Proposals to modernise processes around transfers have received support but miss some key points, writes Michael Klimes
The Financial Conduct Authority's (FCA) consultation published on 21 June aims to modernise processes around pension transfers in response to concerns over surging demand.
The increased number of transfer requests from defined benefit (DB) to defined contribution (DC) schemes has raised worries that such high activity might not be good for several reasons.
Up to £50bn has been transferred out of DB schemes to 210,000 members in the past two years, according to Mercer's estimates compiled for the Financial Times. In April Xafinity said the number of members transferring from DB schemes it works with had more than doubled to 117 in Q1 2017 from Q1 2016.
The decision to transfer out may turn out to be a poor choice financially for the individual, the procedures around transfers are inefficient and the costs of administration for various parties are too high, according to the FCA.
To allay these concerns, the FCA wants to require transfer advice to be provided as a personal recommendation, and replace the current transfer value analysis with a comparison to show the value of benefits being given up.
It also wishes to introduce guidance on the role of a pension transfer specialist and update guidance available to financial advisers, which relates to how to judge whether a transfer is in the member's interest.
Many pension experts welcome these proposals and have a range of views on the wider implications for trustees, investment consultants, and administrators.
For instance, there is much praise for changing the transfer analysis methodology - which calculates the rate of return necessary to reproduce the safeguarded benefits being given up in a transfer. For a long time many have called on the analysis that assumes the purchase of an annuity to be updated.
However, people also point out some areas the consultation has missed out such as the cost of advice for members with small pots.
Cost and workload
There are contrasting opinions about how the FCA's plans will shape the cost of advice, levels of transfer activity and workload of parties in the supply chain.
Pensions expert Baroness Ros Altmann does not believe the proposals will burden trustee boards.
"I hope the proposals will help trustees to be more relaxed that members who do transfer out have taken an appropriate decision, because they have been properly advised and it might be right for them," she says.
"If trustees have to spend more time preparing materials and answering member requests, they may consider that a negative, but I believe it is an important part of trustee duties to members."
Furthermore, she does not anticipate the changes would lead to higher charges for advice or present any problems in terms of who pays for them.
"I do not think the proposals should increase the cost of proper advice, as good advisers should have been doing this already. If the sponsor wants members to transfer and is offering an enhanced transfer value or pension increase exchange (PIE), then I believe the employer should pay for the advice. If the request is initiated by the member, then presumably the member should pay," she adds.
Conversely, Redington investment consulting managing director Patrick O'Sullivan argues the administrative cost of large transfer exercises could go up due to tougher regulations.
"For many firms it won't be the independent financial adviser (IFA) that picks up the cost but the sponsoring employer. A process [for transfers] where the oversight needs to be more holistic will increase the cost for sponsor companies doing the transfer exercise. Therefore it might not be possible to do these exercises though the regular streamlined process."
The FCA's demand that transfer advice be provided as a personal recommendation that takes the whole circumstances of an individual into account is relevant here.
For consultants, O'Sullivan observes the proposals could affect the advice they give to schemes regarding their investment strategies. The pension freedoms have already resulted in large transfers out of DB. In turn these have influenced levels of liquidity, how schemes hedge and the rate of return from assets needed to close a deficit.
O'Sullivan says consultants should be monitoring closely how FCA proposals influence the level of transfers.
Advisers and administrators
For Hymans Robertson partner Jon Hatchett there are two things to watch out for. The first is how the cost of advice, which is expected to go up, influences the relationships between trustees and IFAs. Currently some schemes with over 1,000 members partner with IFAs as it reduces the cost of fees for advice by 20% to 25%.
"The consultation's demand that advice is made more bespoke for individuals could make it more expensive. In turn this could make it harder for schemes with more than 1,000 individuals to partner with IFAs to reduce the costs of advice than in the past."
Secondly, he hopes the consultation will pressure administrators to become quicker when it comes to the release of information needed to do transfer value analysis.
"Administrators will get more detailed questions from financial advisers about transfers and they will need to find an effective way to respond."
Although the consultation covers a lot of ground, there are gaps that need to be tackled, including the cost of advice for members with small pots and the transfer analysis comparator.
Hatchett explains: "What the consultation misses is the transfer of small pots where it is costly to get financial advice. If you have a transfer value of £40,000, that person may find it really hard to get advice because advisers are not interested in pots of that size.
"Also, the problem with having any comparator which the FCA prescribes is that people are going to start focusing on that number which is not good. In a complex decision, one number should not dominate the conversation."
Instead people should concentrate on something far more quantifiable.
"What they should be focusing on is the likelihood you will run out of money. A probabilistic chance of ruin is something that people can understand better rather than the technical details of what they are invested in or the comparator," Hatchett continues.
Also unaddressed is whether advisers should consider if the employer covenant is strong enough to 'safeguard' benefits of the member who transfers.
Lincoln Pensions chief executive Darren Redmayne says: "Particularly for members who haven't reached normal retirement age, the cliff-edge nature of Pension Protection Fund compensation means that the covenant strength of the employer could materially impact their decision-making.
"We believe covenant advice will need to be made available to IFAs and members so they can factor it into transfer decisions."
Many of the FCA's ideas have the potential to shake up the system of transfers in the direction which the industry has demanded for a long time. The initial responses also show the sector is not shy of suggesting how these ideas could be improved.
It will be interesting to read the full responses to the consultation which are expected to be published with an official response from the FCA in early 2018.
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