IFAs: The ramifications of COVID-19 on DB Transfers

The team at Howden have written previously about DB Transfers and the Professional Indemnity Insurance market however we need to consider whether the Agenda will be altered by the pandemic.
For context, it is worth reminding ourselves of the factors driving insurer behaviours to date:

What are the ongoing issues surrounding DB Transfers? 

·        Stakeholders acting in silos – Numerous Government announcements were not previously discussed with other stakeholders, particularly the FCA in 2015.

·        The FCA’s consistent message that DB Transfers should be for the few – their view is individuals should only be giving up a guaranteed income for life in exceptional circumstances however the FCA’s statistics indicated that most seeking advice ending up transferring.

·        Inaccurate recordings - Transfer requests where no advice was undertaken are not always recorded which paints an unflattering picture for numbers enquiring then transferring.

·        Changing guidance - Various best practice guidelines and consultation papers have been produced over the last four years with the requirement on IFAs becoming increasingly onerous.

·        Debate around responsibilities around splitting roles - Where an adviser passes to a specialist to complete the transfer then taking the investment advice back.

·        The increase in the FOS award – The FOS award increased from £150,000 to £350,000 for advice post 1st April 2019 (and now £355,000).

·        Insurance capacity shortages - The shortage of capacity in the Insurance market occasioned by poor underwriting results particularly in the Professional Indemnity Insurance class.

·        Insurer concerns – Insurers have become worried about their aggregate exposures emanating from this sector (as a result of the previous point).

·        Rise in ‘customer detriment’ - The FCA extrapolating their ‘unclear and unsuitable’ file review results and multiplying this by the number of individuals transferring, gave rise to a ‘customer detriment’ figure of GBP2bn per annum since 2015 (per CP19/25).

·        Difficulty in rectifying mistakes – As a result of a successful complaint, the difficulty a firm (and by addition their Insurer would face) in putting a complainant back in the position they would have been before the transfer.

So where are we today? 

The Insurance market for IFAs has been problematic for at least two years but the position worsened considerably on the publication of CP19/25 last July. 

Many firms had been awaiting the publication of the best practice guidelines following CP19/25 which were due to be circulated in March. The FCA subsequently advised that this has now been postponed until 3Q 2020.

What else has happened to the Insurance market?

The FCA contacted all firms with DB Transfer permissions (circa 2,700 firms) in January 2019 asking them to complete a pro-forma grid advising on the numbers transacted and in October followed up with individual letters to around 1,600 firms.

The basic principle of these letters was that the FCA was not comfortable about the number of transactions and the conversion to those who were recommended a transfer. Many of the responses from firms have been well thought through and will have given the FCA comfort by providing additional information to put the figures in to better context. It is going to take some time to work out what the FCA will do with this information but to a certain extent we are in limbo on this (and maybe for some time).    

The FCA’s ‘Dear CEO letters’ of early January 2020, included a number of points around coverage under Professional Indemnity Insurance policies specifically on DB Transfers: 

·        Too high an excess meaning an affordability issue to the individual firms;

·        No coverage at all thereby likely pushing a cost to the FSCS which is unfair on firms with suitable coverage or that haven’t undertaken this area of advice; and

·        Firms with insufficient limit which means that the cover is materially ineffective.

This letter appears to be contextualising other contact from the regulator which may have requested that individual firms surrender their DB Transfer permissions. 

Following CP19/25 in July 2019, the FCA had planned to issue the finalised Handbook rules for DB Transfers during Q1 2020 however we wait to see whether this will be circulated in Q3 2020.

The points the FCA have advised they will cover: 

·        Conflicts of interest caused by charging structures (both for advice on the decision to transfer and any on-going investment advice);

·        Inadequate fact find (increasing the risk that advice will be unsuitable);

·        Gathering sufficient information to carry out appropriate transfer analysis and making suitable recommendations; and

·        Ensuring they have adequate advisory, transfer specialist and compliance resource for the level of business transacted.     

So where does all this leave us? 

Insurers have to be realistic and prudently they need to have reserves to cover the increased cost of claims which will be occasioned by the increase in the FOS awards. 

They also need to consider the point raised in CP19/25, whether they think the FCA’s ‘customer detriment’ figure is accurate or not. Or even if the FCA have exaggerated this 10 fold their £2bn figure which is still certainly more than the Insurers take in premiums from the profession.

Insurers obviously need to understand what their overall exposure is from this area of advice. This in part explains why many insurers are closed to new business or are only accepting new business from those firms with no DB Transfer exposure or those firms prepared or forced to accept no insurance coverage for this area of advice.

What we don’t know and currently can’t possibly predict is what appetite there is likely to be for transferees to complain down the line and if they do how strong the defences available will be.  
 

How has the COVID-19 pandemic impacted DB Transfers? 

One of the great concerns with DB Transfers was the swapping of the certainty of a DB scheme and a monthly index linked payment until death to the uncertainty of a transfer and investible lump sum.  In a strong economy with growth and rising stock markets a number of these concerns were marginalised. Certainly cash flow modelling and risk attitudes helped but now that we face a significant rebalancing of assets what is the prognosis?  It seems to me that a well thought through transfer before Coronavirus and post (once the Worldwide economy returns to normal see final point) should still stand. Most reviews and their subsequent recommendations were looking at issues around risks and for many in the early stage of a transfer, ‘the sequencing risk’. So taking the transfer, losing some of the value through adviser fees and then investing in a balanced portfolio just as investment values fall. One of the recommendations in most reports was to keep some cash to tide one through this very scenario and many advisers also looked at other assets which could be drawn on to mitigate this. Although most investment portfolios have a balanced mix of equities against GILTs, Bonds and Cash; we do need equity growth in order to keep the overall pot building. It therefore depends how long it will take for the overall stock markets to recover.

Insurers should be comforted by the fact that transfers from DB schemes, for nearly all firms, have to pass pretty stringent suitability tests. These include cash flow forecasting to ensure transferees do not run out of money and also stress testing for market falls. Although most worldwide stock market indices are down by around 20-25%, the reality is a balanced investment portfolio is currently much more likely to be down by between 5-8%.  

Nearly all firms have strong monitoring processes in place; only qualified individuals are responsible for giving advice, with sign-off usually by another qualified individual or within larger firms by a committee of directors and compliance.   

Regarding regulatory pressures it is by now almost certain that the FCA wanted to be able to regulate a smaller number of firms for this advice. In our opinion they want to work more closely with fewer firms where they can continue to look at the statistics and refine their best practice ideals.  
We continue to work with Insurers and lawyers engaged in this market to understand the regulatory pronouncements, statistics emanating from FOS and our own claims trends to ensure that there is a functioning market for professional well-run IFA businesses, wanting to support positive outcomes for their own clients.    

There will also continue to be a demand from employers and trustees to explore possibilities to de-risk schemes by encouraging transfers and, in some cases, the transfer will continue to make sense. 

The Pensions Regulator (TPR) guidance

In guidance issued on 28th April and in a letter sent to the Trustees of Pension Schemes, The Pensions Regulator (TPR) warned it was unlikely that people transferring to defined contribution arrangements during the Covid-19 pandemic would benefit in the long term. 

Although it is difficult to completely understand the rationale for this letter (there could be some good counter arguments around it being a good opportunity to find value in investments), the mere fact that the TPR have felt it necessary to issue this letter could have consequences for complaints down the line, i.e. transfer now, complain in a couple of years and cite the TPR letter with FOS.