Defined BenefitFeb 25 2021

We need to fix the broken PI market

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
comment-speech

Unless you had a very small DC pot which could be cashed out or a very large pot with drawdown options, the mass market outcome would be to buy an annuity.

With annuity rates plunging and too few people shopping around, retirees were often getting poor value and millions of tomorrow’s retirees were set to follow.

Although pension freedoms were fundamentally about DC savers, the government had to make a decision about whether people in Defined Benefit pensions should be able to benefit. 

PI insurers had financial ‘skin in the game’ and quickly realised that they could be on the hook for large compensation claims

Those in unfunded public sector schemes were not allowed to transfer because of the immediate impact on government cashflow.  

But a more relaxed approach was taken to allow private sector DB transfers, presumably on the assumption that most people would still want to retain valuable DB benefits.

What happened next surprised both the Treasury and the FCA. 

The volume of DB transfers was much higher than expected, and income tax revenues from pension transfers have consistently exceeded Treasury forecasts. 

The FCA also got caught up in the early euphoria around the new policy, even consulting on dropping the presumption against advising people to transfer in favour of a ‘neutral’ starting point.

The real regulation of DB transfers has come not from the Government or the FCA but from the Professional Indemnity insurers. 

The PI insurers had financial ‘skin in the game’ and quickly realised that they could be on the hook for large compensation claims if poor quality advice was given.

With record transfer values on offer and a booming stock market, the flow of complaints about inappropriate advice to transfer was initially very low and remains subdued. 

But the warning signs were there, whether in concerns over the advice given to British Steel members or in the FCA’s small-scale sampling which showed alarmingly high levels of unsuitable or unclear advice.

Long before FCA clampdowns, I was hearing from advisers who were getting a tough ride from their PI insurers.  Professional Indemnity insurance for financial advice is only a small part of the overall PI market, and capacity in the market as a whole was coming under pressure. 

But the commercial viability of PI insurance to advisers in particular was becoming increasingly challenging. PI insurers were taking on a ‘black box’ liability for all past advice, and the FCA’s method of calculating compensation could easily generate six figure sums. 

The decision by the FOS to hike its maximum compensation level made matters worse.

PI insurers responded rationally but in a way which made it much harder for advisers to get affordable cover.  Premiums were hiked, excesses on individual claims were increased, caps were placed on volumes and specific exclusions (such as on advice on British Steel schemes) were introduced. 

The supply of cover became so tight that firms who had to renew towards the end of the year could find it impossible to obtain cover, as would those who failed to engage early ahead of their renewal date.

The PI market remains broken. Although the FCA has driven out some of the advice firms who it believes were offering the worst advice, providing PI cover for DB transfer advice remains a high risk activity and some providers have withdrawn altogether.  

Some will only offer renewal terms to existing customers, leaving advice firms little option to shop around if they face a hike in premiums at renewal.

We urgently need creative thinking from the FCA to make sure that affordable cover is available to high quality advisers who want to do the right thing. 

The publication of the FCA’s Defined Benefit Advice Assessment Tool offers one glimmer of hope in that it provides some transparency on how suitability of past advice is being assessed. 

But the FCA remains rigid when it comes to other options such as allowing firms to ‘self-insure’ by setting aside capital for future claims.

A root-and-branch review is needed to avoid a situation where advice firms are a captive market with a take-it-or-leave it situation when it comes to obtaining PI cover for DB transfer advice.

Steve Webb is a partner at consultants LCP