Summary of FSA Thematic Review

Their project was split into 2 parts:

1. Assessing the quality of advice given to customers since pensions A-day to switch their existing pensions into a personal pension plan (PPP) or self-invested personal pension (SIPP) and firms’ systems and controls relating to this advice; and

2. Whether the actions of pension providers were affecting the quality of this advice (for more detailed information in this respect, please see the report itself).

Firms Giving Advice

The FSA visited 30 firms giving advice and assessed 500 of their files. These firms represented a broad cross-section of the market and accounted for around 10% of pension-switching sales since A-day. Results were variable and, whilst they considered some firms were consistently giving suitable advice, they were also concerned to find that other firms, in their opinion, were providing unsuitable advice in a high proportion of the cases sampled. Overall, this represented 16% of cases to be unsuitable advice.

Some of the main reasons for unsuitable advice

Unnecessary additional costs; this was by far the most common reason for unsuitable advice in the FSA’s opinion which accounted for 79% of cases.
The switch involved extra product costs without good reason (65% of unsuitable cases);
The fund(s) recommended were not suitable for the customer’s attitude to risk and personal circumstances (40% of unsuitable cases);
The adviser failed to explain the need for, or put in place, ongoing reviews when these are necessary (26% of unsuitable cases);
The switch involved loss of benefits from the ceding scheme without good reason (14% of unsuitable cases).
Switching to consolidate different pension schemes where the cost was not explained or justified to the customer (35% of unsuitable cases); and
The new pension was more expensive than a stakeholder pension, but a stakeholder pension would have met the customer’s needs (21% of unsuitable cases).

The FSA intends to put in place a range of measures depending on the extent of each firm’s failings and requiring them to address their unsuitable sales. Several firms will be subject to enforcement investigation as a result of significant failings identified during the review.

Review of Past Business

The FSA will be writing to over 4,500 firms, responsible for the majority of pension switching business, asking them to consider their past and future sales in the light of this review and to take remedial action where necessary. They will follow this up in 2009 with a series of firm visits and desk-based file reviews, to assess whether firms have taken adequate action in response to their communication.

Pension providers and SIPP operators

The FSA did not have serious concerns about the ways the pension providers visited were marketing their products to advisers through their literature and broker consultants. They were, however, concerned that some seemed unlikely to be complying with the requirement to use lower projection rates where the standard rates would overstate the investment potential (COBS13 Annex 2, 2. 4R(1). In particular, there were cases where providers used the standard 5%, 7% and 9% rates of return to project for cash funds. The FSA intend to pursue this with the providers concerned and are also considering, more widely, providers’ compliance with their projection and illustration rules.

Good and Poor Practice

The report provides examples of good and poor practice. Unquestionably, while some of the poor practices cited are pretty obvious, the good practices point towards the standards expected.

Cost Comparisons

Good practice:
The firm set out a section in its template suitability report outlining any switch penalties on the ceding scheme and clearly explained the impact of charges of the switch. They did this by comparing the reduction in yield (RIY) figures for the ceding and new scheme The firm also had guidelines around the level of additional charges that were considered acceptable and, although these could be exceeded, this could only be done with head office agreement.
Another firm had a similar process, but used projected fund values instead of RIY figures.

Poor practice:
The firm included a table in its suitability reports setting out and comparing the projected Retirement fund value from the ceding scheme and the new scheme. These typically showed that the new scheme had lower charges. The advisers indicated that the new scheme involved lower costs and, therefore, this formed part of the reason for switching. However, the projection of the new scheme was often on the basis of 100% investment in a cash fund (which had no charges) where the fund was to be managed by a discretionary fund manager. The projections left out the cost of the discretionary management service and any underlying funds. Therefore, the comparative table and the advice were misleading.

Attitude to risk

In 40% of unsuitable cases the fund(s) recommended were not suitable for the customer’s ATR and personal circumstances; generally, the funds recommended were too high risk and in a small number of cases the funds were too cautious. The reasons for the advice being unsuitable included cases where the adviser had taken insufficient account of:

the nature and overall risk level of the investment(s) recommended;
the impact the term of the policy has on the choice of funds. For example, in some cases there was little understanding that a fund that is suitable over a term of ten years is unlikely to be suitable for a term of three years for a customer with the same ATR;
the customer’s investment knowledge and experience; and
the benefits of diversification – sometimes the adviser did not appear to appreciate that investing in a single area or asset class is more risky as the customer has ‘all their eggs in one basket’.

Good practice:
The firm used a risk profiling tool to make an initial assessment of the customer’s ATR. They then used a stochastic modelling tool to create a series of model portfolios, with the individual funds selected by an independent fund research company. Although systematised, the approach was not used as a ‘black box’ – the tools were used as a basis for discussion and the process was adapted, when merited, for individual customers.

Poor practice:
The customer had previously been invested in with-profits and property funds and originally had a low/medium ATR. The file recorded that the customer now wanted to take a medium/high risk approach to investment in order to achieve better returns. The adviser recommended a new pension investing in ten different external funds, all equity-based. The selection included 60% in specialist and overseas funds and a further 30% in more adventurous UK equity funds. FSA considered this fund selection to be too high risk for this customer given that they intended to retire and take benefits in around five years.

Ongoing investment advice

Where an ‘asset allocation’ approach (using a spread of individual funds to meet asset allocation profile) has been recommended, the FSA advise the scheme needs to be reviewed periodically and rebalanced where necessary, to ensure it continues to be suitable. Otherwise, this type of portfolio will become unbalanced over time and no longer meeting the customer’s attitude to risk and personal circumstances. The same risk applies when funds with different risk profiles are used. In order to be suitable in these cases, the adviser must explain the importance of such reviews, offer them periodically, or put them in place. In 26% of unsuitable files, none of these had been done.

Good practice:
One firm had a very clear explanation in the template suitability report describing why ongoing reviews and rebalancing were needed for their portfolios (where an asset allocation approach had been recommended). Their standard service for customers also incorporated a full annual review and biannual rebalancing.

Poor practice:
Many firms had not clearly established the risk of investments becoming unbalanced over time without readjustment back in line with the customer’s risk profile, and had not explained this to customers.(COBS 9.4.6R(3)). Although in most cases advisers had ongoing relationships with customers, it was not clear that these arrangements addressed the issue of rebalancing on a consistent basis.

Loss of benefits

Where an existing scheme has particular product features or benefits that are of value to the customer and are not replicated in the new scheme, then there needs to be a good reason why the switch is suitable, despite the loss of these features or benefits. For example, the loss of guaranteed annuity rates (GAR) that is higher than is likely to be available on the open market. In 14% of the unsuitable files, the customer had lost valuable features or benefits without good reason

Good practice:
When recommending switching from a pension with a GAR (for valid reasons which benefited the customer) one firm would quote the current market annuity rate alongside the guaranteed annuity rate (on a like-for-like basis) in the suitability report. This helped the customer understand the value of the GAR.

Poor practice:
The adviser did not adequately consider the nature of the existing with-profits policy. The policy included a significant guaranteed sum assured and also a GAR. The with-profits fund was highly rated. The new pension would have had to provide a net return of over 5% per annum just to match the scheme’s existing guaranteed benefits, ignoring any future bonuses.

Procedural failings when giving advice

The FSA saw a wide range of procedural failings, including rule breaches, across the sample of files assessed. In many cases these did not result in unsuitable advice (for example, an adviser may have failed to check whether the new scheme was more expensive than the old scheme, but research showed that the new scheme had lower charges) but they did increase the risk of unsuitable advice being given. These included:

failing to adequately evidence the customer’s needs (20% of all cases);
failing to adequately consider the ceding scheme, its options and whether it was able to meet the customer’s needs, for example, by means of a fund switch (26% of all cases)
failing to ascertain whether the new scheme was more expensive than the old scheme(s) (26% of all cases)
failing to explain why the product or the provider was recommended (22% of all cases); and
failing to consider or discount a stakeholder pension (COBS 19.2.2R) (19% of all cases).

Many of these issues were also raised in the FSA’s review of investment advice processes earlier this year, which provides further examples of good and poor practice here.

Systems and controls

The FSA assessed firms’ systems and controls relating to pension switches, in particular their sales processes, compliance monitoring and management information (MI). The assessment focused on whether firms’ controls would prevent unsuitable advice and ensure fair outcomes for customers. They found many firms’ controls were not well suited to this and were overly focused on procedural aspects, not outcomes (see comments on file checking processes below). They also found the elements of control were generally not consistent.

[As an aside, please note the FSA’s emphasis on ‘outcomes’ (above and below) – this is a change of focus and is in line with their TCF focus on 6 outcomes].

In the better firms, there was a clear link between the way the sales processes had been set up, how they were monitored and how the results were captured through MI. This included senior management making necessary changes to the sales or compliance processes on the basis of the issues highlighted by MI. Some smaller firms visited had a simpler process, but achieved the same effect.

Sales processes

The degree of sales process and procedural documentation varied between firms. Some had a standard fact-find for gathering ‘know your client’ information and a template suitability report. Others had long sales manuals covering issues such as how to review ceding schemes, how to undertake cost comparisons and the approach to recommending investments.

Generally, the FSA found that the larger the firm, the more processes and procedures are in place. However, this did not prevent poor outcomes for customers as some advisers used them poorly in practice. All firms had sales processes to some extent, whether written or otherwise, but their effectiveness was down to how well they were used as much as what exactly they covered.

Compliance monitoring

The main form of monitoring by firms was file checking. There were variants of pre and post sale checks, some included 100% checking of pension switching files and others just used a sample. The FSA found no clear link between the firm’s precise approach and its customer outcomes. More important was how well monitoring was done in practice.

The FSA was concerned that their file review results differed significantly from those of some firms. This seemed to reflect the following.

Some approaches to file checking tended to focus on the procedural aspects of the sale, such as whether initial disclosure was undertaken and whether the key features document was provided. Whilst this is important, a more realistic assessment of unsuitable cases would be achieved if the file checking procedures were focused more on the outcome.
There were also instances where the FSA rated a file as unsuitable although the firm only rated it as a procedural failing. This was in relation to the funds chosen in relation to the customer’s ATR and personal circumstances. Whilst this was checked and identified by the firm, it was wrongly concluded as a procedural failing of the adviser not explaining the risks to the customer.

In nearly all of the cases assessed by the FSA, firms agreed with their conclusions, having reconsidered the files in the light of their assessment (no real surprises there; after all who would disagree).

Management Information (MI)

The collection and use of MI in firms was variable. Two-thirds of firms had adequate MI on pension switching. The rest collected insufficient MI (or none) and/or MI from which it was difficult (or impossible) to identify trends. Some firms collected MI that showed the need for action, but did not then act on it.

Many of the smaller firms had poor or no MI, but some were collecting and using it well. Others had weak MI but were, nevertheless, dealing with issues effectively on a day-to-day basis.

FSA Actions with adviser firms visited

Findings were reported to each firm individually, followed by appropriate action with each firm.

The firms fall into three broad categories:

some firms are required to undertake only minor actions (or none);
some are required to address specific, significant failings; and
some will be subject to enforcement investigation.

For each case where unsuitable advice was identified, the firm is required to examine the findings and, where necessary, provide compensation to the customer. Further action was also required for each customer where it was assessed as unclear whether the customer had received suitable advice (and, if the advice was unsuitable, provide compensation to the customer where appropriate). For firms where process-related issues were identified, they are required to address them.

Lastly, some firms are required to undertake a wider review of past pension-switching business and in some cases they have extended this to other investment business.