New regulations on DB Transfers look set to put a further dampener on adviser participation but market drivers remain powerful
Explains Adrian Boulding, Director of Retirement Strategy at Dunstan Thomas.
Just before Easter, the Financial Conduct Authority (FCA) published its much-awaited Policy Statement (PS18/6)detailing the new safeguards it requires of all parties involved in the Defined Benefits (DB) Transfers market, following a nine-month review of the market and intense Parliamentary pressure from Frank Field’s Work & Pensions Committee.
There are two clear and powerful drivers stimulating increased DB to DC transfers which have risen close to 100,000 per year from less than half that number in 2016. The first is the eye-poppingly high transfer values being offered by employers to DB scheme holders. Transfer values are often 25 to 30 times the value of the annual pension that the occupational pension had promised – a life-changing amount of money for many.
However, it is not just the amounts of money on offer but the potential for immediate access to these sums - the arrival of Pension Freedoms three years ago offered the potential to transfer all this money (minus charges) into a DC scheme, thereby opening up a range of decumulation options for over 55 year olds, by far the most popular of which is to take all pension assets out in one go (after age 55 and after tax of course).
Another reason why transfer requests are on the up, from our own research into Baby Boomer decumulation decision-making, is that increasing numbers of people are experiencing ‘career shocks’ in their 50s . Many have been made redundant from well-paid senior positions and been forced into lower-paying positions offering less income security. Others have simply opted for more flexible, part-time working arrangements later in their working lives.
There is a clear attraction to getting the funds across to a more understandable benefit structure, even if you don’t take all the money out straight-away. And, what with the job shocks that many have experienced, they may even need to access some of that money from age 55 while remaining monies can be moved into an array of decumulation-orientated policies. Even if the DB scheme allows early retirement, it won’t allow the benefits to be segmented in this way.
After discovering in its October 2015 Thematic Review that only 47% of the transfer cases it reviewed adequately demonstrated suitability, the FCA fixed on hammering out and imposing new requirement on Pension Transfer Specialists (PTSs), providers and advisers, together designed to safeguard an increasing number of DB holders requesting transfer valuations.
The scope for customer detriment is of course very significant when transferring out of DB schemes as consumers risk giving up extremely valuable (percentage of final or average salary-based) retirement income guarantees and other difficult and expensive to replicate employer covenants. That customer detriment can quickly turn to adviser detriment if their recommendations were not fully-compliant and relevant, detailed records were not filed away securely.
We now know the bulk of the changes, laid out in the Policy Statement, centre around a new Transfer Value Comparator (TVC), sitting within a highly-comprehensive Appropriate Pensions Transfer Analysis (APTA) report. Both need to be in place by 1st October 2018. Other changes are effective from the start of this month.
Quoting from the Policy Statement on the new TVC:
“The purpose of the TVC is to provide consumers with some context for the level of their transfer value to help them make an informed decision. That context is the cost of providing the same benefits of the DB scheme but in a DC scheme.”
The assumptions that FCA have mandated for the TVC are ultra-conservative, like gilts minus 0.75% for roll up, and all clients buying an annuity with a 4% advice charge on retirement. This will make it very clear to anyone that is seeking a safe, stable, gently-rising income of the sort that DB schemes provide, that by far and away the best way to get this is to stay in your DB scheme. And indeed, the FCA has re-iterated its previous stance that “for most people keeping safeguarded (DB) benefits is likely to be in their best interests”.
With the Pension Protection Fund now well-entrenched in the pensions landscape, I think we have seen the end of transfers driven simply by a lack of trust in the sponsoring employer. Emotions may still run high, as big transfer exercises are often part of wider corporate upheaval including redundancies, site closures and sales of historic elements of a business. However, advisers which handle transfers for emotional reasons do so at their own peril. Recent experience shows they may be quickly put out of business by the regulator.
Interestingly, the TVC itself does not need to be personalised: “no allowance for individual circumstances, marital status or a desire to take tax-free cash,” needs to be made. However, it’s clear that the APTA fills that gap. Indeed, the two documents combined need to be designed to ensure that a much more comprehensive, personalised suitability reporting is carried out for those considering transferring out of their DB pensions.
The FCA pours a great deal of cold water on use of critical yield calculations which are at the heart of the outgoing TVA-based transfers regime. Critical Yield is the estimated investment return, after charges, that must be achieved in order to receive retirement benefits at least as good as those offered by a DB scheme. The FCA also states that where cash flow modelling is used, any limitations in the software are not an excuse to limit advisers’ responsibility for providing suitable advice.
Essentially, what the FCA emphasises throughout this Statement is that advisers should not place too much reliance on any specific software tool but instead focus on providing a personal recommendation based on a very thorough analysis of the would-be transferee’s personal circumstances and retirement income needs. They demand a clear-eyed focus on “a client’s financial situation and investment objectives, as well as their knowledge and experience in the relevant investment field.”
This is a real game-changer. Transfers are no longer going to be about whether the sum offered by the ceding scheme is good value. They are going to be about whether the shape of DC benefits fit the individual client’s needs better than the DB equivalents.
I believe the answer will often be ‘yes’ and can be demonstrated by a cash flow analysis tool. DB benefits are very back-end loaded. They usually increase, often at rates ahead of today’s low level of inflation. And yet a Finalytiq study proves that pensioner expenditure falls during retirement by around 1% per year in real terms.
Meanwhile, a DC pension can be front-end loaded - taking some cash at outset to pay off any remaining mortgages or loans, to replace a company car or to add a conservatory for those ‘pipe and slipper’ mornings. And then provide a higher pension in the early years of retirement when one is still fit enough for jaunts like taking the grandchildren on holiday.
The APTA is a robust way of demonstrating that a benefit reconstruction is being done to meet agreed client needs. Adviser firms will be responsible for ensuring the APTA is undertaken thoroughly and supports the personal recommendation.
Advice firms are held liable for the advice, even where it is checked by a third-party pension transfer specialist. Consequently, advisory firms must make sure that any software used in their transfer analysis is supporting their recommendation, not driving it.
The APTA has to look forward. FCA have woken up to the fact that taking a transfer value is not a point in time decision. It’s a commitment to a new way of life, underpinned by an investment and income withdrawal strategy, both of which will require monitoring over time. The APTA must bring both of these into play.
Communication aspects are clearly going to be tricky. The TVC will be conveying a clear ‘don’t do it message’. But it’s housed within an over-arching APTA that may say:‘we’ve identified your personal needs and found that transferring to DC is the best way of meeting them.’ Whatever you do, don’t take the short-cut favoured by lazy advisers of saying ‘this bit is only included to keep the regulator happy’ .
Successful advisers will be able to show clients how moving to the much more flexible structure of DC enables the large quantum of wealth tied up in their pension to be deployed in a better manner than the DB scheme was going to. Two further changes will make life more expensive for advisers: Firstly, TVC and APTA software suites can no longer be given away to advisers free of charge as software is now classified as an inducement. Already we are seeing major players like Standard Life pulling the plug on free TVA software well ahead of the 1st October changes. The FCA found some evidence it didn’t like in its review that providers were providing TVA tools free on the condition that any subsequent transfer business done using their tool needs to be done through them.
Secondly, advisers must consider the client’s workplace DC scheme as a potential home for the transfer value. Many workplace schemes accept transfers and often offer exceedingly low charges, negotiated with providers on grounds of scale. However, these policies are unlikely to facilitate adviser charging in the way that a SIPP or platform can. Apparently this has always been a requirement, but FCA have now spelled it out as not all advisers were giving consideration to workplace schemes.
Stiffening of the DB to DC transfers regime comes at a price. The FCA reckons the bill for making the changes will amounts to between £6.5m and £8.13m per year to market participants, and their Cost Benefit Analysis expects this to be passed on to consumers, who will benefit from the improved advice the new regime heralds.
Clearly there is a massive job on now for providers, advisers and PTSs to prepare for doing transfer business in this new, tougher regulatory regime. It remains to be seen if fully-compliant TVC and APTA documentation can be put in place by 1st October or whether we will see more market participants racing for the exit door.