Financial advisers will be familiar with the details of the pension freedom reforms that came into effect in April this year. One of the key changes is that people will now have full access to their pension pots when they reach the age of 55, with no requirement that they purchase an annuity to provide a guaranteed income until death.
Substantial regulatory reforms such as these often present opportunities and risks to those in the industry.
Advisers themselves will be best placed to assess how they can capitalise on these changes in their own businesses. However, those working in the professional indemnity insurance market, particularly defendant lawyers such as myself, may be able to provide some helpful guidance on the risks which might be posed by the changes and, specifically, how they might result in further claims being brought against advisers. Such claims and complaints can result in increased costs for firms through rising insurance premiums and the payment of insurance excess contributions.
Advisers will be aware, of course, that the removal of the requirement for pensioners to purchase an annuity is not a new development. Reforms in April 2011 removed that requirement and introduced the income drawdown regime whereby the pension could be invested and withdrawals made up to certain limits. The new full access pension regime simply removes those limits and allows people to make as many withdrawals as they want. There have been suggestions that people will effectively be able to use their pensions as bank accounts.
For the purpose of looking at the potential for claims to arise from the new regime, we can think of the full access pension regime as ‘income drawdown max’. We can therefore examine the possible future trend in claims arising from advice given in respect of full access pensions by considering the trends we have already seen with income drawdown pensions.
While the number of complaints received by Fos relating to pensions decreased by 2 per cent overall last year, the number of those complaints which related to income drawdown actually increased by 7 per cent. This would suggest that there is something about income drawdown pensions which has a tendency to result in more complaints than some other types of pensions advice, and that this is getting worse rather than improving.
In some companies’ experience as lawyers acting for advisers and their insurers in the defence of such claims, many income drawdown claims and complaints have common features. In particular they often arise from one or a combination of the following scenarios:
• The client took the maximum lump sum benefit and then drew down the maximum or very substantial income for several years. The client’s capital suffered significantly, and he subsequently sued his adviser or complained to Fos on the grounds that he was not properly advised of the risks of withdrawing significant capital from his pension in the early years.
• The client’s pension had suffered losses, or not grown as expected due to the performance of the underlying investments. Either the client alleged that he was not properly advised as to the potential impact of his chosen attitude to risk, his attitude to risk was mischaracterised by his adviser, or the investments recommended were not suitable.
The advent of full access pensions can be expected to produce an increase in claims of these kinds as consumers look to enjoy the fruits of their pension pots in the early years of retirement, only to find that they have depleted their capital to a critical level through withdrawals, or an unexpected stock market dip has caused losses to their pension pots.
Fos will normally look for and expect advisers to have provided consumers with a clear and succinct statement of advice to the effect that:
• income drawdown involves greater risk than the purchase of an annuity;
• taking the maximum or large withdrawals from income drawdown involves considerable risk that the fund will run down;
• if the fund runs down in the early years it is very difficult for it to recover; and
• generally 100 per cent investment in cash is inappropriate for income drawdown, and therefore in order for these policies to work, investors must be prepared to accept some level of risk.
Fos will also expect that much, if not all, of this advice should be reiterated at each review, particularly if the client has made significant withdrawals, thereby depleting the capital of his pension fund.
Unfortunately we sometimes see suitability letters where this advice can be inferred, but is not as explicit as it might have been. This will rarely satisfy a court or the ombudsman.
We also find cases where the adviser is adamant that the relevant advice was given in meetings and that the client fully understood the implications of his approach to investment. However, it is very difficult to defend claims and complaints on the basis of advice which was given orally but not recorded clearly and legibly on the file.
We therefore recommend that advisers should ensure that all advice is fully recorded on their files including file notes of meetings. Where clients opt for income drawdown or full access, the file and correspondence should clearly record their reasons and that they understood the implications and risks of doing so. The same applies for the client’s approach to investment risk.
There is little in the recommendations outlined above that is different to the steps advisers should take in order to best minimise the risk of complaints being made generally. However, it is apparent from the statistics published by the ombudsman that advice in relation to income drawdown pensions poses a particular risk to advisers, and in these instances they should pay particular attention to their day-to-day risk management practices.
Perhaps the reason that income drawdown and full access pensions create these difficulties is that, in addition to assessing the suitability of well-documented products and dealing with the uncertainties associated with financial markets, advisers must also take into account their own clients’ self-control and spending habits.
To some extent we might now be approaching a situation in which advisers will be expected to protect consumers from themselves. Undoubtedly this will be an unwelcome development in the industry but it is one that firms should be able to mitigate through good risk management practices.
James Field is a solicitor at Triton Global
Key points
Reforms in April 2011 introduced the income drawdown regime whereby the pension could be invested and withdrawals made up to certain limits.
Last year, the number of those complaints which related to income drawdown increased by 7 per cent.
We might now be approaching a situation in which advisers will be expected to protect consumers from themselves.
