Never before has the need for clarity in investments been as important than it is these days. A huge wall of money is being transferred from defined benefit pension schemes looking for place to be invested in drawdown investments.
With the FCA removing the guidance that a DB transfer is unsuitable, but needs to be in the client’s best interests, the floodgates have been opened for advisers to advise on transfers. Nigel Chambers of financial services software firm CTC believes that around 50 per cent of DB pension members would benefit from a transfer as they will not live to the average expectation of life.
Unless you do not read the press, you will know the many factors taken into consideration when advising a transfer from DB pensions to DC drawdown. We have become bogged down by critical yield and sky-high cash equivalent transfer value calculations. These high numbers are a once-in-a-generation opportunity to boost the value of the transfer. What we know is that as interest rates and gilt yields rise the transfer values will drop.
The biggest consideration for DB transferring clients is risk based on the variability of investment. Those not receiving advice tend to trust the banks and cash Isas so billions of pounds are invested in where consumers are effectively losing purchasing power year on year.
In the FCA’s asset management market study, the regulator found price competition is weak in many areas; evidence of sustained high profits over many years. It also found investors are not always clear what the objectives of funds are and fund performance is not always reported against an appropriate benchmark. Good work by the FCA and good luck to the fund providers that need to capture all their costs and fees for the first time – not an easy task.
Making sense of illustrations
To bring the ceding DB transfers and the receiving investment together perfectly, we need fund providers to illustrate returns on the same basis for similar asset classes. The FCA does not currently stipulate the assumptions to be used.
On, say a UK Growth fund from one fund provider to another, the illustrated mid-rate can vary currently from 4 to 5 per cent, or higher. As the DB scheme critical yield needs to match the receiving drawdown fund’s projected growth rate, the funds with the highest growth rate used will look more attractive. This will cause a bias to use the higher projected funds in drawdown.
Professional indemnity cover and misselling implications on DB transfer advice, plus the examination rigors, result in many advisers not advising that a client should take a DB transfer. I predict that where clients have been in meetings with advisers with, say, £250,000 as a CETV but are turned away as insistent clients, if they return in two years and the CETV has dropped to £180,000 they may seek redress for the loss.
The Financial Ombudsman Service has seen a limited number of DB transfer complaints since pension freedoms but wait until rates start rising. The FOS will be inundated with complaints about advisers advising not to transfer. You have been warned.
Kim North is managing director at Technology & Technical