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Pension transfers – how to ensure client understanding

How can you reasonably assume that the client understands the advice they are being given? Steve Bailey, director ATEB Consulting, points to COBS for direction and offers eight conclusions that can help advice firms achieve that client understanding  

Effective communication comprises three aspects. In walkie-talkie speak these would be

• Transmitting

• Receiving

• Understanding

It is obvious that for a communication to be effective, all three parts have to be successful. There is no point transmitting if nobody is listening. And someone hearing the message cannot be automatically assumed to have understood it. There is the, probably apocryphal, story from the 1914/18 war of a message being sent to say, “Send reinforcements. We’re going to advance!” but being received as, “Send three and fourpence, we’re going to a dance!” Post decimal currency readers might not understand the reference to three shillings and four pennies (around 17p in today’s parlance) but should get the point of the anecdote in confirming the importance of understanding in the communication equation.


The challenge for advisers
Which brings us to the challenge that the FCA has set for advisers in the pension transfer rules that came into effect on 1 October 2020. These introduced an obligation on advisers providing transfer advice to :

• explain the risks of proceeding with a pension transfer or conversion in a way the consumer can understand; and

• demonstrate that the consumer understood the explanation.


Meeting the challenge
That is all very well and it is doubtful that many advisers would disagree with the desirability of clients understanding what is being recommended, but clearly it is easier said than done. The difficulty is that ‘understanding’ is a bit nebulous. How can you ever know with certainty what is in someone else’s mind and whether they not only received your ‘transmission’ but actually understood the message.

Transmission happens in two ways during the advice cycle – verbally, pre and post suitability report and, of course, in the suitability report itself. Advisers need to have some means of presenting both the verbal and written communication in a way that can be reasonably assumed to have resulted in client understanding … but how can that be done?

 
The clues are there
Careful scrutiny of the rules and guidance around ‘understanding’ COBS throws up a number of clues.

COBS 9.4.12 refers to the one-page summary that clients now have to sign but it is clear from other rules (see below) that a signature here is not of itself sufficient to demonstrate understanding. This rule also makes specific reference to COBS 9.4.11R(2)(d). This relates to the transfer risk factors in COBS 19.1.6 (4) b), namely: 

“Firms should assess the retail client’s attitude to, and understanding of the risk of giving up safeguarded benefits (or potential safeguarded benefits) for flexible benefits, taking into account the following factors:the risks and benefits of staying in the ceding arrangement;

the risks and benefits of transferring into an arrangement with flexible benefits;

the retail client’s attitude to certainty of income in retirement;

whether the retail client would be likely to access funds in an arrangement with flexible benefits in an unplanned way;

the likely impact of (iv) on the sustainability of the funds over time;

the retail client’s attitude to and experience of managing investments or paying for advice on investments so long as the funds last; and

the retail client’s attitude to any restrictions on their ability to access funds in the ceding arrangement.”

See Conclusion #1.

COBS 19.1.1D refers to the suitability requirements detailed in COBS 9 and specifically to the need to assess a client’s knowledge and experience (K&E). This assessment should not be done for its own sake, it should inform the way that the adviser approaches the client throughout the advice process. COBS 19.1.1D includes the following guidance …

“When a firm is obtaining evidence as to whether the client can demonstrate that they understand the risks involved in the pension transfer or pension conversion, it should tailor its approach according to the experience, financial sophistication and/or vulnerability of each individual client.”

… and also states that each firm should make a clear record of the steps it has taken to satisfy itself on reasonable grounds that it has adequate evidence of the client’s demonstration of their understanding of the risks.

See Conclusions #2 and #3.

COBS 19.1.9A R and COBS 19.1.1C R(5) require a clear record of the evidence on which the firm is relying to demonstrate client understanding and a record of the steps taken in obtaining and assessing that evidence. There is also clear guidance on how firms should proceed if it is not possible to evidence client understanding. Like all records relating to transfer advice, evidence of understanding needs to be retained indefinitely.

See Conclusion #4.

GC 20/01 includes this example of good practice in the triage process.

“A firm directs potential clients to an online triage presentation where each client has a unique log in so the firm can monitor how each individual interacts with the presentation. The presentation is interactive and requires users to answer questions to demonstrate their understanding of the content. The firm does not contact the client again and only gives advice if the client gets back in touch and has completed the online content. The firm then uses the answers to the questions to understand each client’s level of knowledge and manage their misconceptions.”

The key here is the interactivity and being able to evidence that.

See Conclusions #5 and #6.

The guidance also refers to the need for advisers to challenge clients when appropriate. For example, a client may not necessarily inherit a parent’s health condition, where these are not genetic, and may not have the same working conditions.

Or the client may have conflicting objectives and these need to be resolved. The guidance makes the point that:

“Sometimes, this will mean giving them a message they do not want to hear. For example, if a client wants to retire early and draw income, the fund will be depleted sooner. This means that another objective, for example, maximising the potential pension legacy they pass to their dependants on death, may not be met. You should explain these trade-offs clearly to your client. With your help, they can prioritise what is important to them, which will help you make a suitable recommendation to them. Your role is not to take orders. You need to make sure your client understands what they can realistically achieve.”

See Conclusion #7.

Guidance around ‘attitude’ questions makes clear that the questions should not lead or mislead clients. Firms should have a range of balanced questions so that they get a spread of responses from different clients. If most of the clients answer each question in the same way, it is likely that the questions should be reviewed. 

Firms should also ensure that questions are not biased so as to steer the client towards answering in a certain way. The FCA stated:

“If you ask, ‘do you want flexibility and control?’ you are unlikely to get enough information to understand whether your client is more suited to safeguarded benefits or flexible benefits.”

The guidance encourages greater use of open questions. If you ask, ‘how would you feel if your pension pot didn’t grow as expected and you had to take less income from it so that it would last?’ the client is more likely to explain what is important to them.

Good practice example

“A firm devised a bank of open questions to ask the client to check their understanding of the advice given. Only questions that were relevant to each client were used, for example, a question on the client’s understanding of how the lifetime allowance affected them was only asked of relevant clients.

The firm also asked the clients to explain what might make them regret their decision, as the firm thought this question was an indicator of the client’s degree of comfort with the proposed transaction. The firm documented each client’s answers.” 

Poor practice example

“A firm used a tick box form for a client to complete and sign to confirm that they had read the suitability report and understood the contents.”

See Conclusion #8.

Our conclusions

Conclusion #1
Firms must have a formal method of assessing the transfer risk factors. In our experience, many firms do not have an adequate transfer risk assessment process.

Conclusion #2
Firms must have a formal method of assessing the client’s knowledge and experience. Again, firms’ K&E assessment often falls short of the requirements in the rules and it can be difficult to see how a particular K&E assessment has altered the firm’s approach to that client in discussions or the suitability report. 

Conclusion #3
In addition to having the evidence of client understanding, firms must have a record of steps taken to achieve that – i.e. a checklist.

Conclusion #4
In addition to confirming conclusion #3, the rules also confirm that firms need to log the steps taken to obtain evidence of understanding even if they were unable to evidence it AND explain why the firm proceeded with the recommendation regardless. We think this scenario should be one for firms to AVOID. If you can’t demonstrate that the client understands your recommendation, it is risky for both the firm and the client to proceed with that recommendation. 

Conclusion #5
External or internal online (i.e. with no firm involvement in the process – client does it alone) video or presentation with inbuilt ‘self-test’ process that is logged could help evidence understanding of the tested aspects. Firms need to undertake appropriate due diligence on the process to assess what the video covers / misses in relation to the transfer risk factors.

Validated output from the process should be retained on file to support evidence of understanding. The process would ideally also have verification checks such as time spent by the client in each area so as to identify where a client might have simply ticked quickly through the process.

Conclusion #6
Any apparent conflicts or misunderstanding arising from such an external process or the internal transfer risk, K&E and ATR processes should be challenged, discussed, resolved and documented. 

Conclusion #7
Similar to #6, any misconceptions arising in relation to relevant aspects of KYC should be discussed and documented. Advisers should challenge and clarify any conflicting ‘objectives’ and ensure the client understands any trade-offs that might be required. 

Conclusion #8
All KYC docs should record the answers to open questions that are not leading or misleading. A ‘how would you feel if’ question with free text recording of the client response is better than the same question with a tick list of optional answers. 

Bonus Conclusion #9
What about the suitability report? How can it aid evidence of client understanding?

We would suggest that the report should include all the standard suitability and COBS stuff but should also: 

– Be as short as possible;
– Not contain reams of padding;
– Be client specific at every opportunity;
– Avoid jargon or explain it in clear plain English where it must be used 
  and using language generally that is reasonably appropriate to the 
  client’s assessed K&E level;
– In particular, should include a clear and balanced explanation of key 
  metrics such as transfer value comparator and the critical yield such 
  that the positive and negative implications of these are likely to be 
  understood by the client. It is not sufficient merely to state the 
  figures.

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