DB to DC transfers – a poisoned chalice?

The City watchdog estimates that up to 35,000 members of DB schemes or private sector final salary schemes will switch to a DC scheme each year now that the pension freedoms have come into effect.

However, research from Bristol-based Hargreaves Lansdown suggests that more than half a million people are set to give up their DB schemes to capitalise on the pensions changes.

Meanwhile, pension consultancts Hymans Robertson estimates that between 2.5m and 2.8m people currently with private sector DB schemes may retire in the next 10 years.

In March the FCA announced its intention to regulate all defined benefit pension transfers after 6 April to ensure mandatory advice had been taken and fully understood.

However, for many financial advisers, DB-to-DC pension transfers is a poisoned chalice which comes at a high cost – in the form of an inflated professional indemnity cover.

Advising on DB-to-DC transfer is a risky business. Concerns have been raised in the past – most notably over enhanced transfer value.

The FCA’s thematic review on ETV and pension transfers published in July last year, deemed ETV pension transfer advice unsuitable in just over one-third of 292 cases it reviewed from 2008 to 2012.

The problem when it comes to advising on DB-to-DC transfer is that the client is moving from a scheme which guarantees income for life to one where income is not guaranteed and subject to investment peaks and troughs, according to Keeley Paddon, pensions technical manager at SimplyBiz.

She said: “With current investment returns it is frequently not possible to match the level of income offered by a DB scheme, compared to a DC scheme.”

Paul Afteni, divisional director at insurance broker Willis, which offers professional indemnity insurance for IFAs, said the issue stemmed from clients who insisted on a transfer. It is at this point when advisers have to decide whether to go down the client’s route or allow the individual to go to another adviser who will do it for them, he said.

Concerns have been raised in the past – most notably over enhanced transfer value

This view is echoed by Mr Robertson, who said that some clients were bent on transferring from a DB scheme even though such a move would be unsuitable.

A spokesperson for the FCA said: “Financial advisers are required to ensure any advice they give to a client is suitable to that individual’s circumstances.

“The section of our handbook dealing with pension transfers specifically includes guidance on suitability, which was extended in 2012. However, this ultimately requires an adviser to use their professional judgment.”

The professional indemnity insurers have taken on board the viewpoint that the transfer is a high-risk area and if an advisory firm has DB-to-DC transfers on their books then the PI costs are significantly higher, according to Oliver Slade, chartered financial planner at Surrey-based Walpole Financial.

He said that he discovered that an advisory firm had seen its PI cover soar from £7,000 to £35,000 within 12 months as a result of advising on a DB transfer, during a conversation with a PI broker. The PI costs for the firm would remain at a figure above £30,000, he added.

However, the risk this type of transaction poses to PI insurers is nil at first, Ms Paddon said.

“Premiums will often remain at the same levels, with some firms reporting no increase to the PI premiums when obtaining pension transfer permissions with the FCA,” she added.

“However, a firm that undertakes lots of transfer business is likely to see an increase in PI costs over time. Complaints that are upheld will also affect the PI premium level.”

To reduce the risk of claims, IFAs should make sure that they have very rigorous control of any advice given to clients who are looking to switch, or employ the services of a compliance officer who specialises in the area, according to Jonathan Bogan, director at professional indemnity insurance broker, Pure Risk.

“Where they trip up is not necessarily on the advice they give. It is the audit trail. Advisers have to ensure that their documentation is kept up to date. They have to engage with their clients correctly, making sure that they express and concisely list the options available to that individual.”

What insurers are keen to see from financial advisers is good process and record-keeping, according to Willis’ Mr Afteni, adding: “When they look at an adviser’s existing exposure to transfers out of DB schemes they want to know that there is clear evidence on file to demonstrate that the correct advice/checks and balances were given prior to the advice to help aid defence in the event of a claim.”

There is a new trend of claims management firms farming claims by encouraging those unhappy with their financial situation to point the finger – albeit rightly or wrongly – at those who provide advice, he added.

One insurance underwriter said: “The problem we have got is it is a bit of a technical area. The pensions ombudsman and the FCA say that the transfer is rarely suitable – if you look at the reviews it seems to be what they are suggesting.

“It is a problem if an adviser has a lot of pension transfers on his books because the chance of one of the clients claiming on the grounds of bad advice is higher.”

When asked what advisers advising on DB-to-DC transfers could do to prevent a rise in PI cost, the underwriter said: “I don’t know. It is up to the ombudsman and the FCA to dictate what is good advice.”

Responding to the same question, Ms Paddon said: “They can transact low and/or sensible numbers of transfer business and give sound advice to avoid the possibility of future complaints.”

There could be good reasons as to why DB members

willingly choose to relinquish regular income for life.

The transfer may only be suitable in exceptional circumstances, such as where there is a shortened life expectancy, according to Steven Robinson, managing director of Bristol-based IFA Clarke Robinson & Co.

He said: “Who would want to give up a guaranteed pension? In the past, I would say that transfer from a DB scheme into a DC scheme would be unsuitable for 19 out of 20 people. Now I would say it is unsuitable for 39 out of 40 people – the only thing that has changed is the number of people seeking advice in this area.”

Current rules stipulate that an individual must seek professional advice from a financial adviser with a Pension Transfer Specialist qualification.

The City watchdog estimates that there are currently around 7,000 individuals with the appropriate qualifications.

Mr Robinson added: “The seasoned pension transfer specialist would fully understand the risks involved in DB-to-DC transfers, but PI insurers do not have the same knowledge as these specialists.

“I think PI insurers often overrated the risk and tarnished advisers with the same brush,” he said.

An Association of British Insurers spokesman said: “The ABI supports financial advisers carrying an appropriate level of professional indemnity insurance, as required by the FCA, to protect themselves and their clients against potential claims.”

Myron Jobson is a features writer of Financial Adviser

Key points

The FCA announced this year it will regulate all defined benefit pension transfers after 6 April.

The PI insurers have taken on board the viewpoint that the transfer is a high-risk area.

A DB transfer may only be suitable in exceptional circumstances, such as those with a shortened life expectancy.