Regulation around defined benefit transfers and drawdown must be strong enough to protect consumers but not to the extent it erodes pension freedoms
The FCA has had its work cut out since pension freedoms took effect. Having taken the industry by surprise when announced in 2014, the reforms have thrown up plenty of concerns for the regulator.
It has a number of inter-related issues on its plate, such as misselling risks, access to advice and the lack of consumer awareness around retirement options. Protecting consumers is delicately poised against preserving the freedoms those consumers want to enjoy. Go too far one way and there is a risk of compromising the other.
Some commentators are concerned that this is what is happening in the defined benefit transfer market.
Intense regulatory scrutiny in the light of high transfer values and the unscrupulous advice that characterised the British Steel crisis has led professional indemnity insurers to increase premiums and limit cover for firms involved in DB transfers.
Advisers who were already spooked by worries about complaints are thinking twice about the risks of operating in this market. But without regulated advice, transfers that enable DB scheme members to access pension freedoms cannot proceed. So how does the industry rate the regulator’s response to pension freedoms? Are they slowly being eroded?
‘Goldilocks’ regulation for transfers
“One of the key areas of concern we have seen is the way in which scammers have exploited pension freedoms. They have targeted people who don’t understand the value of DB schemes or where their employers are in distress, such as British Steel,” says Matthew Swynnerton, partner at law firm DLA Piper.
“DB scheme members have a statutory right to transfer out and it is difficult for trustees to stand in the way of that. There has to be a requirement for the delivery of advice for members and checks have to be put in.
“I don’t think regulation has gone too far in terms of protecting members of DB schemes.”
Royal London director of policy Steve Webb says there is a need for a “Goldilocks” level of regulation – not so weak the wrong people transfer and then complain later, and not so strong the market is killed and people for whom a transfer is in their best interests lose out.
However, he fears we are on the road to the latter.
“There is now a real danger that well-meaning actions by the regulator could kill the market completely. For example, the proposal to raise the Financial Ombudsman Service compensation limit seems like an obvious pro-consumer initiative but it now looks as though PI insurers are jacking up premiums in anticipation of the change.
“This will result in perfectly good advisers leaving the market, which is not in the consumer’s long-term interest,” he says.
Chief executive, Forte Financial Group
The problem with being overly bureaucratic is that financial services becomes more cumbersome and it is harder to do business. Ease of business is an important consideration for the regulator, but not to the detriment of the consumer. DB transfers is a good case in point. The general principle is not to transfer but there are certain situations where it is good advice.
We shouldn’t have more regulation but better education and licenses for doing these things should be harder to obtain.
There should be regulation in the right areas, with tougher sanctions for people who don’t do the job properly, rather than focusing on the process and regulating that. We don’t want to be critical of the regulator but it needs to do more on the job, such as mystery shopper exercises. It can’t regulate from Canary Wharf.
Drawdown and the advice gap
The problems coming to light after the introduction of pension freedoms are not restricted to the DB transfer market. More consumers have inevitably gone down the drawdown route, but those who did so on a non-advised basis have the potential to make all the wrong decisions that will cost them dearly in the long run. Some may think they do not need advice but, for others, the cost of advice is a big obstacle.
Capco head of retail asset and wealth management Niral Parekh says: “There does seem to be a major gap left after the RDR and now pension freedoms, where the commercial case for the industry focusing on retirement advice solutions for the mass market doesn’t stack up yet – even if there is an urgent need to fix it.”
In the case of non-advised drawdown, the FCA has intervened with a view to providing consumers with better retirement outcomes in the absence of regulated advice – for example, by introducing investment pathways to prevent consumers defaulting into cash.
PA Consulting pensions expert Mike Teall points to research collated for the FCA’s Financial Advice Market Review which suggested there was a 40 per cent increase in the number of people taking advice in 2018.
“Despite this uptick, there are still people making poor decisions at retirement. Savers keen to dip into their pension pot are often taking all the money out in one go and paying more tax than if they had spread the withdrawals over several years,” he says. “There has to be some kind of backstop for people who are taking tax-free cash and leaving money in drawdown. That money needs to be invested sensibly – and there is a chance that, without advice, people could make the wrong decision.”
Teall regards investment pathways as a helpful mitigation to this and says pension providers are supportive of the idea.
“It gives them the ability to provide simple options for customers that they know the regulator is happy with. But if you are an adviser who wants to look at individual circumstances holistically you are bound to find flaws in this type of process.”
Parekh believes we are heading for “uncharted territory” given the number of pensioners looking to retire will only increase. “They will be faced with no access to advice because of the size of their pension pots; subjected to misselling or suffer from lack of awareness. So, it’s probably the right action for the regulator to look at mitigating those risks in turn,” he says.
Founder, Castell Wealth Management
There is a fine line between consumer protection and pension freedoms, and a common-sense approach should be adopted in reviewing the appropriateness of policy decisions.
I do not feel it is in anybody’s interest to allow complicated pension transfers and drawdown without clients first having access to a trusted advice process.
As an industry, the layers of regulation provide an environment to protect clients and prospective clients. As pension freedoms evolve, it is likely that areas of concern will be legislated against.
In the case of pension freedoms, it seems the regulator and the industry have been caught unprepared, and subsequently have suffered from the unintended consequences of positive government policy change.
Catch-up and refinement
As pension freedoms caught the industry and the regulator by surprise, there is perhaps an argument for saying all the FCA is doing now is playing catch-up. Would establishing a regulatory framework first have struck a better balance between consumer protection and pension freedoms? Selectapension director Peter Bradshaw thinks so.
“When the freedoms were announced, they were a big surprise. Some time later the regulator sampled a small number of client files and judged they didn’t demonstrate the suitability of pension transfer advice,” he says.
“This work and subsequent guidance would have ideally been in place ahead of 2015 to avoid the confusion, lack of confidence and bad press which followed cases like the British Steel pension scheme.”
However, Royal London’s Webb does not think pension freedoms should have been delayed while the regulatory prep work was completed. “You only really know how people are going to react to a change in the rules when they come into force, so the regulatory framework was always going to have to evolve,” he says.
Standard Life head of strategy and development Neil Hugh agrees. “This critical period of watching and waiting allowed us to understand the resultant customer behaviours and answer the big question of what next?”
Hugh believes the FCA’s work around pension freedoms is not an act of erosion but rather one of collaborative refinement. “Some may argue that more of this thinking could have been done upfront in preparation for pension freedoms coming into effect, and that we are working backwards to understand what this landscape should look like now,” he says. “Equally, it may always have taken the opportunity to observe the reforms in practice to gain the level of understanding that we have arrived at now.”