The FCA considers pension switching as a "major risk" and an area it does not feel was handled very well in the past and unfortunately it considers this to be an on-going problem.
When referring to 'pension switching' the FCA means the transfer of funds from any pension scheme (including occupational and personal pension schemes) into stakeholder pensions (SHP), personal pensions (PPP) and SIPPs; "moving a pot of money from one place to another."
The initial review was completed in 2008 and it continues to this date. The 2008 review identified a number of concerns:
- clients switching without justification (churning);
- a significant growth in switching recommendations;
- Extra product costs without good reason;
- Recommended funds not suitable for client's attitude to risk and personal circumstances;
- Loss of benefits from the ceding scheme without good reason;
- Ongoing reviews not documented or not put in place;
- Systems and controls not well suited to preventing poor advice.
The 2013/14 review is continuing to discover similar "unacceptable client outcomes."
The FCA found that features of the existing product (internal switching) were not being considered or used, instead switches were being recommended and this could be seen in some instances as generating unnecessary fees (churning). In addition, some files failed to demonstrate any clear benefit to the client (the 'added value') and stakeholder pensions not being considered or referred to, which itself is a breach of COBS.
The FCA is also concerned at the standard of attitude to investment risk assessments and that in many cases the client's age, time horizon and objectives were not being correctly considered. These failings would suggest to the FCA that senior management are not overseeing and governing their firms correctly and there is a lack of systems and controls.
The comments made by the FCA, especially attitude to investment risk, capacity for loss, tolerance for loss and writing Suitability Reports apply to all aspects of advice, not just pension switching.
Extra product costs without good reason
Where there are additional costs and fees incurred as part of the switch these need to be clear and there needs to be "good reason" for the switch (the suitability); why it has to be incurred in the first place; is there a benefit to the client?
There must also be research into the existing scheme to determine if an internal switch (including an internal switch to a SIPP) is suitable, thereby possibly avoiding exit charges and/or set up charges and fees. By doing this you can prove you are not churning.
The FCA is also concerned about SIPPs in particular and why pensions are being moved in to them where there is no evidence that the client will benefit from or needs a SIPP when a personal pension or stakeholder would do.
They have seen pensions moved to a SIPP because they are "flexible", but the flexibility has not been explained or justified and there is no evidence the client needs this "flexibility"; it is merely an attempt to justify the switch.
The FCA will look to see whether or not an internal switch within the existing scheme was considered during research and why it was suitable to move; possibly as the funds needed were not available in the ceding scheme, but this must be clear in your research.
Nothing in isolation
Another reason given for the switch to a SIPP or pension was to access "2,000 funds". In the FCA's experience this does not justify the switch as they have never found a client using this many funds and again they see this comment an attempt to justify the switch.
The FCA has also seen "consolidation" (keeping it under one roof) as a reason to switch. On its own this is not justification as full research needs to take place; you need to look at costs and charges, fees, taxation, death benefits etc.
Performance as well is no reason on its own to switch as an internal switch may be better for the client and any additional costs such as exit penalties need to be taken in to account.
You need to consider does the switch add value or benefit the client and can you prove it? By having a number of reasons to switch this will add to the recommendation being suitable and in the client's best interests.
The FCA made comment about the volume of SIPPs it sees and there are cases they have reviewed where there is no apparent reason to have a SIPP as they invested in equities which were available in a lower cost personal pension.
Therefore, if you are recommending a switch to a SIPP make sure it is clear WHY and how the client will immediately benefit. Moving to a SIPP in case a client may buy a property within the SIPP in the future is not appropriate; why not leave it where it is or move it to a cheaper personal pension until the time arises.
If the reason is because the client needs to access discretionary services and the only option is to have a SIPP make sure this is clear in the Suitability Report. The person reading your Suitability Report may not be aware of this.
Loss of benefits
On some files the FCA reviewed there was a loss of existing benefits and there was no justification provided as to why it was in the best interest of the client to switch. Some firms had stated that the expected increase in performance would out-weigh the loss of benefits; the FCA does not see this as a justifiable reason on its own.
The FCA expects to see full research into the loss of benefits and the added benefit of switching the pension.
Switching out of With Profit without any analysis is an issue which needs to be researched according to the FCA. Charging structures of With Profit funds is difficult as many do not disclose their fees and costs. However, the FCA expects firms to undertake a full review of the information which is available; the performance, the strength of the provider, the terminal bonuses, reversionary bonuses, and overall performance etc.
Attitude to investment risk
The accurate and correct assessment of a client's attitude to investment risk applies to all aspects of advice, not just pension switching.
The FCA found that in many pension switching files it reviewed there was insufficient information on the client's knowledge and experience and the investment term and how this can affect the risk of the funds recommended and how this was matched to the client's objectives.
The FCA expects to see a process which may start with a risk tool questionnaire. However, the tool used must be clear and unambiguous; does the client understand the questions? If it is not clear the client may not understand and the adviser will end up giving incorrect advice.
Furthermore, does the client understand terms used in the questionnaires such as, "passive", "sophisticated", "experienced" "moderate investor", "an average person" etc.? Do they know what an equity is, or a gilt, or how a property fund works? Again, if they don't it could lead to an incorrect outcome. What about using a glossary?
Also, make sure you are using the same terms, to be consistent. Do not use different terms to attempt to explain the same risk profile; "moderate", "balanced", "medium" as they may be different in the client's mind. Furthermore, does the risk description clearly explain the risk and does the client understand the description?
The FCA does expect the output of the attitude to investment risk questionnaire to begin a dialogue which should include discussions on circumstances, objectives, time horizons, etc. However, do not over- rely on the outcome of the assessment tool used. The output from the attitude to investment risk questionnaire will not, on its own, be sufficient; "it should be part of the process, not the most important part."
Therefore, we, as well as the FCA, expect to see meeting or file notes in addition to the questionnaire. If there are no supporting notes with the attitude to investment risk questionnaire this can be seen as a risk to the client and the firm. However, by having good notes in support of the risk assessment this again will add weight to your recommendations.
The FCA expects to be able to review your due diligence into why and how your attitude to investment risk process is used and how it fits in with your firm's processes.
"The tool is the guide not the answer."
The client who wants to invest may want to take some risk and accept some loss; others will not and it is up to you to determine this. However, clients who are risk adverse, for example because they are close to retirement, should also be carefully assessed when you decide whether or not to recommend funds or deposit. Again, this needs careful documenting so it is clear.
Clients' receiving "poor outcomes" is an issue for all firms to consider as the FCA see this as a major risk of clients receiving inappropriate and unsuitable advice. This applies to all advice, not just pension switching. The FCA saw this as being down to advisers failing to collect and account for all the client information relevant to assessing the risk a customer is willing (tolerance) and able (capacity) to take as part of suitability considerations.
The FCA found that in a lot of cases they reviewed the assessment of the client's attitude to investment risk and their knowledge and experience (COBS 9) was poor and failed to match the recommendation to switch pensions and the recommended funds. The FCA also found that in some cases the client's investment experience was poor but they were placed in funds which they would not understand. Again, this is a COBS 9 requirement; that you can demonstrate the client understands the risks, the product and the services being recommended.
The FCA also commented that they expect to see clear objectives set in the fact find (or notes) and transferred to the attitude to investment risk assessment and in the Suitability Report. Client objectives need to be clear and if it is not the FCA will deem the file to be "unclear" and potentially "unsuitable" (their assessment outcomes).
In their view, the first part of the attitude to investment risk assessment is to look at what the client wants to achieve as this will have a bearing on the risk assessment and how much risk the client wishes to take, or needs to take.
When checking files the FCA does not ask questions of the adviser; it is all what is written in the file. Therefore, the Suitability Report and supporting documents must 'tell the full story' and be totally clear. Nothing must be left to assumption because the adviser knows the client so well; it must be written down.
The FCA confirmed that it is not a requirement to have a technology based risk assessment tool, although they can form an important part of the process. In the 2011 "suitability guidance" issued by the FSA found 9 out of 11 risk assessment tools not fit for purpose. Therefore, an over-reliance on the outcome of the risk tool used can be dangerous.
The FCA found that in some firms' advisers were using different attitude to investment risk tools and the FCA see this is a risk and a failing in a firm's systems and controls as there must be consistency within firms when assessing risk and making recommendations to meet objectives. The firm's internal T&C assessments should be identifying these issues.
'Capacity for loss' is another area the FCA needs to be better documented. The FCA confirmed that the capacity for loss is the amount of loss the client can "absorb" before it becomes an issue and with pensions the forthcoming retirement date could be a major event if it is not that long away as this could affect the outcome of this assessment. Many risk assessment tools do not cover this point so it is important that your risk assessment questionnaire captures capacity for loss and it is personalised and recorded in your notes.
Furthermore, the client's 'tolerance for loss' is the client's ability, or willingness, to accept losses and this will also have a major bearing on the risk assessment process. Again, if your assessment tool does not record this then you must have it in your notes.
The recommended portfolio must match the attitude to investment risk outcome and the capacity for loss and the client's tolerance for loss.
The FCA also has concerns where there are numerical scales used in the attitude to investment risk outcome with no description. There does need to be a description to the scale so the client can assess the score and make a decision.
The FCA considers risk profiling as a critical tool in all aspects of investment advice, pension advice, including switching, and drawdown recommendations. The FCA expects to see attitude to investment risk questions to be clear and not ambiguously worded and not be weighted in anyway.
They also expect attitude to investment risk assessment tools to be tested and adjusted where appropriate to ensure "a fair and clear outcome" for the client. These assessments, whether automated or individual questioning of the client, must include an assessment of capacity for loss and tolerance for loss.
The FCA consider that risk descriptions should "quantify" risk using graphs, figures, explanations etc., provided they are clear and fair with no bias. They should also be used consistently and be objective, avoid jargon and ambiguity and at all-time be balanced and fair.
Performance is an important issue when considering pension switching and the FCA would not expect you to leave a client in an under-performing fund, but they do not expect you to move a client out of a pension without considering any internal switching options first. Furthermore, a client should not be moved for poor performance alone; there must be full research undertaken.
When comparing performance the FCA see it as being "a measure" to allow a client to make an informed decision. Also, if you are moving the client's risk profile up or down then there does need to be more information on impact of this change in risk explained in the Suitability Report.
Furthermore, if you are switching a client to a platform or on to a discretionary service, then the increased fees and charges need to be clearly explained as well as the potential impact of these extra charges have on future returns. It should also be clear in the Suitability Report why the move to a platform or discretionary is suitable to meet the client's objectives.
Overall, there should be enough information in the Suitability Report about performance, fees, charges and costs to allow the client to make an informed decision.
The FCA commented that in some cases the adviser had not explained the importance of reviews and in other cases never put them in place, or they were not carried out on time. The FCA sees this as a major risk as you "must deliver what you promise."
If the FCA visits you it will ask to see your diary system and the back up to this system as the FCA expects you to turn up on time!
The client must also fully understand the review and what this will entail and how much it will cost. The FCA does expect to see a review of the client's objectives and attitude to investment risk in each review, as well as an update to the client's information as certain information does continually change, such as, income, expenditure, assets etc. This all needs recording in meeting notes.
Also, do you document the review? Do you write notes? Are they clear? Are they typed? The FCA considers that what you write down is critical and should be a "mirror image" of the review. What was discussed, agreed and carried forward. By writing notes you are protecting yourself as any disputes in the future will call upon these notes as your defence.
The FCA sees this as the most important element as any failings in research will result in an incorrect outcome. However, completed correctly it will cement the recommendation and make it clear why it is in the client's best interest to switch.
In order for you to give advice to switch you must also be able to demonstrate you fully understand the ceding scheme.
Client objectives are an important part of the research and the FCA expects to see it "weighted" towards the client objectives and clearly documented; what is best for the client. The FCA found that what many firms do is just to compare the ceding firm and the proposed firm without any consideration for the client objectives. If the objectives are included in the research it makes the file more robust.
Charges are always an important part to consider when researching. Using the KFD, fees, charges, TERs and RIY help aide the client experience and using a table in the Suitability Report to compare the ceding scheme and the proposed scheme is a good idea. The FCA feels this puts the client in "an informed position."
Loss of benefits or guarantees must always be considered and compared as part of the research as these will influence the final outcome. Any losses must be justified in full – the added value to the client switching.
If the reason for the switch is to have access to funds not available within the ceding scheme then this needs to be clear in the Suitability Report. They expect a research note to explain WHY the switch is better and the funds recommended are not available within the ceding scheme. This should be repeated in the Suitability Report.
The FCA expects to see where fees and charges increase (and therefore performance could drop) that there is a direct comparison between the ceding scheme and the proposed scheme. This must be on a 'like for like' basis. Sometimes this is not possible, so again, you use the information available to explain to the client the impact of any additional fees or charges, allowing an informed decision to be made.
Therefore, the FCA has asked firms to consider a number of topics when completing its pension switching research and to include these outcomes in your Suitability Report:
- Client Objectives
- Charges - RIY, TER, fees, etc.
- Any loss of benefits
- Availability of appropriate funds
- Financial strength of new provider
- Death benefits
- What is the Added Value
- Is the switch justified
The list is not exhaustive and it must be relevant to the client.
FCA Pension Switching Questionnaire
Although it is not compulsory to have this document (or similar) on your file we would advise you to have it in your file. It does not have to go to the client, but it is an important record to show you have considered the justification for the switch.
The Suitability Report must explain WHY the advice is suitable and the justification for switching is clear. The FCA has asked firms to look at the structure of the Suitability Report and use appendices to hold the technical information leaving the main body of the report as being fully personalised.
The Suitability Report must contain:
- evidence of client circumstances, needs and objectives;
- why you believe the recommendation is suitable and meets the client's needs and objectives;
- what alternatives have been considered? – e.g. internal fund switch or product switch (to a SIPP) and why it has been discounted?
- What benefit (added value) is there to switching the pension?
- confirmation of client's attitude to risk and reconfirmation of risk descriptions;
- matching the attitude to investment risk, capacity and tolerance for loss and time horizon with the recommended funds and why it is suitable;
- comparison of ceding scheme with proposed new scheme;
- any loss of benefits as a result of switch - potential disadvantages and why it is suitable to switch;
- if the new scheme is more expensive, are the implications and benefits of this are clearly explained and why the advice is suitable and appropriate?
- why new provider recommended;
- why the new product, especially if it is a SIPP (the need is now, not switching to a SIPP to use possible options later) if another product is cheaper;
- why stakeholder has been discounted (RU64/COBS 19);
- death benefits & taxation;
- risks and disadvantages;
- confirmation and cost of the review process;
- cost of advice in cash terms;
- ensure systems and controls for checking Suitability Reports are effective and regularly reviewed.
The list is not exhaustive.
Systems and Controls
Firms must have internal systems and controls and the FCA would prefer to see some element of pre-sale approval as checking it later may not be able to "unpick" the advice. The FCA sees pre-approval as an important control within a firm.
Also, the use of checklists and peer checking is also valuable tools.
If you cannot prove the advice to switch is clearly suitable and appropriate then it will look like churning. If the file is incomplete or vague then it will also look like churning. In this instance if the FCA checked your file it would fail as "unsuitable".
In order for your advice to be clear your Suitability Report needs to fully explain all the "whys" – switch, term, funds, product, provider etc. You must prove added value and that it is in the client's best interests to switch. If you can cover these points there should not be any issues.
We have been stating for a number of years that drawdown has become increasingly under the FCA's risk spot light and the FCA see it as a high risk product. With the recent changes in pension rules drawdown is going to be available to a lot more people and therefore the FCA needs to make sure firms have strict rules in place to oversee and monitor these types of products to avoid any mis-selling issues.
The FCA (FSA) has been conducting a review of drawdown since 2011 as it feels it is still a major risk to clients entering drawdown when it is not appropriate. The FCA visited a number of firms and issued 300 questionnaires to firms to understand trends within this area of advice. The review was dictated by volatile markets at the time and changes to GAD limits as the FCA was concerned that this may have a major effect on drawdown investments and advice.
The FCA also found "poor quality" of files which did not demonstrate suitability of advice and the changes at this time to GAD limits. The FCA was also concerned to find that clients were not being contacted following the changes in the GAD rates which could have had an adverse effect on them.
Furthermore, 23% of firms had received a drawdown complaint and this is a major concern for the FCA.
The FCA review identified:
- 6% of firms had not contacted affected clients following changes to maximum GAD;
- 39% of firms had not carried out any training with staff following rule changes;
- 20% of firms had not reviewed drawdown processes in last 12 months;
- 22% of firms did not specifically review drawdown cases;
- 23% of firms had received a drawdown complaint in last year.
Key Findings from File Reviews
Following its file review the FCA found:
- 36% of advice was suitable;
- 18% of advice was unsuitable;
- 46% was unclear (180 files).
The FCA also found:
- A lack of Systems & Controls, including a lack of Management Information, to oversee the suitability of advice in these cases;
- No documented advice process for advisers to follow;
- No, or inadequate, business reviews following HMRC (GAD) changes for example;
- Poor monitoring of advice;
- Management Information not interrogated by senior management to identify trends and risks.
Furthermore, the client file assessments undertaken by the FCA found in many cases poor 'know your customer' information; poor fact finding and a lack of supporting notes. There was also in many cases a lack of research to support the advice, including a lack of a review in to the existing scheme.
The fact that the FCA has found that two-thirds of the files were unclear or unsuitable will lead it to consider further action in this sector. Therefore, it is critical that your processes and in particular your recommendations can stand up to scrutiny.
The FCA expects a "risk based approach" to the oversight of drawdown and in particular client file assessments.
The FCA found that in many files it looked at they found the Suitability Reports were not personalised and lacked evidence of client needs and objectives, confirmation as to why drawdown was needed, why the level of tax free cash was required and why the level of income was required.
Furthermore, the FCA found:
- There was poor 'know your customer' information (poorly completed fact finds including a lack of income and expenditure information and emergency fund requirements supporting the need for TFC and income);there was insufficient or missing client objectives;
- there was insufficient evidence to explain why the recommendation was suitable to meet the client's needs and objectives;
- this included why the client needed TFC and what it was for and why income was needed and how much, or why income was deferred;
- why the new product/provider was recommended and why existing provider had been discounted;
- there were cases where income risks were not documented; what if GAD rates reduced or the 'pot' significantly reduces what impact would this have?
- the explanation of the potential disadvantages was poor (this needs to be covered as well as fund and investment risk. The FCA also want to see you consider the product risk of drawdown as well and linking it to the objectives as well as attitude to investment risk);
- some reports lacked the necessary general and drawdown risk warnings;
- there was a lack of evidence to prove the client understood and accepted the risk of running out of money or capital erosion?
- the Suitability Report did not state why other options were discounted (or why not an annuity?);
- there was insufficient or incorrect disclosure documentation;
- there was insufficient evidence to show why and how client's attitude to risk has been arrived at and how it matched the objectives;
- there was insufficient evidence on how the attitude to investment risk matched critical yields or if the critical yields were reasonably achievable when compared to the attitude to investment risk?
- there was a lack of evidence to determine if the client was able and willing to take; their capacity for loss (the ability to absorb), their tolerance for loss (their ability or willingness to accept and to take risk);
- there was a lack of information on the taxation of the product and a lack of explanation of the death benefits;
- there was a lack of disclosure of the advice costs in cash terms before the client was committed to anything.
- there was a lack of explanation of the reviews – why and when.
The FCA found:
- a 'full and fair analysis' of the market place was not clear in a lot of cases;
- all post retirement options were not being considered (annuities, fixed and capped and flexible drawdown etc.);
- the reasons for the Provider was not clear (fees, costs, charges, administration, service, strength of the provider. They want to see the filter process used);
- the research did not explain why a new product was required (why was the existing provider not used?);
- the research did not include an analysis of the increased costs which were not fully justified at this stage. (The FCA is concerned that SIPPs are being recommended with no apparent justification where increased costs are involved);
- there was a lack of discussion or discounting of other post retirement options (annuities are still an option despite the recent changes in the Budget);
The FCA did comment and say that they do expect to see a limit set on drawdown cases and this could be £100,000, but each firm must set its own limit. However, this would not exclude smaller pots being moved to drawdown if the reasons and justifications were clear and it was in the client's best interests. However, as a word of warning the FCA would look closely at these cases and they would expect them to be pre-approved and signed off.
Systems & Controls – Demonstrating Suitability
The FCA expects to see robust systems and controls and senior management governing drawdown. In particular:
- Documented advice process for advisers to follow – this lays out the steps for your advisers to follow (file check lists, dedicated fact finds, manuals etc.);
- Audits of your business (these should be on-going – keeping a register of all drawdown advice and keeping it under constant review);
- Business Reviews – a full review of your systems and controls, internally or externally, including 'Systems and Controls Toolkits';
- Quality checking of advice/Pre approval (risk based approach – all drawdown business should be checked);
- Monitoring of quality checking (over half the files checked by the FCA had been reviewed and passed internally or externally but there was no 'check the checker' approach);
- Management Information (there should be MI used by the senior management to identify trends and there should be evidence of the MI being assessed and reviewed by senior management);
- KPIs – who in the firm is involved with drawdown;
- Management Information – you should have a breakdown of flexible and capped drawdown;
- Management Information – in the event of changes in markets or HMRC rules can you quickly identify the clients affected and contact them?
- The FCA expects to see contracts of employment that require the individual to follow your rules and processes, if they don't then this is an issue the FCA expects you to follow up as it is a risk to the firm;
- The FCA like to see pre-approval of drawdown cases, avoiding the possibility of an unsuitable file check meaning you cannot unpick the advice;
- Training & Competence – you need to ensure that the advisers are competent to give drawdown advice. In addition you would need to use KPIs as part of this process.
The FCA also wants to see systems and controls where an adviser who is not regularly involved in Drawdown to be closely monitored.
Client File Content
- Checklists - The FCA like to see file checklists, provided they are fully and correctly completed.
- Disclosure – the Client Agreement must be clear. Fees (initial and on-going) must be clear and examples given in the Client Agreement. KFD and KIIDs need to be issued where appropriate. If the KFD is not on file the FCA will judge it to be "unclear".
- Fact-find - Objectives, needs and circumstances need to be fully documented. If they are not complete the FCA will judge the file as "unclear". The FCA see "large chunks" of information in the fact find not completed and when challenged the adviser has said it was not necessary or that they know the client well. This is not acceptable. The file must stand up on its own (FOS will not interview the Adviser either; their decision will be based on the file content).
- Objectives - At retirement and post retirement there will be different client requirements and objectives and the FCA would like to see dedicated questionnaires or parts of the fact find, or at least detailed notes.
- Attitude to investment risk – the FCA expects to see fully documented capacity for loss, tolerance for loss, attitude to investment risk, the need for loss or risk and notes.
- Critical Yields - The outcome of these assessments should always be matched to the Critical Yields and these needs to be kept under constant review as they will change.
- Notes – the fact find will record hard facts, all soft facts (discussions, agreements, etc. must be written down in the fact find or notes).
- Options – all options need to be considered and recorded.
- Research – full, clear and a fair analysis of the market including the ceding scheme(s).
- Full unambiguous Suitability Reports detailing all the recommendations and how this will meet the client's objectives.
- Reviews – when and where and diarised and overseen by senior management.