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Percival highlights key areas in Defined Benefit Transfers suitability

With the Financial Conduct Authority (FCA) continuing to find problems in the DB transfers market, Rory Percival provides an update on the policy developments, the FCA’s thinking and potential for new rules to come in

The FCA introduced new rules and guidance in its Policy Statement in March 2018 and has also included further assessing suitability guidance in the new Consultation Paper. In this article I focus on the assessing suitability guidance in the two papers.

The new guidance means that firms should consider the following factors:

The client’s intentions for accessing pension benefits

Suitability is all about meeting the client’s objectives and hence understanding about the client’s intentions for accessing pension benefits is fundamental to this. This is a key area to explore at the fact-finding stage. Files which record the client’s objective of ‘flexibility’ without any colour and detail are simply inadequate. They do not clearly demonstrate that the transfer is in the client’s best interests and hence do not meet FCA requirements. At an event recently, the FCA Supervision team highlighted that it had found basic lack of detail about the client’s circumstances and objectives.

You need to ensure that the advisers discuss, and record, what objectives the client has and, where there is a need for flexibility of income and/or taking ad hoc lump sums, then this needs to be covered.

The client’s realistic retirement income needs

You should establish at the fact-finding stage what the client’s retirement income needs are and the handbook adds that you should consider:

(i) how they can be achieved

(ii) the role played by safeguarded benefits (or potential safeguarded benefits) in achieving them

(iii) the consequent impact on those needs of a transfer, conversion or opt-out, including any trade-offs

In my opinion this is a key area and touches on the importance of what I refer to as ‘core secure income’. Core secure income includes state pension, DB benefits, annuities, guaranteed third way products and, possibly, good quality rental income (although this is not as secure as the other sources in this list).

When establishing the client’s realistic retirement income needs, I suggest establishing their fixed outgoings and discretionary spending plans. Although this may involve some discussion and assistance to the client with calculating this, it is essential to obtain this information for two key reasons: in order to meet the requirements of COBS 19 to consider how the income needs can be met and also to assess whether the recommendation meets the client’s capacity for loss.

Having established the client’s retirement income needs, you need to consider how this income is going to be met. Having adequate core secure income at least to cover the client’s fixed outgoings – but preferably their discretionary spending as well – puts the client in a very secure financial position. They know that, whatever happens, they have enough money to live on.

My interpretation is that the FCA consider core secure income to be an important factor in suitability. If the DB scheme is needed to provide this core secure income, then this is a significant factor to take into account when assessing the suitability of the transfer.

Considering alternative courses of action to meet the client’s objectives

This requirement in the Handbook stems from the FCA’s view that DB scheme benefits are valuable and that a transfer should only be recommended when it is clearly in the client’s best interests. Hence the FCA expect advisers to consider other ways of meeting the client’s objectives and maintaining the DB scheme.

The file should demonstrate that alternative options have been considered – and considered genuinely – not just going through the motions and ticking the box. There may be occasions where it is useful to summarise these in the suitability report but you should avoid routine coverage of alternatives discounted.

Attitude to transfer risk

This is a new expression and unfortunately named as it is entirely separate from the client’s attitude to (investment) risk (ATR). You should therefore treat it separately from your risk profiling process. The attitude to transfer risk is about the client’s attitude towards the features of the DB scheme benefits and certainty of income versus the flexible benefits approach. Specifically, the FCA refer to assessing the client’s attitude towards:

• the risks and benefits of staying in the safeguarded benefit scheme

• the risks and benefits of transferring to a flexible benefits scheme

• the client’s attitude to certainty of income throughout retirement

• whether the client is likely to access funds in flexible benefits in an unplanned way, and the impact of that on the sustainability of the funds over time

• the client’s attitude to any restrictions on their ability to access funds in a safeguarded benefits scheme

• the client’s attitude to and experience of managing investments themselves or paying for them to be managed in a flexible benefit scheme.

I suggest firms turn these into a set of questions as part of their fact-finding process. Further, I suggest they are summarised in the suitability report in a section after summarising the objectives. It is probably better to head up these sections ‘Security versus flexibility’ rather than attitude to transfer risk which is jargon.

Future new rule

The policy papers include a range of other changes, including the proposal that recommendation to stay in the DB scheme should involve a suitability report to explain the recommendation. I think it is good practice to do this irrespective of the proposed FCA requirement. If this becomes a new rule – which I think is very likely – I anticipate that it will come into effect late this year or early next year.

Overall, the policy changes are wide-ranging but sensible changes. The Policy Statement following the new Consultation Paper is due this Autumn.

Rory Percival has recently published ‘An ex-regulator’s guide to defined benefit transfers suitability and controls’. For more information click here.

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