If you are an adviser and you explained to someone outside financial services how much regulatory and financial risk you take on just doing your job, they would think you are nuts. There are obviously easier ways to make money!
The direction the regulator appears to be taking, however, is one of top down assessment; looking at the controls a business has in place at the top before deciding if any holes mean looking at individual files would be necessary.
As such, one of the best ways a firm can reduce its risk is with a well-constructed Centralised Investment Proposition (CIP). The problem, however, is that most CIPs we review try to do too much. As such, we are encouraging firms to build a separate Centralised Retirement Proposition (CRP).
The reason is that most investment propositions are geared towards saving, investing and accumulating money and very few are geared towards helping a client spend money without going bust.
Think about it this way. Historians may well remark that the end of the 20th Century as the time when the bell finally tolled on Final Salary / Defined Benefits (DB) pensions. It also probably marked the end of people working for 40 years with the same company and being the start of the mass personal pension/defined contribution era.
Previously, for most people it was simple: when those with a company or government final salary scheme retired, they got their tax-free lump sum and a pension for the rest of their lives and probably a half pension for their spouse when they died. No thought required really.
In addition, they would get their state pension at the age of 65 (men), 60 (women), again no thought required really.
Those with a private pension instead of a company DB scheme would be expected to take an annuity, with or without spouses benefits or indexing. This would probably be from the same insurance company who they bought it off in the first place. Again, no real thought required, particularly as annuity rates were into double figures in the 1980's.
No flexibility of income of course or death benefits for the remainder of a fund, but nobody really gave it much consideration back then.
Move the clock forward to now and Pensions Freedom obviously
creates choice for the public, but choice for someone who doesn't
understand the implications is bewildering.
There is no default position - no 'no thought required' options.
This coupled with the State pension age increasing also means that it is likely people will draw pensions prior to the state retirement ages to be able to partially give up work.
The Office for National Statistics (ONS) pension survey 2015 indicates just how much growth in the membership of defined contribution pensions has taken place as well as the ever-growing demise of DB schemes.
- Active membership of private sector defined contribution (DC) schemes, which has remained around 1.0 million since 2008, rose to 3.2 million in 2014 and 3.9 million in 2015.
- Active membership of private sector defined benefit (DB) schemes remained at around 1.6 million over the last 3 years.
The fall in active membership of DB schemes is linked to the rising costs of providing these pensions. Partly due to DB schemes' approach to dealing with risk and partly due to increased life expectancy, a growing number of private sector employers have sought to "de-risk" pension provision by closing DB schemes and replacing them with DC schemes.
- Active membership of open private sector DB schemes fell to 0.6 million in 2015, from 1.4 million in 2006. (A reduction of over 50%)
The Association of British Insurers (ABI) pension freedom statistics from Aug 2016 also illustrates the demise of the number of annuities arranged (80,000) versus the 1.03 million Income Drawdown withdrawals.
This was also reiterated in the FCA Retirement Outcomes Review (ROR), Interim Report (FCA MC16/1.2. July 2017). The FCA suggest that DC pension savings are expected to become an increasingly important source of income for later life for future generations: in particular, by 2030 it is estimated that workplace DC schemes will hold £1.7 trillion, five times the £340bn held in 2015.
In such a low interest environment, annuities are now as rare as a Leicester City premier league title. At present only seven firms remain.
All of this is rapidly moving the pressure away from companies and the government onto individuals to manage their own retirement funds. For the overwhelming majority, they need help to do this from financial advisers.
All of this is potentially brilliant for you as an adviser.
Over time of course this may change when interest rates pick up or there is yet another change in legislation which requires people to go down the annuity route.
In the meantime, what is clear is that more and more people will require advice going into income drawdown as part of their retirement process.
As you have come to expect in this profession, with opportunity comes risk.
Without the certainty of a pension from an annuity or final salary scheme lots of decisions need to be made on what to do with the personal pension fund - this equals RISK for the client and RISK for the adviser and firm providing the advice.
How do you quantify, manage and reduce that risk where possible in a way clients can understand and deal with - what do you need in place to do this and can a CIP really be suitable for this.
We believe that clients looking to accumulate wealth over time will have very different needs to clients entering retirement.
What is required is a similar process and procedures to be adopted for a CRP as it is for a CIP to deal specifically with retirement clients. From the point a client says I want to part retire or fully retire and draw a pension, what happens next?
Having processes and procedures in place to ensure that the retirement they want can be delivered initially and then be sustained over 20 or 30 or more years is substantially different to those that helped them accumulate the capital in the first place.
The "Sustainability" issue of income in retirement will always be the key factor for clients and firms alike. Failure to meet the sustainability of this income is the massive risk for clients and firms.
How much would a PI claim be, if a client and their dependant went broke? What lump sum would be required to replace that income if the adviser was found to be at fault? Depending on the loss of pension per annum, particularly if this was after giving up a DB pension, it could certainly test the firms PI limits with claims quite easily exceeding £1million.
The recently published revised FCA redress calculations for unsuitable DB transfer advice gives a clue as to the scale of compensation likely. The factor is as high as 28 times the lost DB pension per annum. FCA FG17/9.
CRPs are quickly moving up the agenda and priority list and we are seeing a rise in the number of Firms asking us to help them implement a CRP or to review and validate what they already have in place.
As if we didn't have enough to deal with, an additional challenge faced by firms in this market is the frequency of reviews required by the clients to ensure their retirement income stays on track. It is likely that in order to do this effectively, firms may well have to review clients on a half yearly or even quarterly basis as opposed to the yearly norm that we currently see. The new rules coming into effect with MiFID11 on the 3rd Jan 2018 carry a sting in the tail.
From this date, if you review your client's circumstances in any way, you are now obliged to conduct an interim suitability assessment. Not only that, you also have to produce a suitability report, whether or not anything is bought or sold!
This has the potential to significantly increase the workload for firms. It also brings into sharp focus how firms are to be remunerated for this work. If you charge based on funds under management you may well end up doing a lot more work for less as the funds shrink over time in drawdown. Firms are recognising this by outsourcing regular reviews to us to manage their workload and we have designed a service that will manage this process for you if required. We literally take all or part of your customer base, in this case the retirement clients, manage them proactively and give you everything you need to deliver interim suitability assessments.
If clients run out of funds part way through their retirement - who will they blame? Having a robust CRP in place that is reviewed and validated will be beneficial for all parties. It will help avoid this event and demonstrate to the FCA and your PI Insurers the Firm had in place a dedicated process and acted responsibly.