It’s a more and more common scenario nowadays. The client has been offered an eye-watering sum, more money than they have ever had in their lives before. Word has gone around their colleagues or former colleagues, everybody else is doing it… There’s only one slight problem…
COBS 19.1.6 states categorically that when a firm is making a personal recommendation for a retail client in relation to the transfer of safeguarded benefits, the firm should start by assuming that a
transfer, conversion or opt-out will not be suitable. The firm should only consider the transfer if it can clearly demonstrate, on contemporary evidence, that the transfer, conversion or opt-out is in the retail client’s best interests. To demonstrate which, the firm should consider factors including the retail client’s attitude to and experience of managing investments or paying for advice on investments so long as the funds last.
Experience is a crucial point in making a defined benefit transfer recommendation. It is also one which in my experience is often overlooked, given insufficient consideration, or simply paid lip service to.
Consider the financial crisis in the latter part of last decade and the problems with Northern Rock which acted as a trigger. What happened was the bank ran into liquidity problems and was obliged to ask the Bank of England as the system’s lender of last resort for a bail-out. Whilst Northern Rock’s assets were always sufficient to cover its liabilities in the long-run, its business model was high risk, relying on wholesale funding from the money markets. When the funding dried up from institutional investors nervous over lending to mortgage banks, it created liquidity problems.
Ironically enough, the run on Northern Rock began in earnest on Friday 14 September. This was the first opening day following the announcement of the news that the Bank of England had agreed to a £3 billion liquidity support facility. The result was pandemonium, with savers queueing outside
branches to withdraw their savings. In the most retrospectively hilarious incident, two account holders in Cheltenham, Gloucester barricaded the manager in her office. Her crime? Refusing to allow them to withdraw £1 million from an internet-only account which they were unable to access
after the website crashed due to the volume of use.
Ironically, as The Economist put it, ‘The panic was prompted by the very announcement designed to prevent it’. The Bank of England made public the liquidity support facility in a bid to assure depositors that the cashflow problems were of a temporary nature and their funds were safe. What happened was that an entire nation panicked and in the rush to avoid imagined losses to their funds, created the very situation they feared.
Where am I going with this and what is the relevance of it to advising on a pension transfer? Well, the relevance is that it demonstrates the herding mentality and the aversion to logic and common sense that is commonplace amongst the average British saver. Had everyone held kept their nerve,
trusted the Bank of England and acted as a collective, then the liquidity problems at Northern Rock may very well have been able to have been worked through. Instead and paradoxically, despite being assured that appropriate support was in place, the public panicked, sought to protect their own interests and created mayhem.
If I had a pound for every file I had seen whereby the inexperienced client had stated that in the event of a 20% market fall, they would ‘understand that it is only temporary and I need to hold the funds long term to let it recover’. Well, let’s just say I wouldn’t be blogging for a living! It is very easy to say and it sounds good in theory. The reality is that for someone who is not very experienced in financial markets, panic often sets in. The risk-averse side comes to the fore and people act in a counter-intuitive manner, contrary to all the logic they espoused at point of sale.
When advising on a defined benefit transfer, the firm needs to make certain that the client truly understands and is comfortable with the risks attached. Where the client has a low risk profile or does not have proactive investment experience, the transfer recommendation is unlikely to be suitable. Yet too often in my experience, there is a token effort made at justifying a recommendation which the client’s recorded experience does not support.
I have seen cases where the client is recorded as being part of an employer share scheme and the file states that ‘you have a reasonable understanding of investment, and you understand the volatility of stock markets’. There is insufficient colour and detail here to justify a recommendation to transfer. Employer share schemes are incentive plans, which are generally entered into due to financial incentives as opposed to through any individual appetite to take investment risk. I have also seen general investment cases where the client is justified as having ‘held shares in your own limited company’. Where the client owns their own limited company, shares held will almost certainly be private, will not be traded on a regulated market or subject to daily fluctuations in value, and are held for entrepreneurial, rather than pure investment purposes. This justification is absolutely not appropriate.
Where a client’s only long-term investments involve direct shares, it would be prudent to cover how these were acquired. Often, we find that they may have been part of an inheritance, or acquired on the demutualisation of a building society. In this case, it is perfectly valid to question how actively the client monitors their performance and whether they can really be taken to indicate a disposal towards personal investment. Likewise, we often see cases where the client is claimed to have professional experience in the field as a result of employment in a bank/ insurance company? As what, the office cleaner? It is important where a transfer is being proposed that we nail down specifically how the client’s prior experience
justifies a decision to commit what is often the vast majority of their pension provision to risk. Files should evidence scrutiny and challenge on this point. Far too often I have seen files which come across as scraping the barrel for any possible justification, as opposed to a genuine consideration of appropriateness.
This continues to represent possibly the single biggest bugbear with EPC case reviews. Firms who fail to give it sufficient attention may well be storing up future problems for themselves…