Defined benefit (DB) transfers are one of the hottest subjects in financial advice at the moment. One of the main talking points related to these transfers is firms’ charging models, specifically contingent charging.
But while charging models are an important consideration when examining the outcomes customers receive, the main focus should be on a firm’s culture and ensuring that the adviser makes a suitable recommendation regardless of the charging model used.
Recent reviews undertaken by the Financial Conduct Authority (FCA) indicate that advice on pension transfer suitability is around 50 per cent. It is unlikely that firms’ charging models are the root cause of these findings. So, while the Treasury select committee has called for a ban on contingent charging, let’s consider the broader issues around DB pension transfer suitability and this charging model.
Arguments against contingent charging
It is important to remember that contingent charging is permitted under the current FCA rules, not just for pension transfers, but also for other financial planning advice. Therefore, firms who use this pricing model are not automatically in breach of any FCA rules or principles.
- DB transfers are a hot topic in financial advice at present.
- Contingent charging is currently allowed under FCA rules.
- Culture is more important than banning contingent charging.
The main argument against contingent charging is the conflict of interest that advice firms face, knowing that they will only be paid if they advise a client to transfer. However, the FCA’s suitability rules are in place to ensure any advice given is suitable for the client’s specific needs and circumstances, and conflicts of interest are managed appropriately. Within any advice firm’s business model, there will be a number of inherent conflicts of interest (not only relating to charging models), and it is not possible to establish rules and processes to remove them all.
What is important is that firms understand the conflicts of interest within their operations, and take reasonable steps to mitigate their impact on customers. Over the last few years, the regulator has been moving away from a prescriptive, rules-based approach to a regime that focuses on the outcomes customers receive. Its stance on conflicts of interest is one example of this.
Even if banning contingent charging did mitigate the conflicts within this charging model, it would not address a potentially much bigger conflict, specifically if the adviser recommends the transfer they are also likely to benefit from significant advice charges for many years to come.
The average size of a DB pension transfer is reported to be approximately £250,000. A transfer of this size with a 1 per cent ongoing advice fee applied for 20 years could generate £50,000 of income for a firm. If the transfer value is £750,000 that figure rises to £150,000. Of course, if the firm advises not to transfer, then it will not receive any income for funds under advice. Therefore, banning contingent charging would, at best, only mitigate one of the potential conflicts within the DB pension transfer market, with others remaining unaddressed.