DB pension transfer – consideration of death benefits and life cover
Consideration needs to be given to life cover options when firms are assessing suitability of a DB pensions transfer, says ATEB Consulting’s Steve Bailey.
We often see death benefits cited as a key objective by clients when discussing potential transfers out of a Defined Benefit (DB) scheme. Given the changes around taxation of pension benefits before age 75 (DC benefits would essentially be tax free), this can seem an attractive option to clients, particularly where there are existing health issues. However, the Financial Conduct Authority (FCA), has published findings and guidance around death benefits and outlined their expectations as to how to approach this with clients.
FCA Findings – British Steel
As part of the findings of its supervisory work around the British Steel Pension Scheme, the FCA made specific reference to the lack of focus around death benefits being a driver behind unsuitable, including the following:
• Prioritising the provision of ‘death benefits’ for spouses and dependants in the event of the client’s death without exploring alternative options (e.g. existing DB scheme benefits or an insurance policy). Firms also failed to take into account the risk that the flexi-access funds could be depleted by the time of the client’s death.
• Recommending a transfer because the client wanted immediate cash and income in retirement and to leave residual funds as a legacy without considering or demonstrating to the client the impact that achieving one objective may have on the client’s other objectives.
• Failing to consider the client’s actual health, as opposed to the client’s perception of their risk of early death, which may often solely be based on the early death of family members, many of which could have been due to lifestyle or environmental factors that do not apply to the client.
FCA – Guidance for firms during Covid-19
More recently, the regulator has provided an update around how firms should communicate with clients, addressing potential misconceptions that clients may have around death benefits within DB schemes , notably:
‘Death benefits will be better in a DC scheme’. Firms must adequately consider how death benefits are provided by the DB scheme and the proposed DC arrangement throughout retirement. They should also consider alternative options, such as term life insurance, and any tax implications, especially if a client has a life expectancy of under 2 years.
Understanding death benefits within the scheme
The starting point for any consideration of death benefits is to understand what death benefits will be provided within the scheme. Clearly, this will vary from scheme to scheme. Typically, as a minimum, most schemes offer a spouse’s income of 50% or more. However, some schemes offer more generous death benefits and this may include a children’s pension or perhaps provision of a guarantee period where full pension benefits are payable for a minimum period or a lump sum. Trustees may also have the discretion to provide a pension to non-married partners.
That said, there may be instances where scheme benefits do not meet the needs of the client or the different death benefit profile of a drawdown plan might still be desirable having considered what is available within the DB scheme.
Consideration of Alternatives – Life Cover
In order to approach death benefits in a comprehensive manner, any discussion should involve clarifying the client’s objective for wanting to increase death benefits and outlining whether this is driven by provision of benefits to the client’s spouse, other dependants or both. Clearly, client circumstances will dictate which potential alternatives are appropriate for consideration in relation to death benefits. However, in line with the regulators view that “a firm should start by assuming that a transfer, conversion or opt-out will not be suitable” As such, we would typically expect files to consider a range of different options which could potentially achieve the client’s objectives in relation to death benefits, including (but not limited to):
• Existing assets – Using existing assets in combination with the death benefits provided by the scheme;
• Partial transfers and/or transferring one scheme – where a partial transfer is available or the client has more than one scheme;
• Partial transfers – Retaining benefits of one scheme whilst offering:
• Whole of life insurance – this could potentially be funded by receiving ongoing income from the scheme;
• Term assurance – as above but, but instead consider a short term life insurance to protect against death until other income sources become available;
• Term assurance – to cover any genuine legacy concern during an interim period until a decision to transfer is reconsidered nearer to scheme NRD or the date when the client wishes to start drawing benefits.
In relation to life assurance products, files should reflect the level of research that has been conducted into different options. And it is important that the options have been seriously considered rather than just done as a compliance tick box exercise.
First, there needs to be lateral thinking about the sum assured that is appropriate. Bearing in mind that, for example, a whole life plan would be a means of providing a legacy while remaining in the scheme, it is arguable that it is not necessary to cover the entire CETV amount as a sum assured.
In the event of death, scheme benefits would be payable and the ‘value’ of these should be considered when assessing an appropriate sum assured. In addition, the drawdown fund might well reduce significantly by the time of anticipated death of the client. The sum assured should take account of that too.
We see cases where life cover options have been researched but not evidently actually discussed with the client. What happens in these cases is that a paragraph, usually standardised, is included in the suitability report stating that the life cover option has been considered and discounted because the premium of £X (frequently not even the lowest premium from the research) is considered too expensive. Clearly, at the time the report is prepared, the client has a) not yet been made aware of the cost and b) has not had the concept of protecting a legacy by this means adequately discussed/explained. Simply discounting a whole of life plan because the adviser considers it too expensive or sees the transfer route as an easier pitch is unlikely to be viewed as having been robustly considered!
Clearly, each case should be addressed on its own merits, and there are several additional factors which need to be considered including client health, age of the client and their spouse, marital status and entitlement to death benefits within the scheme, other assets available, existing life cover in place, number of dependents and family history. Furthermore, where income is required in retirement, then this will clearly have an impact on the level of benefits which the client could pass on on death, and this should be reflected through cashflow modelling, as should the cost of any life cover. The legacy of the residual fund may turn out to be more illusion than reality.
There’s an old truism in financial services that nobody wants more life insurance! But what we are talking about here isn’t ‘insurance’, it’s a viable alternative to meeting a client objective without transferring and needs to be presented in that context.
The FCA has previously raised a number of concerns around how some advisory firms approach DB transfers in relation to death benefits and it is likely that this will be an ongoing area of scrutiny.
We suggest that where legacy is an objective for the client, files should clearly demonstrate consideration of all the options available and the level of research into these options including quotations for different forms of cover.
Firms should also make clients aware of the impact that income taken (on transferring from the scheme) would have on the client’s ability to pass on death benefits, as well as reflecting the impact of paying different forms of life cover within cashflow model projections.