The advice that IFAs gave on contracting out of Serps in the 1990s will be making headlines through 2007, leaving the industry bracing itself not just for another bout of recrimination and self-examination but also potentially looking at compensation running into hundreds of millions of pounds.
The FSA did not give contracting out of state second pension a clean bill of health when it carried out its investigation into the advice on contracting out, with the help of Oxford Actuaries and Consultants, in 2005 and has stayed tight-lipped as to where its review is going.
So far, the regulator has only said it will be taking the matter further this year and it is in talks with the industry and consumer groups about pockets of concern, notably where advice was given to people above pivotal ages in the period up to 1996.
This is best interpreted as meaning that the FSA is deciding the criteria for assessing who should be compensated and how much they should get.
This process will be forced by consumer groups. Which? recently compared the state of negotiations with the early years of the endowment review, with across-the-board compensation payments still looking at least a year away.
Further pressure for compensation will come from the claim firms, which, with time limits for endowment claims starting to kick in, are turning their marketing gaze to the fertile ground of the advice given on contracting out. Some firms have already won compensation running into five figures, although the majority of successful cases so far are where the individual has already retired and so has a quantifiable loss. One of these firms, registered in the UK but operating from a call centre in Spain, is already cold-calling Britons who have contracted out, offering to take up their case.
In many cases, IFAs and the claimants will know that the risks of equity performance were explained. Most financially literate people understand that by contracting out, you take on some level of personal risk. However, it is impossible to say there are not many genuine cases where the risks were not explained. As with most misselling reviews, there will be claims which are justifiable and those that are not.
Unfortunately, for those advisers who have clients who fall into the criteria ultimately set by the FSA for compensation, the fair and the unjust claims will be lumped together. Advisers’ defence against claims will have to rely on the quality of their fact-find and reason-why documentation. Unfortunately, for many, this is likely to be little more than rudimentary.
Calculating the level of compensation that will ultimately be paid is as complex a task as a making a definitive decision on whether people should be contracted in or out today.
Given that this is something neither the Government nor the regulator is prepared to do, those IFAs forced to fork out for attempting to help their clients make sense of a ridiculously complex pension system will doubtless feel aggrieved, particularly as, unlike pensions transfers and mortgage endowments, contracting out was an option that was introduced by the state.
Fixing a figure when people have not retired yet also seems harsh as no one knows what equities will do in the coming decades. Yet this seems to be the most likely course of action for the regulator.
But the issue of fixing a figure for compensation is further complicated by putting a value of the benefits of contracting out, such as the access to tax-free cash for S2P funds and the value placed on having a fund of your own that ministers cannot get their hands on.
On a slightly more positive note, at least the shortfalls identified in August 2005 will have been reduced with the rebound in markets but despite these gains the total cost to the industry is likely to be substantial.
Compensation for misadvising on contracting out will still be small by comparison with the billions of pounds paid in the pensions review and still being paid to endowment customers but some in the industry are predicting it could run into hundreds of millions of pounds, much of which will be shouldered by IFAs.
John Greenwood is editor of Corporate AdviserMoney Marketing.