I wrote here that the entire basis of the FCA’s assessment of the suitability of transfers from a DB or final-salary scheme to personal pension in readiness for drawdown was so flawed on first principles as to make any s404 consumer redress scheme that relied on it unfair and potentially unlawful. It would therefore be vulnerable to judicial review. At the point I wrote that, I did not know what the template for the redress scheme would be (it has yet to be published). And my assumptions about the problems firms must have had, for the same reasons, with Past Business Reviews and s166 orders were just logical inferences. Since I wrote the article I have had feedback based on actual examples from advisers and (indirectly) compliance consultants and regulatory lawyers, as well as comments from the media and other pension professionals. These were not limited to British Streel Pension Scheme (BSPS) but neither was my article.

The feedback may not be representative but it does confirm my suspicions about how the flaws in the existing assessment process must have affected firms already. I thought I should summarise the feedback in a further article, without naming names. It doesn’t change my conclusions but it does refine the arguments so they are probably more consistent with a legal basis of challenge.

Comparison of outcomes

I may have understated the extent to which the assessment of the suitability of past advice has been biased by the FCA’s refusal to accept that the most likely source of gain in individual welfare from transfers is higher income. This is at the heart of the divergence in thinking between advisers and the regulator over transfers. It has been pointed out to me it is also an internal contradiction in the rules.

Before the rule changes and guidance that took effect on 1st April 2018, which introduced a ‘holistic’ context for assessing suitability, it was reasonable for an adviser to consider that the best interests of the member were likely to be served by transfer if the outcomes of the replacement scheme were more valuable to the member than the outcomes of the DB scheme. The FCA has always argued that what is being valued here is typically flexibility.  For example, this is from the Cost Benefit Analysis in CP19/25 (p71):

We know from industry participants that many consumers taking advice on a pension transfer are generally seeking the flexibility to take their benefits in a different way rather than expecting to make monetary gains out of a transfer. We know that many consumers, even when a transfer is suitable, may still make financial losses when they transfer, relative to the value of benefits offered by a DB scheme. The transfer value comparator illustrates the potential loss for each consumer. This is sometimes referred to as the price of flexibility. 

Monetary gain has been a far more important driver of actual economic advantage than flexibility in recent years, due to schemes derisking at a time of low or negative real interest rates. Throughout the period of high transfer activity it would not be surprising if it had been the main basis of advisers’ recommendations. This is so even if the process started with a scheme member thinking that it would be largely about flexibility. As I said in my original article, what consumers most value when presented with investment risk and return trade offs in any context is better outcomes, subject to certain constraints, such as being able to live with risk and tolerate bad outcomes. Where outcomes are better, there is no price being paid for flexibility. Transfers took off virally because of better probable outcomes: small or negligible shortfall risk with many times the upside.

Leaving aside all the things the FCA thinks matter, what was it implicitly telling advisers mattered, if all that advisers knew of the regulator’s attitude was what was then in the Handbook? The importance of the outcomes comparison, as in sustainable real income or (by implication) spending, was not only what mattered from an objective economic or investment-theory starting point. It was also reflected in the central role in the advice process of the FCA’s prescribed comparison of incomes. What was the point of the Transfer Value Analysis System report (TVAS) and the Appropriate Transfer Analysis report format (APTA) that replaced it, if it wasn’t to measure the extent to which a member might enjoy higher income or suffer a shortfall as a consequence of transfer? This is a simple and compelling argument I had not made.

You only have to look at how most advisers went on to apply the resulting calculations to see that they were consistent with the implied importance of identifying monetary gain or loss.

  • A common form the benefits comparison takes is for advisers to calculate how long the capital would last if the member drew at the same real rate as the projected DB income, assuming an investment return consistent with the FCA prescribed rates (at the time), given the planned risk approach. Any gain in welfare then derives from the sustainability of real income beyond a sufficiently-prudent longevity, implying either surplus capital or capacity to draw at a higher rate than the DB pension, either from the outset or, dependent on achieved returns, later.
  • An alternative approach treats the longevity as an input affecting the resource requirement and solves for the required return to meet a draw rate equal to the real DB pension, given the CETV (as the known resources), then going on to check whether the implied required risk level was tolerable and appropriate as well as consistent with the FCA-prescribed rates.
  • Advisers may have used both in the same report.

Either would have been a sensible way to use the TVAS template to support their conclusion. Either way, TVAS is a test of monetary gain or loss, dependent on the risk approach and constrained by the prescribed investment returns. By design it does not consider the use of flexibility in taking benefits.

Our ex post analysis of the BSPS terms, which I said were not particularly generous, used an application of the FCA’s own TVAS/APTA logic. It demonstrated how much more prevalent better outcomes were than the FCA asserted. That, note, was on the basis of applying the same longevity test (in our case, as an input rather than as an output) as we do to healthy and affluent clients. It has been pointed out that, in this respect, BSPS members may in fact be different.

Inflation exposure

Several advisers agreed with the observation in my article that testing comparative real incomes based on expected real rates of return is not a true comparison because the DB income is not normally fully protected from inflation. TVAS/APTA comparisons are even more likely to favour transfer if inflation exposure was properly accounted for. That will be a significant factor for any BSPS redress scheme because the inflation protection was materially weakened.

Stand-alone comparisons

Though the rules in place at the time of most BSPS transfers were those requiring the income comparison via a TVAS report, the FCA had published its proposals for new rules and guidance in CP17/16 in June 2017. Clearly they intended the proposals alone to have some immediate impact on practice. For instance, paragraph 1.12 says: Our new approach builds on the rules and guidance which are currently already in place for advice of this nature including our recent pension transfer alert. The clarity provided by this consultation should better equip advisers to give the right advice. 

Advisers have pointed out to me that they, like us, treated the transfer decision as being driven by the TVAS income comparison, as a necessary basis for measuring likely gain in outcomes. The proposed APTA report template, as a very similar replacement for the TVAS report, did not meaningfully alter the message. There was, however, a loose reference to the wider context of the member’s financial situation (paragraph 3.13): We do not propose to list examples of ‘relevant wider circumstances’ in the Handbook as the relevance will be dependent on the individual. However, this will include tax issues, death benefits, interaction with means tested benefits, state of health, family situation and other sources of retirement income. 

It may be a question for a lawyer but there is not obviously enough in these proposals, even with a reference to ‘other sources of retirement income’, to alter fundamentally an adviser’s reasonable assumption that the client’s economic interests could be derived at that point in time from a comparison of the replacement income with the DB income on a stand-alone basis without a holistic retirement plan or budget.

Consistency of suitability assessment

Though partial and not scientific, feedback on actual disputed cases provided anecdotal evidence that I found significant. It was significant because it supports the main area of our doubt about whether a DB transfer redress scheme can meet a key s404 legal requirement. That is that it should be possible for different individual assessors, whether within or outside the adviser’s own firm, to apply objective criteria that would minimise inconsistent review outcomes.

A deficiency in the design of the DBAAT template for assessing suitability is that the same template is used for cases before and after rule changes. Considering most of the cases requiring assessment were advised before a set of key changes, this appears to be a poor decision. A significant proportion of the questions are vulnerable to hindsight. The DBAAT guidance manual does offer assessors the scope to qualify the binary answers to the standard questions, in the form of subjective comments, and that could include dealing with the issue of not applying a binary test that was not called for by the contemporaneous rules. But this is till the wrong way round, relying on a comment on why the answer is not applicable rather than avoiding the question in the first place. The effect is that avoiding hindsight is excessively dependent on the user’s care and attention.

Even setting aside the high risk of hindsight, DBAAT is incapable of objectivity and consistency, even in the most competent of hands. This stems from the nature of the nuance of suitability in a transfer, and from the presence of biases in how best interests might be defined, both being the key points of my article. Though advisers claimed to be able to point to instances of incompetent observations by FCA assessors, that misses the more important point that, even without these errors, individual judgement, and robustness in following the manual where it guides judgement, will vary for no good reason. That applies equally to the accountants, lawyers and compliance consultants charging advisers very high prices to carry out s166 reviews ordered by the FCA. This is what the feedback confirms, by examples.

I am told that FCA file reviews of cases advised before the change occurred are inconsistent between different FCA assessors, even where the circumstances are broadly similar and the analytical approach by the adviser was the same. Differences can be as fundamental as one assessor taking into account in their opinion the TVAS calculation as a basis of ‘best interests’ and another not doing so.

As already noted, we might expect assessors to place different importance on the demonstration of flexibility benefits rather than on monetary gain and risk of shortfall, if they start from a standpoint that monetary gain is rare. Flexibility benefits are much more subjective as a measure of best interests and may also involve complex calculations that an assessor will not make. If, in the adviser’s opinion, their recommendation did not rely on flexibility, they may indeed not make the case for flexibility benefits adequately, or show all the calculations that might refute the assessment, but not doing so could be irrelevant to suitability. I do not believe the DBAAT template, however well-designed, can prevent assessment being tainted by this bias towards testing flexibility benefits, rather than testing the monetary gain or loss, as the basis of best interests. The FCA might argue that the adviser should in that case have set out more clearly that monetary gain was their motive. That would be disingenuous.

I am told that the FCA’s conclusions about suitability have varied over time for the same case, but not as a consequence of challenge by the adviser. This is hard to account for unless because the FCA’s own process has undergone changes. That would hopefully come about from learning from third-party assessors or from internal efforts to improve quality control. It would at least help explain why the FCA’s published ‘unsuitable’ proportion has shrunk from over 50% to 17% (as I mentioned in my article). It would be helpful of the FCA could address how these inconsistencies over time have arisen and how it has affected their conduct towards firms adversely affected by their original findings.

I am told that suitability conclusions also differ between the FCA and third-party professional firms voluntarily brought in to help firms with Past Business Reviews called for by the FCA. The same file leads to directly-opposed conclusions. If consistency is difficult then it stands to reason that single files assessed by different FCA staff are more likely to disagree with the conclusions of a single assessor in a third-party firm, assuming the adviser’s approach was consistent. How the FCA deals with such conflicts is a question for them to answer. In particular, how often does it reach for a s166 order? And what if that too leads to conflict? Do they go on and on until they get an opinion that meets their expectation or do they at some point admit their expectation may be what’s wrong?

The Arch Cru redress scheme

Media speculation is that the planned BSPS redress scheme will mirror the FCA’s Arch Cru scheme. I have since checked this template. To some extent the problem of nuance in determining suitability must have been an issue using the Arch Cru redress template. But the differences are more important. In the case of Arch Cru the high risk of the investment and the connection between the advice and losses were both evident from the fact that irrevocable losses had already been incurred. Though that may be the case for some BSPS replacement investments, it is clearly not the case for more nuanced examples, possibly the majority. They may even be in substantial profit, at least on paper.

Reliance on the income

There appears to be a problem with the way reliance on the DB income is in some cases being applied to advice given before April 2018. As noted, this may stem from using a single template. Some assessments apparently treat the dependency ratio as being a component of the personal information that, even before the new guidance, was necessary to support a personal recommendation. I believe this is not supportable, for the same reason that advisers were entitled to assume that the context was not relevant to the identification of best interests, as long as outcomes for that amount of money in isolation were demonstrably better.

Whether assessments are applying reliance to cases before or after April 2018, there is clearly a difference of interpretation anyway about how to deal with cases where the DB income is likely, if retained, to be the funding source for all spending or for some subset of spending that represents (say) non-discretionary spending. The idea that reliance is an absolute test is consistent with the FCA’s other assertions about guaranteed income that we have attributed the ‘safety-first’ utility definition to. In my article, I suggested that the FCA eventually removed the contradiction between the safety-first utility and more commonly-observed definitions of utility by adding some new wording to paragraph 2.22 of the DBAAT manual.

I took the view that that was the intention of the amendment because clearly the contradiction needed to be resolved. I thought it must by then have caused problems for external assessors performing Past Business Reviews or s166 reviews. It was resolved by making it clear that the CETV, once applied to an investment strategy in a personal pension wrapper, could be a valid replacement for a guarantee. In other words, I assumed it could itself be the ‘alternative’ investment able to meet the member’s total income requirements, alone or with other assets, alone or with the underpin of the State Pension. This makes it consistent with the idea advisers have that the APTA comparison of monetary outcomes is the key test of suitability, subject (after April 2018) to a budget constraint.

I was therefore very surprised to be told that most compliance consultants and regulatory lawyers interpret 2.22 as meaning the alternative has to be exclusive of the CETV. If so, I question their grasp of English as well as their unwillingness to question the logic and therefore press the FCA for clarification. Let us remind ourselves of the wording: The client may not be reliant on income from the scheme if they can produce the same income via a suitable alternative, with or without a guarantee, and this income is able to meet their needs throughout retirement. For example, if the recommendation is to transfer to a personal pension and the cash flow modelling (in real terms) evidences that with a sustainable withdrawal rate the client will not run out of money in retirement, allowing for beyond average life expectancy and stress testing of returns. How can the offered example be interpreted any other way than that the DB and the personal pension replacement are potentially equivalent as means of meeting the required spending, as implied by the APTA?

The fact that there is doubt about this makes me wonder how often assessors in or outside the FCA have applied reliance inconsistently, in terms of the date the guidance was introduced (affecting either requisite personal information or the relevance of the TVAS calculation) and, even after, in terms of whether or not to treat the APTA calculation as relevant at all and, if it does, whether to rely on the adviser’s APTA return assumption as a reasonable ‘bad case’ scenario.

Age bias

In my article I explained why a bias against younger people transferring conflicts with the underlying economics of harvesting risk premiums, or ‘trend’ real returns: the more time, the lower the risk of shortfall against a fixed risk free rate. If this bias, which is not explicit in the rules, results from interpretation of the FCA’s statements about the importance of being able to quantify retirement needs, any lack of visibility should not trump the economic drivers of probable gain in utility. That is to make the perfect the enemy of the good, which an adviser will not want to do. However, it may be more important that these statements were only added to the rules after the BSPS transfer window closed.

Gaming the redress scheme

The argument in my article that struck a chord even with long-standing opponents of transfers, including those that would rather the ‘safety first’ utility description did in fact hold and regret Pension Freedoms ever happened, was that the industry should not have to pay for complainants gaming the redress scheme. Support might best be described as coming from a spirit of ‘natural justice’. Considering most of my arguments were quite technical, it is good to see that this requires no technical knowledge to form a strong principled opinion.

Media reports have suggested that the planned BSPS redress scheme will incorporate a possible return to the original BSPS scheme, which has now (unexpectedly) left the PPF. Whilst this is constructive, it will not resolve the core problem of demonstrating objectively in most cases that unsuitable advice was the probable cause of loss or the cause of probable loss. Nor will it prevent gaming of the redress scheme if complainants are not obliged to return to the scheme as a condition of any redress offer.

Opinion amongst advisers appears to be that their clients would have no interest today in modifying, let alone giving up, their replacement investments if that were made a condition of redress payments.

I have not had any legally-informed answers to me question whether the client’s current intention for their investment strategy may itself negate the finding of the suitability assessment. Clearly it can in logic but does it in law? I gather that that is the question FOS have been asking transfer complainants, in order to test their claimed risk attitude. If so, good for FOS.

What next?

In making these points before the FCA’s ideas are formed about a s404 redress scheme for BSPS transfers, our intention is to flag the issues that need to be addressed by the detailed proposals, if the scheme is not to be open to legal challenge. We will be paying close attention to the proposals, even though we did not advise any BSPS members, because we have a set of indirect interests that were set out in my article.

I also suggested in the original article that it was surprising that firms with a direct interest in non-BSPS cases involving questionable unsuitability findings (via FCA file assessments, Past Business Reviews or s166 orders) have not already sought to defend themselves  through judicial reviews, given the potentially dire consequences of the findings. Though it is not our business, the feedback to the article makes it even more surprising that they have not.

We are open to further feedback on matters of fact or interpretation, either in connection with transfer advice generally or BSPS specifically. We do not need to be told that there were egregious cases of bad advice at BSPS. We know that. To [email protected].