How Much Detail Does a Defined Benefit Scheme Report Really Need?
There is often a great deal of apprehension amongst financial advisers about defined benefit (DB) pensions compared to their defined contribution (DC) counterparts.
The FCA introduced the idea of giving abridged advice relatively recently, which can simplify the process of reviewing a DB pension if the advice is to retain it. However, if you're looking to advise a transfer, this process is not sufficient and full pension transfer advice is required.
What is Full Pension Transfer Advice?
Full Pension Transfer Advice is in line with the FCA requirements for any typical pension transfer. It covers analysis of the existing pension(s), including the evaluation of any guarantees that may apply, and forming a recommendation for a new pension based on the client's risk profile, considering personal preferences (such as ESG considerations) and objectives.
This is the case for DB as well as DC schemes, and if you don't have enough information to be able to do it then you're at risk of falling foul of the regulations. Regardless of plan type, the FCA mandate that advisers demonstrate any advice is in the client’s best interests taking into account their needs, objectives and personal circumstances - i.e., its suitability.
What's Different about DB schemes?
Transferring a defined benefit pension is considered higher risk because of the guarantees attached to these types of plan, although the requirement to correctly and thoroughly assess suitability is actually just as crucial as with any other type of pension.
Indeed, COBS 19.1 doesn't actually make any explicit mention of defined benefit pensions in the guidance about pension transfers, conversions and opt-outs. This is a very sensible approach, in my view, as it's the guaranteed annuity benefits that encapsulate the value of a DB scheme, and there's no reason why an occupational DC scheme couldn't theoretically offer a similar guaranteed minimum pension.
The FCA are also particularly keen to see a sign off from an appropriately-qualified pension transfer specialist in cases where there is a need to evaluate safeguarded benefits.
What Needs to be Covered in the Report?
As is often the case, the FCA have not been absolutely prescriptive in this regard, except for the single-page advice summary that must be included at the front of any suitability report that delivers advice on a defined benefit pension.
Aside from this, you need to ensure that your DB suitability reports are personalised to the extent that the client can make an informed decision about his/her pension arrangements. In particular:
A comprehensive assessment of the client's objectives
Citing the client's current circumstances, acknowledging the current financial position and any foreseeable changes are a key part of explaining suitability, as it allows the client to spot whether anything's missing or incorrect that may affect the advice. It's also a good idea to quote clients' own words in the objectives, so they know you've listened to them and understand what they're trying to achieve.
Another thing that may be especially important for DBS advice is health considerations. With some schemes, not taking benefits means the DBS would effectively die with the plan holder, so it's crucial to understand the client's life expectancy and legacy wishes. It's also important to bear in mind that any transfer out of a defined benefit scheme within two years of death may potentially give rise to an inheritance tax liability.
Admittedly, this is potentially a difficult subject to discuss, but failing to have this conversation and record it on the client's file could land you in trouble with the regulator if the worst happens.
A clear explanation of the existing scheme and the benefits it offers
Transfer value comparator tools are really useful here, although their outputs are generally tens of pages and produce technical detail that is inappropriate for a client. It is a good idea to extract from these tools the parts that elucidate the value of the benefits the client is giving up in terms of the annuity on offer versus the amount needed to buy an equivalent one in the open market. This is a great way to attach a tangible monetary value to the benefits and enables the client to understand relative value.
A statement of the risk of transferring to achieve the objectives
It's crucial that clients understand the risks and rewards of the advice they're given. There is no going back into a DBS once the CETV has been accepted, so everything must be absolutely clear and well-understood before commitment is made. Explaining risk warnings or potential losses in a manner that is personal to each client is a good way to make these key points more relatable and encourage the reader to take them seriously.
It's worth stating that technology can help de-risk this aspect. The software we use at PowerPlanner automatically includes the appropriate risks for any pension transfer advice with appropriate personalisation, so it is impossible to miss out this crucial part of the suitability report when using our services.
A comprehensive coverage of alternatives to transfer
As the client needs to be making an informed choice, alternative solutions need to be discussed.
Commonly, a cash flow model is also used to test the potential outcomes of different choices. It's a good idea to stress test the transfer scenario to show a realistic worst-case outcome for the client, and to reference the discussions around this in the report.
Not all advisers do cash flow models, but given the prevalence of quality tools like Fin Calc these days they should be a no-brainer. After all, without this analysis, can you really say that the client can achieve their goals by following your advice, or, in a DB transfer case, that the lifestyle the client plans for retirement is affordable?
What Doesn't Need to be Covered?
Often, the anxiety around defined benefit pension transfers gets the better of paraplanners/advisers, and many succumb to the temptation to add tonnes of extras into the report in an endeavour to mitigate the risk of non-compliance.
For example, there is a prominent financial planning network in the UK whose DBS transfer template, at the time of writing this report, is 41 pages long. It should probably be half that. Its format essentially presents the objectives, followed by the reasons for the advice and the disadvantages of it, then the reasons for the advice, followed by the disadvantages, and then, to finish off, the reasons behind the advice given followed by the disadvantages!
Hammering home the disadvantages does not make the report more compliant. Indeed, it is more likely to be considered a poor report due to this repetition, as it just adds more volume unnecessarily and puts the client in a "can't see the wood for the trees" situation. Repetition doesn't add clarity; it adds noise.
Summary
Suitability reports for DBS transfers don't need to be hugely verbose compared to their DC-only counterparts. Although there are some extra requirements, it's really a matter of covering the safeguarded benefits and assessing them openly and objectively, making clear any risks and how the choice to transfer (or not) affects the client.
If you are able to demonstrate all this and have information on file to back up your advice then you'll not go far wrong.