Is a third of all transfer advice unsuitable?
That's what the FCA is telling us from the evidence of its file searches. This is shocking - if it's true. We would like to understand better what's really going on. So should financial journalists.
Less than one fifth of transfers have been suitable, according to the data. Though grist to the mill of transfer opponents, this should strike objective observers as odd. Economic advantage alone suggests a very high proportion of done transfers would have increased utility. Most with no obvious advantage should have been eliminated at the 'triage' stage. Many more genuine opportunities will have gone begging out of inertia or ignorance - or even negative publicity.
Economic advantage, though not sufficient, stems from the member's risk tolerance being greater than the scheme's and from real discount rates being negative. Both are likely to apply widely given the level of derisking that has occurred in DB schemes. The implications are that the FCA approach is biased in principle (valuing safeguarded benefits regardless of their cost); that its prescribed advice process has not been efficient at measuring economic advantage; that its file searches are risk-based rather than representative. What cannot be concluded is that the FCA has provided evidence of widespread misselling, not just technical shortcomings in process but rather causing actual harm.
We will reserve for a separate article the question of whether the FCA's new changes to the prescribed process are likely to achieve their objectives. Some changes, notably triage and contingent charging, are still in consultation so we have an opportunity to respond formally.
Why does evidence matter?
The FCA blamed evidence of unsuitable advice for its decision to reverse its consultation-stage proposal to adopt a neutral position on transfers. (It has been careful in its published papers to avoid describing them as 'missold' - though this would apply to scams which have been less prevalent than many feared.) Previous to the Pensions Freedoms, and until the recent consultation, the FCA's rules required a starting point for advice that giving up the 'safeguarded' benefits of a final-salary pension scheme was unlikely to be in a client's best interests. Switching to a neutral starting position, as proposed last summer, would have removed the defence provided by a default of advising a client to retain these benefits, a bedrock on which most financial planners and pension advisers were happy to rely - until, that is, the effect of pension schemes derisking and real interest rates turning negative meant that transfer values genuinely offered greater utility or benefit for many scheme members. Now that the FCA has decided to go back to a presumption of lower utility from transfer, advisers will have to work hard to justify customer behaviour informed by conclusions based on mathematical calculation of economic advantage. Nowhere is this better captured than by the warning to advisers that they may satisfy the 'objectives' of clients while failing to satisfy their 'needs'. This is not casual language: it points to significant belief differences.
At one level, nothing much changes, because advisers were always mindful that any absence of bias only helped them if it was shared by the Financial Ombudsman Service, as this is where advice normally gets tested. Unless, that is, the FCA is doing its own file testing. Which it is.
But this is not the only change of outcomes after the consultation. The FCA has also adopted the position that the negative starting point does not in fact provide a defence for advising retention of DB pension rights. It believes that advice to retain or transfer requires exactly the same standards of analysis, following its prescribed format in the new rules and culminating in a personal recommendation. Arguably, this change has greater practical impacts on consumers and the advice industry than the change in initial presumption. We cannot fault the logic and as advisers we might be expected to welcome a new fee source. Yet it feels wholly impractical. It exposes consumers to higher costs without equivalent benefit; it will encourage agency risk aversion (including by advisers' PI insurers) that makes access to advice harder to obtain; it will test the industry's already stretched capacity.
It is not obvious that the FCA's attitude to DB to DC transfers is consistent with what Parliament intended when it decided in 2015 that drawdown, not an annuity, should be the default assumption for taking personal pension benefits. Parliament changed its implied view of the supreme value of safeguarded benefits, after recognising its cost and consequences. The FCA appears not to have done so.
If the changes announced by the FCA a week ago genuinely reflect its findings from conducting its own file checks on transfers, the nature of the evidence matters.
What is the evidence?
Lots of us working in pensions have been shocked by the FCA's statement in its new consultation, CP 18/07, that its working assumption is that 30% of all pension transfers have been unsuitable. "Our supervisory work found that 17% of advice to transfer was unsuitable. The work also found that, for a further 36% of cases, firms failed to demonstrate whether the advice to transfer was suitable. It is likely that a material proportion of this advice would have also been unsuitable. Therefore, we have assumed that 30% of transfer advice is currently unsuitable. We have no evidence of unsuitable advice not to transfer." We know there are bad advisers and even some scammers but this implies widespread shortcomings relative to all other areas of financial advice. And this in spite of the fact that transfer specialists are individually amongst the highest qualified and that transfers are under the closest internal compliance scrutiny. There are reasons to be mystified. So we dug a little deeper.
The data referred to above dated from a news release in October 2017, covering a total of 88 file checks performed by the FCA since October 2015. The 30% figure quoted above for presumed unsuitable, note, was not part of the release in 2017. The data that was released was broken down into tests of the suitability of the transfer advice and suitability of the receiving scheme or replacement investments. This is a logical and helpful differentiation if (as might be expected) there were differences in the findings as between each element of the process. But curiously they were not significantly different in any of the three categories: suitable, unsuitable and unclear.
The more recent letter sent by the FCA to the Chairman if the Work and Pensions Select Committee refers to file checks since October 2015 numbering 100, so only a small advance on October last year. The letter does not break down the data between the transfer recommendation and the replacement product. This data points to 34% of all 100 being unsuitable and 32% being unclear. This implies that all of the increase in the unsuitable category is from the unclear category. In fact, taking the higher previous percentage of 24% (rather than 17%) being unsuitable (the proportion applicable to the advice on the receiving scheme), it implies that 10 out of the additional 12 files were found to be unsuitable. But it could equally be all 12. This has either occurred randomly or some inconsistency has crept in. These additional cases being available when the policy statement was published, it is odd that the data quoted was not that for the 100 files rather than the 88, given that the results apparently differ so much.
What other analysis has the FCA conducted? The letter to the W&PSC refers to file checks on transfers handled for British Steel Pension Scheme members, where we might expect the risks to be higher due to the lower investment experience of steelworkers and the haste with which they had to make decisions. This showed the same percentage of suitable recommendations as for the 100 (assuming no overlaps in the two samples). It also showed the same lack of clarity as for the previous sample.
Is the data representative?
Assuming the data is accurate, how poor the general state of transfer advice is clearly depends on whether it is also representative. If it is not representative, we ought not to rely on the presumption of either 17% or 30% of all advice being unsuitable. But neither can we assume that the observed suitability failings and the observed lack of clarity about suitability, that apparently differentiate transfer advice, indicate a general failing specific to transfers.
In the absence of explicit reassurances from the FCA, we might assume the data is not in fact representative. However, the FCA Though it may have wished at outset to sample randomly from amongst the more active firms, it seems unlikely that its sampling would not have been informed by early results. It also referred to 'local intelligence'. It would be more important to make the analysis risk based if the intention to put an early halt to bad practice was itself more important than the desire for a clear view of the average standards. Most people would say that halting bad practice ought to have dominated.
What technical explanations are available?
The two-firm structure
One feature that differentiates transfer advice is that it is a separately-regulated activity under the Regulated Orders Act, with its own professional qualifications and its own FCA Handbook rules and guidance. A relatively small proportion of firms have this as a permitted business and many firms with the permission may only have a small number of individual advisers with the qualifications. This is a structure that was not designed to cope with the volume of transfer interest sparked by either Pension Freedoms or by the publicity given to the exceptionally high transfer values created by unorthodox monetary policy. It was also clearly not designed to cope with a situation like the collapse of Tata Steel which created thousands of instances of demand for transfer advice within a short time fame that was beyond the capacity of the industry. But, as we have noted, the transfer advice to members of British Steel Pension Scheme was not obviously of a different standard, in spite of these differences. And also as noted, the differences in standards are not specific to transfer suitability but carry across to investment recommendations where suitability standards are generally found to be high.
An obvious technical explanation for different standards to advice generally results from this structural feature because it leads to a separation of functions between two firms: an adviser who has the client relationship but does not have the permissions and a pension transfer specialist in another firm who has the permissions but does not have the client relationship. The typical shortcoming picked out by the FCA was evidently insufficient personal data being collected. This is what might be expected when the transfer advice process is divided between two firms.
This is not to say the personal data validating the transfer was not available between the two firms but rather that the documentation of the advice process by any one of the two does not join them up, as should be the case. If joining them up did in fact validate the advice then there would be no detriment and possibly no complaint upheld by FOS. There may have been technical process failings but not necessarily ones that caused harm. The same applies to the recommendation of the replacement investment product in the DC scheme, which the FCA said showed a similar percentage of 24% unsuitable and 40% unclear. Testing for the suitability of the replacement investment strategy, usually in the form of a fund or product, would not be possible without good analysis of the risk appetite and loss tolerance of the client which might be something a referring adviser had already dealt with separately and previously. Since unsuitability findings for fund recommendations in other fields are very low it looks like a process issue.
The new rules and guidance do suggest that the two-firm structure has been an observed weakness, hence FCA stipulations that it requires extra care to ensure responsibility is always taken for each required function by one or other party. The FCA presumably has enough data to control for this factor but it has not shared it with the public.
Many people have argued that transfer advice is different because it is more prone to bias to transfer arising from contingent charging: the adviser does not get paid unless a transfer occurs. Is that a technical explanation for the FCA's findings? Though a seductive argument it is not specific to transfers, as much advice (and particularly investment advice) is subject to a commercial conflict that could bias recommended courses of action. The FCA has suggested that the bias created by contingent fees for transfers may be different from other commercial conflicts in retail investment because in most cases one firm or another will get to charge a fee, but not in the case of a DB scheme. This seems a spurious distinction as all that matters to any one firm, in a transfer or any other situation where the winner takes all, is that they either win or lose. They are indifferent to whether they lose at the expense of a competitor rather than from a client doing nothing.
In all cases, the best defence against conflicts is the required standards for testing advice, which, as we have noted, are not exactly weak in the area of transfers.
Can we eliminate interpretative bias?
The FCA needs to strike a balance between consumer protection measures and
personal freedom. It cannot avoid the divide in society between paternalist traditions and more libertarian principles. The very origins of the regulator are in failures arising from the paternalist tradition in finance: exploitation of information advantages by financial agents; failed technical integrity of products designed with good intentions; consumer inertia; poor financial literacy. So it is not surprising if it errs in favour of protection rather than freedom to make mistakes.
Recognising this, it should be ready to answer the question whether the differences it has observed between transfer advice and other advice is partly explained by its own bias towards safeguarded retirement benefits. That is not necessarily a fault: it could be robustly defended given a particular view of the public interest. But we ought not be left guessing.
We have very limited opportunities to question the FCA or to lobby it except when consultations provide an opportunity. But we would be very happy to see financial journalists probing the FCA's narrative instead of just quoting the findings as if matters of fact.