA accepts there will be customers who are not eligible for contingent charging who will not be able to afford advice where a transfer may well be suitable. They are aware these people may lose out but they are of the view that will be an acceptable cost of reducing unsuitable advice for a larger amount of people.
Can the system be gamed?
There are lots of measures to prevent workarounds, such as;
- In the two adviser model the fee for the advice must include the work by both advisers
- Not being able to offset transfer/conversion work against other work undertaken
- Not charging less for advice on pension transfers and conversions than if they provided and transacted investment advice for the same size of (non-pension transfer or conversion)
- Limit any subsequent ongoing adviser charges on funds that are transferred
Basically, fee models cannot be developed that effectively allow contingent charging to remain.
It is hoped this proposal will reduce costs of advice, especially for those clients where a transfer is unlikely to be suitable. You’ll need to conduct a full fact-find and risk assessment, including an assessment of the client’s attitude to transfer risk in line with guidance on assessing suitability. Only two outcomes can be advised under this process, you should remain in your scheme or, that it’s unclear if a transfer is suitable or not.
It cannot be used to meet the requirement to have taken independent financial advice prior to transfer where you have safeguarded benefits above £30,000. That requires full advice.
An appropriate pension transfer analysis (APTA) – including transfer value comparator – is not to be included, as this would then mean that you have started full advice and must charge accordingly.
But without an APTA, can you be confident in a recommendation to remain in the scheme? Will we see a lot of “unclear without full advice” decisions? Is it a bold move to recommend remain without full analysis?
The FCA is concerned by the level of and the necessity of ongoing adviser charging in some circumstances. Its data is suggesting an annual review takes around 13 hours. The FCA believes that transferring into a workplace default arrangement without ongoing advice charges may well be more suitable for those transferring. The paper says advisers have only been paying lip service to the need to discount the WPS and more robust analysis and disclosure will need to be undertaken.
There were a number of technical amendments in the paper too, the key ones being the reduction in the assumed annuity charge and the mandating of cashflow modelling in real terms. There are more than my word count allows, but on face value they all seem reasonable.
Your voice counts
The paper has grabbed headlines and you have until 30 October to respond. Come Hallowe’en it’ll be too late for that treat!
Mark Devlin is senior technical manager at Prudential