I think we were all pleased to finally see the FCA’s consultation on defined benefit transfers.
Even for those that don’t agree with all of the content, the time for revision of the current rules is long past. Even before pension freedom, the rules, many of which were formulated in the aftermath of the mis-selling scandal in the 1990s, were definitely showing their age.
Having said that, there’s probably not too much in the consultation that most good adviser firms aren’t doing already. Certainly, many will have been looking at buy-out cost as a way of judging value but it’s useful to see this simpler measure being included. No doubt the actuaries will have plenty to say on the basis for this and it does seem that we will need more detailed guidance on exactly how this comparison is made. This is particularly true where the benefit date is still some time away.
Shades of suitability
The slight change of emphasis around suitability is subtle but important. The assumption that a transfer was unsuitable unless proven otherwise was an alarm bell for many advisers. Requiring the advice to show that the transfer is in the client’s best interests is consistent with what an adviser should be doing in any case and seems to reduce some of the risk of this type of business. No doubt the lawyers will have plenty to say about this one!
The consultation doesn’t necessarily provide advisers with more certainty of what good advice looks like. While it lists some of the factors to be taken into consideration, it gives little guidance on how these should be assessed and balanced against each other. I expect advisers will be split between those who welcome the flexibility this gives and those who might prefer a more black and white approach.
But that’s the challenge here. There is often no right or wrong answer, just shades of grey. How do you balance what are often subjective factors against the objective financial analysis? This is not beyond the skill of a good adviser but it’s perhaps one of the most difficult areas of advice to get right.
Guaranteeing the best solution
However, what all of this debate keeps taking me back to is a concern that the whole approach is too binary. Clients are being asked to choose between a guaranteed benefit on the one hand or an uncertain one on the other.
Behavioural biases swirl around this choice with the prospect of having a large sum of money now versus a series of payments in the distant future distorting any objective assessment of value. But for most people the right choice will not be a binary one between guaranteed lifetime income and flexibility but rather a combination of the two.
Whichever way you come at this, a blended approach makes sense. On a basic financial planning level, having enough guaranteed income to meet essential expenses is solid advice. Yes, the state pension is a useful bedrock but will fall well short of what many clients will need. But the more interesting lens to look at this through is how guaranteed income can work alongside investment solutions to deliver a better overall outcome than either on its own.
By securing a base level of guaranteed income either from an annuity or a defined benefit pension, one can increase a client’s capacity for loss and so the potential for greater reward on their investments. Put simply, if I know that a bad market outcome means I can’t put food on the table then I will naturally be more cautious than when I know that dinner is already paid for.
Parting with part of the pot
But very few defined benefit schemes offer partial transfers that would allow a client to give up only part of their guaranteed income. I suspect there are a number of reasons for this ranging from the administrative complexities this would create to unwillingness on the part of scheme sponsors to encourage an approach that might have them holding onto liabilities for any longer than they need to.
I do believe though that a greater availability of partial transfers would be in everybody’s best interests. It would allow clients to get the flexibility that many are looking for without completely giving up on the stability that they need.
It would also likely mean that more people would consider transfer and so overall could reduce plan sponsors’ liabilities. Trustees might also favour the approach as it would help them ensure that members get the best outcome from their schemes.
Finally, it would significantly reduce the risk for advisers advising these clients since they would not be trying to make a black and white decision in a world of grey.
Richard Parkin is head of pensions policy at Fidelity International