While the majority of advisers may not agree that the move will improve outcomes, the potential for contingent charging to be contributing to what the FCA says is a high incidence of unsuitable advice was enough to prompt it to act.
How did we get here?
Since pension freedoms were introduced in 2015, the FCA has confirmed that approximately 235,000 DB members have received advice on transfer values totalling over £80bn.
Given the FCA requirement that the starting point for advice should be that a transfer is unlikely to be in the client’s best interests, it is surprising that more than 170,000 of these members were advised to transfer benefits to a defined contribution arrangement.
These figures are far too high to expect the FCA to not intervene.
Key points
- The FCA has banned contingent charging
- It has concluded that too many clients are transferring their DB pensions to a DC scheme
- Clients may underestimate the value of a guaranteed income
Now if we assume that each of those 170,000 recommendations to transfer were in the client’s best interests, this could then cast doubt on the numbers quoted by the FCA of individuals seeking advice.
In practice, it is likely there are a large number of potential clients who withdrew from the advice process following triage – the process used to educate clients on the drawbacks and benefits of a potential transfer prior to progressing to regulated advice.
However, the FCA has deemed that having over 70 per cent of cases that proceed to regulated advice resulting in a recommendation to transfer is unacceptably high and counter to its initial assertion that it will not be in the best interests of the client in the majority of cases.
One of the conclusions drawn by the FCA was that advisers are potentially being financially incentivised to recommend a transfer if their fees are structured in a manner that results in a higher charge following a transfer.
Coupled with ongoing advice charges, this can have a significant negative impact on transferred funds and, as a result, the client’s retirement income and financial security.
The way forward
The ban on contingent charging provides advisers with the opportunity to review their advice process and potentially move to an even higher level of professionalism.
As qualified specialists, clients should not be paying for a transfer but for the detailed analysis undertaken to assess whether it is in their best interests to take this life-changing decision.
Many clients may not have realised they were sitting on a pension valued in the many hundreds of thousands of pounds.
In these situations, advisers are often faced with clients with a preconceived notion that a transfer is in their best interests due to the large sums made available to them.
Given the current financial situation many will find themselves in, with the fallout from coronavirus still unveiling itself, clients may see the large sums offered by pension trustees as a way of relieving some financial pressure.
Clients can often underestimate the true value of the guaranteed income provided by a DB pension when faced with an appealing transfer value that can be accessed as and when they please.
This lump sum bias can lead to clients identifying objectives that have potentially been driven by the availability of this large transfer value, as clients begin to imagine what these funds can be used for.
One has to wonder whether the increase in DB transfers in recent years has led to a corresponding increase in the number of campervans being purchased?
Clients should be under no illusion that they are paying for a review of their retirement plans and how their existing DB schemes can be used to achieve their objectives.
If, following this review, it can be clearly demonstrated that it is in their best interests to transfer their pension, then this should obviously be the outcome.
However, clients should not enter the process under the impression that they are paying a fee to potentially facilitate a transfer.
It is important to make it expressly clear during initial conversations with clients that they are paying for your expert knowledge and professional advice and that, in the majority of cases, it is highly unlikely to be in their best interests to transfer an existing DB pension.
This is an opportunity for advisers to display the worth of their advice and demonstrate to clients their expertise and knowledge. While this may lead to difficult conversations and potentially disappointed clients, the challenge will be to demonstrate the value of a recommendation to remain.
This will involve a full appraisal of their retirement objectives and existing arrangements and working to meet these via the lowest risk and least disruptive method possible.
However, it may result in a number of DB members being priced out of advice, with upfront fees acting as a barrier to clients with smaller DB pensions.
There will always be examples of clients where a transfer may be demonstrably in their best interests but with insufficient liquid cash to cover an advice charge in the result of a recommendation to remain.
While these clients may be negatively impacted by these changes, the recently launched client-focused ‘advice checker’ page on the FCA website confirms that a recommendation to transfer where the DB pension is a client’s only or largest guaranteed pension, and where they have few other assets, is likely to be deemed poor advice in the event of a complaint.
While this ban on contingent charging may result in some advisers having to revamp their approach to DB advice, it should be welcomed and seen as a move in the right direction and an opportunity for professional advisers to thrive.
David Lloyd is technical services and research team leader at Tenet Group
