Making DB transfer rules fit for purpose

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For adviser use only


In the last year or two, transferring out of a defined benefit (DB) pension scheme has gone from the darkest of taboo subjects to a favourite, if controversial, topic for wide discussion. High profile concerns over the adequacy of DB scheme funding, rocketing transfer values and the lure of Defined Contribution (DC)  pension freedoms have come together to create a surge in demand for advice in this complex area. However, so far, that demand has not been met with sufficient supply partly because many firms and their compliance departments still have memories of ‘pensions mis-selling’ in the late 80s and early 90s. Of course, the pension world, and industry as a whole has moved on hugely since then, but until recently, it took nothing short of a mind reader to know if the Financial Conduct Authority’s (FCA) expectations on DB to DC transfers had evolved to reflect these changes.

For those wary of second guessing future FCA decisions, their recent consultation paper CP17/16 on advice when transferring ‘safeguarded rights’, including DB pensions, is good news. At Aegon, we’ve been calling for the FCA to revisit ‘what good looks like’ when advising on DB transfers, and specifically, to reflect the pension freedoms in its expectations. Starting with a presumption of unsuitability seems unreasonably biased, and a Transfer Value Analysis (TVA) that produces a critical yield based on a replacement annuity is simply out of date. It’s good to see that the FCA agrees.

Stick or twist?

Let’s be clear. Transferring out of a DB scheme isn’t right for everyone. If still accruing benefits, it’s extremely unlikely to be a good deal, and giving up a guaranteed income for life isn’t a decision anyone should take lightly, or without specialist professional advice. But, as an industry, we’re not meeting our customers’ needs if we can’t offer that advice. Putting clients off isn’t a great approach when we have no way of knowing if gilt yields will stay at their current low levels, or if an increase will lead to transfer values coming back down. By delivering regulatory clarity, the FCA is enabling adviser firms to offer DB transfer advice with confidence. Hopefully, Professional Indemnity Insurers (PII) will also accept that this clarity reduces the risks of poor advice and reduce their premiums accordingly.

What is the FCA proposing to change?

While the FCA continues to believe that for most people, retaining their DB pension will likely be in their best interests, they will no longer require the adviser to make an initial presumption that transferring is unsuitable. The adviser will still need to demonstrate the suitability of their advice, which will in future always include a personal recommendation.

Guidance will set out elements to consider. These include the client’s income needs (rather than wishes) and expectations, how safeguarded benefits can meet these, and the risks of transferring. The adviser must consider the receiving scheme they would recommend, the investment strategy based on the client’s risk profile, as well as charges. Another key consideration is how and when the client will be accessing funds. Alternative lower risk ways of meeting objectives such as providing death benefits should also be assessed.

The role of the pension transfer specialist in checking advice is also being clarified. This goes beyond ‘checking the numbers’ to assess the appropriateness of the personal recommendation, allowing for the client’s wider circumstances and risk profile and the receiving scheme.

One of the biggest changes is the replacement of TVA with a new Appropriate Pension Transfer Analysis (APTA.) As a minimum, this should assess;

  • the client’s income needs throughout retirement;
  • the role of the ceding and receiving schemes in meeting these alongside other income sources;
  • death benefit considerations, and
  • a new Transfer Value Comparison (TVC) diagram.

The TVC diagram will be in a prescribed format, comparing the transfer value on offer with an estimate of the cost of replacing the pension being given up through an annuity, either immediately or from ceding scheme retirement age. Many of the underlying calculations are similar to those within current TVA although some of the assumptions are being reviewed. But rather than producing a critical yield, the client will be able to assess the ‘adequacy’ of the transfer value by comparing this with the cost of replacement, shown in pounds and pence. The FCA expects this to be more powerful in helping customers reach an informed decision on whether or not to transfer.

The calculations must take into account the charges of the receiving scheme the adviser would pick and also the projection rates the receiving scheme would use for the recommended investment strategy. How best to obtain this information and factor it into calculations needs further thought. The use of provider-supplied software will continue to be subject to inducement rules.

The FCA continues to recognise that there’s a likelihood of disproportionate numbers of insistent clients in this field but, rather than dealing with this here, it will consult more widely on insistent customers later in the year.

When the chips are down: our initial thoughts

There has been some debate as to whether or not these new rules will increase the number of DB transfers. I believe they will, primarily because they provide some long overdue clarification of FCA expectations which should give more firms the confidence to advise in this market. I’d also like to think clarity will reduce extra PII costs, allowing the supply of advice to increase by attracting more qualified advisers to match demand.

I also believe the FCA has correctly identified the elements advisers should take into account and removes the previous bias which encouraged an overly cautious approach. This will mean advisers are more likely to recommend transfers where these are in the client’s interest, rather than erring on the side of caution.

I also hope the new TVC will help clients understand adviser recommendations, including where this recommendation is not to transfer, leading to fewer clients insisting on transfers that may not be in their interest. An environment where more individuals can access appropriate advice, and receive a better understanding of the pros and cons of transferring, has to be a good outcome.