PS16-12 compliance – lifestyle funds, suitability and pensions transfers
ATEB’s Steve Bailey looks at key areas of the FCA’s 111-page policy statement PS16-12, including the final rules and guidance and recommends action to be taken by adviser firms
Following the introduction of pension freedoms in April 2015, the FCA undertook a thorough review of their regulatory requirements to ensure that they were adequate. They also issued Consultation Paper CP15-30 to gain industry views on proposed changes to rules and guidance.
Policy Statement PS16-12, published in April 2016, summarised the responses received and included final rules and guidance. At a whopping 111 pages it is not a quick read but it is a recommended read for anyone involved in advising on retirement options, including transfers from Defined Benefit or safeguarded schemes.
There are some new rules and some amendments to existing rules. Most of the new rules cover illustrations and communicating with consumers about the options available to them. These rules apply to providers and will not take effect until October 2016 or April 2017 in order to allow enough time to make the necessary changes to systems and literature.
The aspect of Lifestyle Funds, although directed at providers, should be noted by advisers. Primarily concerned with the communication to consumers around the appropriateness of a default lifestyle fund following the pensions reforms, advisers will undoubtedly come across clients who have pension plans with default lifestyling kicking in automatically at, say, age 60. This might no longer be appropriate, given the options now available to clients, and is something for advisers to note.
The paper reminds firms involved in debt counselling or collection that rule CONC 7.3.10 states firms must not pressurise customers who are in arrears or default on borrowing. Additional guidance states that pressurising a customer to access a lump sum payment from his/her pension plan in order to repay debt would contravene CONC 7.3.10.
The remainder of the rule changes and guidance revolve around the pensions advice process and took effect on the day the policy statement was published, namely 25 April 2016.
Advice and suitability
COBS 9.3.3 G has been amended to explicitly require uncrystallised funds pension lump sum (UFPLS) to be considered when advising on pensions options. The guidance now reads:
When a firm is making a personal recommendation to a retail client about income withdrawals, uncrystallised funds pension lump sum payments or purchase of short-term annuities, it should consider all the relevant circumstances including:
1. The client’s investment objectives, need for tax-free cash and state of health;
2. Current and future income requirements, existing pension assets and the relative importance of the plan, given the client’s financial circumstances;
3. The client’s attitude to risk, ensuring that any discrepancy is clearly explained between his or her attitude to an income withdrawal, uncrystallised funds pension lump sum payment or purchase of a short-term annuity and other investments.
A suitability report is required where a personal recommendation is made and the client will elect to take income withdrawals, a UFPLS or to purchase a short-term annuity. The report should, in explaining the disadvantages, highlight the relevant risk factors. These include –
• the capital value of the fund may be eroded;
• the investment returns may be less than those shown in the illustrations;
• annuity or scheme pension rates may be at a worse level in the future;
• the levels of income provided may not be sustainable; and
• there may be tax implications.
The Policy Statement devoted eight pages to issues around the part that transfer value analysis (TVAS) plays following the reforms, the difficulties posed by insistent clients and a few other transfer related matters. The concept of ‘insistent client’ is not actually referred to in the FCA handbook although Factsheet 035 offers some guidance on how to deal with insistent clients.
With regard to TVAS, the regulator acknowledged that there is a view held by some that TVAS is no longer appropriate post April 2015. The main argument put forward is that the TVAS compares scheme benefits with the yield required in order to buy a matching annuity and, following the reforms, most clients will never buy an annuity so critical yield is now meaningless!
The FCA’s conclusion was essentially that they could not reach a conclusion and that they will be doing further work to examine how best to tackle this and other aspects of advising on transfers.
However, while recognising that current TVA comparisons are unlikely to be helping consumers to make informed decisions, the FCA believes that it is the volume and complexity of information that might put consumers off reading the TVAS. There are questions around the value of ‘excess’ information that is not key to the transfer decision, such as the comparison with Pension Protection Fund. But the regulator did not suggest that the basic critical yield comparison was no longer relevant. They still believe that, as the actual outcomes of a decision to transfer might not be known for many years, the focus on ensuring that consumers understand the value of what they are giving up remains appropriate.
Meantime, the FCA stated, “We do not see any case for moving away from client’s best interests as a starting point for advice.” (The current starting point when assessing the suitability of a transfer from a DB to DC is that it will not be suitable, unless it can be shown to be in the client’s best interests.)
The introduction of the pensions reforms in April 2016 created difficulties for the FCA in ensuring an appropriate level of consumer protection while not getting in the way of the Government’s desire to give more flexibility to people on how and when they can take their pensions benefits.
The reforms also created difficulties for advisers who were faced with a sudden deluge of clients tempted by the newly granted freedom to access their pension fund but still constrained by the starting point that a transfer is not suitable.
We firmly believe that the insistent client route should only be taken in exceptional circumstances.
The rules and guidance have changed but there could be more change to come. Meanwhile, advisers need to ensure that they cover the UFPLS option in suitability reports and discussions with clients as, in some cases, this will prove to be a more tax effective way for clients to draw funds from their pension plans. And it will be prudent to watch out for clients with an automatic Lifestyle option in their pension plan and consider whether that is still appropriate.
Otherwise, the basic suitability requirements remain firmly in place:
• Transfers can be recommended only if it can be shown to be in the client’s best interests;
• A TVAS comparison is still required.
• Make sure that your advice covers the UFPLS option
• A TVAS comparison on a relevant basis and using accurate assumptions must be obtained
• Ensure that your suitability report covers disadvantages and risk factors
• Watch out for clients with Lifestyle options.