Following the sweeping changes to pension legislation, combined with financial adviser concerns over compliance and PI cover in the area of Defined Benefit Scheme transfers, I thought I would give my two pennies worth of thoughts on the matter.
Presently, we appear to review a DB scheme and take future responsibility if we advise a client to transfer and should walk away if we advise them not to, even if they listen to our advice, but wish to proceed anyway.
I think this issue goes to the heart of the claims culture that has increased in this country and the cause of paralysis amongst competent and experienced financial advisers who are turning down clients in fear of future regulatory and financial burden.
As the system is currently arranged, we are correct to be fearful and to tread extremely carefully, however I feel we should move to a situation where financial advice is only counsel – unbiased, in-depth counsel with a client to give our professional opinion and best thoughts on the risks and rewards trade-off, the pros and cons of the options available, with the final decision and ultimate responsibility for the outcome resting with the client.
I personally feel that if you have properly advised someone of the potential consequences of their decision to transfer from a DB scheme and then after giving your advice some thought, they elect to overrule your advice in favour of a transfer, then it seems perfectly reasonable that we should be able to conduct the transfer without fear of a future financial claim, or a regulatory telling off and pilfering of pockets using the benefit of 20:20 hindsight we do not possess when providing the original advice.
Many of the issues with DB scheme advice yet again relate to adviser charging structures. How can we provide an in-depth and truly unbiased analysis of the scheme in relation to an individuals personal circumstances if our earnings are dependent upon the client transferring that scheme?
Unfortunately we can’t and if we continue with the path of commission wrapped up as fees, i.e. transaction based charging models, we will always have firms or individual advisers that are blinded by the lure of short-term earnings, without giving due regard to the long term implications on both the client and the firm. Whilst as a firm you may feel that you are doing everything correctly, there is likely to be a firm out there who isn’t and we all suffer the consequences through subsidy of failure (FSCS levy), increased regulatory burdens that tend to be bureaucratic in nature (costly and dull) and reputation damage through the press (an elderly person becoming impoverished by a slick talking man in a suit is always going to cause outrage, and therefore will always be newsworthy).
There is a red herring in relation to charging fees irrespective of a transaction – the ability and willingness for a client to pay our rather high fees for advice in this field.
Firstly, each adviser will have varying levels of salesmanship and marketing skills to be able to express how important it is for unbiased and non-transaction related advice and that one should be charged accordingly. This will inevitably mean that some will be more reluctant to take this approach than others purely from the need to earn a living.
Secondly, depending upon the type of client you have, there will be varying levels of ability to actually pay the fees charged without taking it from the pension pot at the point of transfer. It is all well and good charging separate fees to a well off family, but what about an average person who happens to have the majority of their savings in the DB scheme and their monthly expenditures are largely taken up by a mortgage? As well as the financial difficulties involved, I think it is psychologically more difficult paying someone thousands of pounds in fees from your bank account as opposed to paying these fees from a pension pot that appears more remote to the general public.
Putting aside the difficulties of how to charge, there are numerous challenges just to provide the correct advice, the majority of which can be summarised under uncertainty.
As I have outlined in my previous ramblings on uncertainty, despite our best efforts we are entirely incapable of predicting what will happen in the future and therefore much of our analysis is based upon projections that are built upon a shaky foundation of assumptions – one can only assume that at least one of these assumptions will be turn out to be incorrect and it is obvious to predict that in some circumstances, our advice based upon these projections will be simply wrong.
Our analysis is based upon projections that are built upon a shaky foundation of assumptions.
The uncertainty of the outcome
Whilst we quite rightly start from the premise that a defined benefit scheme offers the client a higher degree of certainty of income than a defined contribution scheme, these schemes haven’t eradicated the risks of miscalculation, increasing longevity and poor investment outcomes. They have simply been transferred to the scheme level and if these risks materialise, they will present themselves in different ways:
- Declining profitability of companies operating these schemes, as they need to divert income to honour past promises made. This may result in your clients losing their jobs?
- An increasing desirability for higher levels of inflation across the economy to erode the liabilities without the need for difficult negotiations with unions etc. This may result in your client becoming financial poorer in the future, without fully understanding why.
- In the event of a scheme collapsing, the PPF offers limited protection and in future, the PPF comes under increased pressure and has to dilute it’s protection across the members.
- Finally in an even more disappointing situation, the PPF could require further subsidy from the industry, increasing charges that a client suffers elsewhere or increasing taxes that a client will need to pay as the PPF needs government subsidy in the future. (I know that there isn’t an explicit governmental guarantee for the PPF, but there wasn’t for the banks either – How will a politician react if that situation occurs on their watch?)
So whilst we can say that at an individual level a DB scheme offers a more secure and certain income, it is unwise to give the impression that these schemes are immune to the risks of poor investment returns, uncertainty and misjudgment.
At an individual level the advice is fraught with difficulty:
Whilst important, it is essential to understand that they are projections based upon wide ranging assumptions on interest rates, inflation rates and investment returns, none of which can be accurately predicted in any of our clients timescales for the outcome of this advice.
We may give the ‘correct’ advice to transfer a scheme in relation to an individual’s personal situation, yet if future investment returns turn out to be poor, the actual future outcome will not be satisfactory. Does this then make the advice to transfer ‘incorrect’?
Flexibility and control of the fund.
Whilst we portray this as a positive in favour of DC schemes (which it is), if this flexibility is used to either spend too much as income in the earlier years of retirement or enter investments that turn out to be unfavourable, then again the actual outcome isn’t satisfactory.
What is mathematically and financially the correct decision may not be right from an individual standpoint.
Say we ‘know’ that a scheme will provide a higher level of income in the future and we again ‘know’ that a client will live until they are 95 years old. We calculate that the scheme in this circumstance will provide an extra £100,000 to the client over the course of their lives. In this scenario advice to transfer would appear wrong, yet what if personal choices override the mathematics or long-term financial implications? What if they have a need to pay off their mortgage because they have lost their job? What if they have the desire to start their own business?
Perhaps our emphasis on long-term mathematical projections, combined with our fear of redress leads us to give inadequate weight to a client’s life when assessing the many factors of our advice? What is ‘correct advice’ in this regard? Perhaps it is not always the optimal financial decision.
The desire for enhanced death benefits.
I expect this will prove popular but correct advice is again extremely difficult.
It is worth starting with my belief that the vast majority of retirees will not be leaving very much, if anything, to their families in the event of their death. The combination of increasing longevity and the desire for income negating the benefits offered by compound interest is highly unlikely to result in much opportunity for generational wealth planning.
It will sound like a great benefit in favour of DC schemes, and please don’t misinterpret me these are positive developments in pension legislation, but whilst I expect it will be used as a reason to transfer in so many cases, very few will actually benefit from it, simply because the clients need to die young. (LTA approaching pension pots excluded).
Finally, when considering a transfer for improved death benefits, don’t forget about Life Assurance. This could well provide the twin benefit of a DB scheme inflation linked income with some capital for the family in the event of death.
As an aside, I feel it is worth discussing here that the structure of DB schemes transfers wealth (or claims on wealth) from the dead to the living. I’m not entirely certain that is the best way for wealth to be transferred.
Take an example of a poor family who’s father has a defined benefit scheme with a CETV fund of £50,000. Now like many modern families this ‘family’ is divorced with the two young adult children living with their mother (perhaps on benefits). The father has a car accident and unfortunately passes away at the age of 50. He worked hard to accumulate that £50,000 entitlement and yet he never received a penny of that promise made to him. Not a Penny! This £50,000 entitlement is taken up by the scheme to make payments to other members who live a long life. When you consider that increased longevity tends to coincide with a higher standard of living (i.e. financial better off), the defined benefit scheme can create a situation whereby we transfer wealth from poorer people to richer people. Surely the children, in desperate need to break the cycle of benefits that befalls so many families could use this £50,000 for education or business venture. Notwithstanding the moral implications of how we have structured DB schemes, the economic implications could result in more wealth going to non-productive members of the economy, when they could go to sections of the economy that are desperate to become productive (i.e. the young and unemployed). In my opinion the death benefits of DB schemes need restructuring, however I concede that in light of the financial position many are currently in, I am doubtful this would ever happen.
At least with a DC scheme, the value represents assets and is actually yours and your families. It is worth bearing in mind that a DB scheme is only a paper promise that offers benefit for members who live for a long time.
There are no doubt many more uncertainties and circumstances that require consideration from an advisory perspective, all of which will be challenged by the uncertainty of the future. In light of these uncertainties and the present advisory situation in relation to DB schemes, I feel I should propose some ideas that I feel may help.
Advice can be paid for out of all schemes through a voucher system. This will help clients pay for advice in the event that they do not decide to transfer.
Furthermore ANY adviser qualified to provide advice could redeem this voucher at the client’s instruction. This removes the relationships between schemes and certain financial advisory firms. These relationships can be unhelpful from an advisory perspective, for instance what if the scheme are encouraging transfers by financial incentives to remove their future burden? An advisory firm solely reliant upon this scheme’s introduction for their income is not as likely to talk down a transfer and risk upsetting that relationship, as firms that only receive the odd enquiry assurance. This could well provide the twin benefit of a DB scheme inflation linked income with some capital for the family in the event of death.
All parties work on a code of good practice in relation to advice in this regard. This will include FCA, FOS to help provide some degree of regulatory certainty and improve the situation with PI Insurers.
Advice is regarded as counsel and is separated from the transaction. This ensures that an adviser can provide an unbiased report and discussion on this subject, with the final decision resting with the client. We only provide our professional opinion based upon a full consideration of the facts and circumstances. It could never be a final ‘I recommend you do this or not’ as we embrace the uncertainty of the final outcome no matter which route we choose.
This should then result in us being allowed to conduct the transfer if the client, after full acceptance and understanding of our advice, elects to overrule our counsel. They are adults after all are they not?
We are moving into dangerous territory where we could be viewed as controlling what clients do with their money and as a result their life.
Plead with them that they are making the wrong decision. Tell them you would like to explain some risks of this decision again. Telling them to go away because you don’t agree with their decision and fear the regulatory backlash? For me that isn’t very helpful.
Under the present system, this is the right thing to do. As an example, what if they go elsewhere and transfer to a DC arrangement but then the investment doesn’t turn out to be as sound as your own proposition, surely by turning them away you could in fact worsen the situation?
It is clear that the current system for advice and fear of redress is not resulting in a positive client outcome. The need for advice in relation to DB schemes has never been so great and it is imperative that this advice is taken up by mainstream, experienced and professional financial advisers and not left to the segments of the industry that are more willing to promote a DC transfer for financial gain.
Let’s face it we will all suffer the consequences of this ‘advice’ anyway so let’s try and take control of it.