The FT Adviser have recently published this article written by our own Managing Director Tim Flippance.
- Describe the challenges with abridged advice on DB transfers.
- Explain when a client might get a negative result.
- Identify the impact of a large cash equivalent transfer value.
Defined benefits transfers have always been a contentious and high-risk area of financial advice, and the British Steel scandal has put them firmly back in the headlines.
Even before this, the Financial Conduct Authority concluded that the “old” model of thousands of independent financial advisers all separately dealing with a handful of transfers a year increases the potential for consumer detriment.
The inevitable conclusion is that effective regulation of this area can only be implemented by reducing the market to a relatively small number of specialist IFA companies, and changing the industry to achieve this has been the regulator’s stated aim for several years.
However, as with all aspects of financial advice, whether you are a specialist DB transfer company or a general IFA that retains the relevant permissions and PI, it should still all come back to the consumer and what is in their best interests.
Following the introduction of abridged advice in 2020, the provision of this — either free or with a limited charge — has become the norm among specialist companies and may well become “best practice” or even a requirement in the future. It is therefore important to consider what types of client factors will have the greatest impact on this simplified version of advice, as well as chargeable “full” advice.
Initial client discussions
First, you need to establish whether the client is a deferred member, still accruing benefits as an active member or has an active salary link. Filtering based on this is a good starting point, because unless the client is definitely planning on retiring, where they are still active in the scheme any advice would be considered an “opt-out” and is therefore even less likely to be appropriate.
Before you obtain a transfer value — assuming the client has not already done so — you can have a conversation about what has motived them to consider the transfer. It is useful at this point to frame your conversations in the context of the FCA’s starting point, which is that a transfer is likely to be unsuitable for the majority of people, unless it can clearly be demonstrated it is in their best interest.
The inevitable conclusion is that effective regulation of DB transfers can only be implemented by reducing the market to a relatively small number of specialist IFA companies
You can discuss the factors of “flexibility, control and death benefits” and gauge the degree of importance, if any, that each of these may carry.
Where the client is realistically unable to attach any importance to any of these, unless they are approaching scheme retirement age and could therefore lose the right to transfer soon, the transfer is unlikely to be worth further consideration. Records of your conversations should be kept; however, focus can be switched to other areas.
Know your client
When it comes to DB transfers, the client’s “soft facts” are vital. The client’s objectives, not just in relation to the transfer, but more broadly their short and long-term goals, must be discussed in detail, as should the relative importance of these objectives compared with the risks of transferring.
Any potential alternatives to transferring should be discussed where applicable, as should their long-term retirement income needs — with context for these provided by a detailed breakdown of current outgoings — along with their attitude to investment risk and attitude to transfer risk.
Since the client’s capacity for risk is also a key factor, standard “hard facts” (assets and liabilities, etc) are also vital. The client’s health should be recorded in detail, which could even include family history of heritable illness.
est practice dictates that clients not just understand the risks of transferring, but that they can also demonstrate their understanding, clearly and definitively. Clients should also be able to explain the benefits provided by the scheme and the implications of losing those benefits and the risks of an alternative investment option, as well as ideally having prior investment experience, which they can quantify.
Finally, the client should be quoted directly in their own words and all of this information must be recorded – ideally both in written format provided to the client for verification and, where practical and with permission, with a physical recording of meetings.
When the ban on contingent charging was introduced fully (COBS 19.1B), the FCA acknowledged that there may be certain client circumstances where this should not apply, particularly if a client is suffering from serious ill-health — making a transfer more likely to be suitable — or experiencing serious financial difficulty.
Best practice dictates that clients not just understand the risks of transferring, but that they can also demonstrate their understanding, clearly and definitively
Where this is the case, the old rule of “no transfer, no fee” can still be used. However, it is important to note that you must be prepared to evidence these circumstances and also give due consideration to the risk that, for the same reasons, the client could be considered “vulnerable”.
Where the client is eligible for the carve-out, you can choose to skip straight to full advice.
Abridged advice – conclusively inconclusive?
According to the restrictions laid down by the FCA, the outcome of abridged advice is limited to assessing only the client circumstances and the value of their pension in today’s terms.
Where a client struggles to attach importance to their objectives, has clear and obvious alternatives, the pension is their only source of retirement income, or they are fundamentally unable to explain the risks of transferring, it is more likely that the conclusion of abridged advice will be “negative”. This is generally summarised as, “based on what we understand of your situation, we do not believe that a transfer is likely to be in your best interests”.
That being said, the single most common motivation for clients considering a transfer is to be able to retire or semi-retire. It is therefore more common that clients will receive an “inconclusive” recommendation; in fact, this is the case around three-quarters of the time.
This means that they must proceed to full advice if they still want to receive a definitive “yes” or “no” recommendation. Similarly, where a client is able to demonstrate a large capacity for loss due to significant other retirement provisions — other pensions or wealth — this increases the probability of an inconclusive outcome.
As well as reaching an initial conclusion, a good abridged advice report will also help the client to further understand the risks and implications of transferring their pension, the possible alternatives specific to them, and the potential advantages. So, irrespective of whether the recommendation is inconclusive or negative, ultimately it is the client’s decision, and as long as it is informed then abridged advice has achieved its goal.
So what do clients decide to do?
When abridged advice was introduced, there was a degree of uncertainty within the DB transfer advice industry as to how this new form of simplified advice could be practically implemented. More importantly, it also was not clear whether it would lead to greater consumer understanding and better outcomes, or consumer confusion around what level of advice was required, how this would be paid for, and what it all meant.
In the event, where abridged advice is applied well, it is an effective way for consumers to gain a greater understanding of the “value” of their DB scheme and what it means in the context of their longer-term financial goals, prior to committing to what could be a significant fee for full advice.
Irrespective of whether the recommendation is inconclusive or negative, ultimately it is the client’s decision, and as long as it is informed then abridged advice has achieved its goal
To demonstrate this point, it is worth considering that where the recommendation of abridged advice is inconclusive, around 80 per cent of clients decide to proceed to full advice — where the full advice fee must become payable. Where abridged advice is negative, only around 40 per cent of clients proceed to full advice.
Abridged advice also allows IFAs to be confident that a key part of their client’s retirement provisions has been considered; this is all the more vital with the introduction of the new consumer duty regime.
Although DB transfer advice is highly individual, there are a number of factors that can have an impact on the likely outcome of full advice. It is therefore not unreasonable to summarise some of these key factors, particularly where this can help identify those clients for whom a transfer is more likely to be appropriate in the first place.
First, it is worth pointing out that the outcome of abridged advice is an early indication of the likely outcome of full advice — where abridged advice is inconclusive a transfer will be recommended around half of the time. However, where abridged advice is negative this goes down considerably to about one in six.
In terms of the transfer value amount, those with a larger cash equivalent transfer value — particularly more than £500,000 — are more likely to receive a positive recommendation. Of course, those individuals fortunate enough to have received larger CETV offers, as a result of many years’ service and high earnings, are also more likely to have other additional wealth.
This, in turn, increases their capacity for risk and arguably a desire for wealth preservation from an inheritance tax point of view. It is also slightly more likely that a larger CETV is just more generous in comparison with the scheme benefits, and this does become a factor at full advice.
If a client has a reduced life expectancy or is at risk of developing a serious disease, then a transfer is more likely to be suitable. However, scheme ill-health options must also be considered
In this latter respect, it is worth noting that of the 26 schemes with higher rates of positive recommendations to transfer, 10 are banks or insurance companies. This suggests that fairly generous CETVs are offered reflecting scheme surpluses, or the clients themselves are more financially astute; that is, well positioned to understand and accept the implications of transferring.
Not surprisingly, a willingness to take some level of investment risk inevitably helps — those of a “cautious” disposition are less likely to be recommended a transfer as the potentially limited returns cannot offset the risks of transferring.
The age of your client is also a big factor. Where clients are around age 60 or above, either retired already or considering early retirement, the likelihood of a positive recommendation increases.
Finally, health: if a client has a reduced life expectancy or is at risk of developing a serious disease, then a transfer is more likely to be suitable. However, scheme ill-health options must also be considered, such as any qualification for ill-health immediate retirement.
Timothy Flippance is managing director of Grove Pension Solutions