InvestmentsFeb 14 2020

FCA hunting for quality advice

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FCA hunting for quality advice

The headline results looked very impressive: 93 per cent of recommendations were pronounced suitable.

The FCA hailed this positive result as evidence that its Retail Distribution Review reforms had achieved their main objective of driving up advice standards.

Regulatory concern about quality increases

Sadly, the message from the regulator about how well financial advisers are doing their jobs has taken a much more critical tone since then.

This change of register was reflected in a speech on improving the quality of financial advice, delivered in September 2019 by Debbie Gupta, director of life insurance and financial advice supervision at the FCA.

Key points

  • The FCA has said that advice on complex products is not consistent enough.
  • It is important to get the basics right.
  • Advisers have to check their clients' planned spending in retirement.

The message from the FCA now is that advisers are doing a good job advising on Isas and pension accumulation, but when it comes to more complex products and services, the quality of advice is much less consistent.

The regulator is therefore taking urgent action to enforce higher standards in these areas.

Of course, this message largely reflects the FCA’s well-publicised findings on defined benefit pension transfer advice, together with associated scandals involving non-standard (often unregulated) investments being sold to inexperienced retail investors.

However, advisers should not assume they are out of the firing line because they avoid DB pension transfers and steer clear of introducers pushing dodgy unregulated investments.

The FCA’s advice quality concerns are wider than that.

Retirement advice in the spotlight

You may have seen the FCA’s recent ‘Dear CEO’ letter regarding portfolio strategy for advisers, which sets out its main areas of concern for the advice sector, how it intends to tackle them, and the action it expects companies to take.

This letter tells us that the latest review of advice quality will focus on “initial and ongoing advice to consumers on taking an income in retirement”.

It also spells out what actions advisers need to take: “You need to ensure that the advice you provide is suitable, costs and charges are disclosed clearly, and that you act in the best interests of your clients. Conflicts of interest must be identified and, where they can’t be prevented, disclosed and managed.”

I have heard that the FCA has already kicked off its review by sending an information request to randomly selected companies.

These organisations are then required to provide a spreadsheet containing all their retirement income advice recommendations made over the past couple of years.

I do not know exactly what issues and concerns the FCA will be focusing on in its latest review, but I can make some educated guesses based on the regulator’s previous advice quality reviews, and the work Bovill has done with companies on retirement income quality.

Based on this, here are my tips on the issues you should be challenging yourself on, to give you the best chance of meeting the regulator’s expectations for retirement income advice.

First, establish your client’s income needs in retirement. 

Ask yourself whether your client files show that you have had a granular discussion with the client about their current spending habits and how these may change in retirement.

Is there a detailed and credible breakdown of current expenditure?

What is the client planning to do with their extra leisure time, and what are the expenditure implications?

Is it clear whether the client’s partner’s income and expenditure has been considered?

Second, assess the sustainability of their retirement income.

Is it evident from the file what sources of household income are due to start or stop, when this will happen, and how this has been taken into account?

Is it clear what assumptions have been used for the cash flow analysis?

Are the assumptions reasonable, and how have they been stress tested (for example, market crashes, higher expenditure, living well beyond average life expectancy)?

Do your client files show that you encourage clients to consider, and plan for, the likelihood of care costs, or do your advisers simply assume that spending will wither away as the client enters the later years of retirement?

Last of all, discuss costs and charges and value for money. 

The FCA is bound to look at costs and charges, so ask yourself the following questions:

• Does your tariff cater for retirement income advice, and is it compliant? What other information does the client receive to help them understand likely costs before chargeable work commences (for example, engagement letter or statement of work)?

  • For new clients, does your suitability report contain a Mifid II-compliant ex-ante disclosure of aggregated costs and charges?
  • For ongoing advice clients, are you providing a compliant ex-post disclosure of costs and charges?
  • How big are your aggregated costs figures? Will they look like good value for money?
  • Do your suitability reports show that advisers are taking the impact of total advice and investment costs on the client’s retirement income into account, by selecting lower-cost solutions where suitable?
  • Is it evident that you are providing a comprehensive annual review service that is commensurate with your ongoing advice fees?

Conflicts of interest and consideration of alternatives

The recent FCA letter warns advisers that it will be looking at the way they identify and manage conflicts of interest.

Challenge yourself about the potential conflicts of interest you are faced with when providing retirement income advice.

For example, if you recommend flexi-access drawdown, this is likely to generate ongoing advice fees for your company and (if you use an in-house investment solution) ongoing investment management or product fees.

The FCA will be looking out for indications that advisers routinely discount alternative solutions that tend to generate little or no ongoing revenue in a tick-box manner, rather than seriously considering them and challenging clients’ preconceptions. For example:

  • Annuities – particularly as clients get older and mortality drag kicks in, securing a stable income makes more sense and annuity rates become comparatively more attractive.
  • Equity release – not enough advisers give this serious consideration as an option. Average fixed rates for life are now less than 4 per cent.
  • Workplace pensions – these can offer a simple, low-cost solution for some clients. Contrary to the outdated claims I see too often in many suitability reports, many schemes currently offer a wide fund choice and flexible retirement options.
  • Use of annuities within a drawdown contract – these can help to provide a balance between income security and flexibility/tax efficiency.

Risk profiling and investment solutions for decumulation

Ask yourself about whether your standard risk-profiling methodology works well for clients in decumulation, given the different risks they face.

Do your client files demonstrate how you are educating clients about sequencing risk and longevity risk, and how you take them into account in the investment solutions you recommend?

One approach could be to divide the client’s retirement income needs into several buckets: living expenses, lifestyle spending, emergency liquid fund, and (for some clients) a legacy fund for beneficiaries, and suggest a different solution for each.

It is clear that improving standards of financial advice is one of the FCA’s consumer protection priorities in 2020. All companies should be prepared to invest time and resources to meet the FCA’s expectations this year, in particular those providing advice on income in retirement and DB pension transfers.

Neil Walkling is managing consultant and head of the investments team at Bovill