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The FCA’s announcement of its thematic review into retirement income advice earlier this year shouldn’t have come as a great surprise to the advice sector. Many of the tell-tale markers of regulatory attention have been present in this area for some time. The impact of rising costs of living and recent macro-economic events will have also reinforced the case for the regulator taking a closer look at this topic sooner rather than later. So why is the FCA interested in retirement income advice and what can firms do to prepare for it?
The first in-depth look at retirement advice since the Pension Freedom reforms
The Government’s Pension Freedom reforms have had a seismic impact on how consumers access their pension benefits and the aftershocks – in terms of consumer behaviour and the evolution of products and services – are still being felt.
Prior to pension freedoms, three quarters of defined contribution pension pots were used to buy an annuity. The FCA’s latest retirement income market data shows this has fallen to less than 10% of pots. And for larger pension pots of £50k or more, almost 90% of advised recommendations are for solutions which remain invested via income drawdown and uncrystallised funds pension lump-sums.
This sharp pivot from secure to investment income will be a key area of regulatory focus given the consequential impact on consumers. Recommendations to generate a sufficient, sustainable income from assets which remain invested place a premium on the quality of firms’ advice processes: not just at the point clients first access their pension benefits but also as part of any ongoing services firms provide to their clients. The FCA will therefore be keen to assess how firms’ advice processes manage these risks and whether firms are delivering suitable advice consistently.
Mind the (regulatory) gap?
A key aim of the thematic review will be to help the regulator explore the effectiveness of the existing regulatory framework for retirement income advice. There is a stark contrast between the detailed rules and guidance governing defined benefit pension transfer advice and the high-level suitability rules within COBS 9 governing other forms of pension advice.
While there’s nothing inherently wrong with higher-level rules, they rely upon firms to interpret and apply them effectively in each situation. And in more complex areas, like delivering a sustainable income in retirement, firms need to work harder to ‘fill in the gaps’ in order to assess suitability in a robust and consistent manner. The FCA will no doubt want to explore how the suitability status quo is holding up and whether further intervention – in terms of additional guidance or new rules – could be necessary.
In search of orthodoxy
Another likely driver for the review is the fact that, some eight years after the pension freedoms were introduced, there is still limited orthodoxy within the market on some of the key building blocks of good retirement income advice. A wide variety of approaches exist for areas like risk profiling, cash-flow modelling, calculating sustainable withdrawal rates and structuring income withdrawal strategies. And while it’s unrealistic to expect there to be single ‘solutions’ that all firms should be following, the multiplicity of approaches and the differing rationale underpinning them will be on the regulator’s radar.
The FCA will also be keen to explore the extent to which firms are reliant on third-party tools and software to help them deliver their advice. Again, this is no bad thing: it’s positive that firms seek the support of expert providers to help them deliver more complex parts of the advice process. But the regulator will want to check whether firms understand the tools they use, have satisfied themselves that the outputs are fit for purpose, and are taking account of any limitations when they integrate them within their advice processes.
Potential for conflicts of interest
It’s no coincidence that the FCA is kicking off its thematic review of retirement income advice at the point that its work on defined benefit pension transfer advice nears completion. Part of this is practical: the regulator has limited resources for proactive work and so needs to plan accordingly. But that’s not the only area where its work on pension transfer advice is likely to have a bearing on the retirement income advice review.
The FCA has already noted the potential conflicts of interest from how some defined benefit transfer advice firms charged for their advice and their ability to influence the nature, and the quality, of the advice given. This led it to introduce a ban on contingent charging for pension transfer advice (except in very limited circumstances). Given this context, the FCA will be keen to explore whether there are similar risks for retirement income advice.
The focus will be on whether the revenue firms generate from delivering ongoing services to clients has any impact on suitability of the solutions they recommend. This is a key issue for retirement income advice given the recommendation of certain products – like annuities – are likely to exclude or reduce firms’ ability to levy an ongoing adviser charge.
FCA data on the importance of ongoing services to advice firms will have informed this. Its evaluation of the RDR found that 90% of new clients were placed in services which included ongoing advice and its fee data shows that ongoing adviser charges make up around three quarters of firm revenue. So the FCA will be keen to assess whether there’s a risk of the ongoing service tail wagging the suitability dog. And it will also be likely to have an eye on whether this risk is greater within certain business models, such as consolidators and vertically integrated firms.
A side-helping of Consumer Duty
Finally, the FCA will be likely to use the thematic review to provide a litmus test for how advisers are implementing the Consumer Duty. This is because a firm’s approach to retirement income advice will reveal how it’s treating its customers in a number of key areas. Expect questions on how you’ve tailored your advisory services to meet the particular needs, objectives and characteristics of customers at and into retirement.
The design and delivery of ongoing services will also be key given the important role ongoing advice plays in ensuring recommended solutions adapt to clients’ changing needs and circumstances. This is an area the FCA hasn’t looked at in detail before. So the review will be likely to probe key areas such as whether ongoing service recommendations are in line with client needs, whether ongoing service charges represent fair value, whether services are delivered as promised, and whether services deliver good client outcomes.
What you can do to prepare for the FCA review
Advice to help clients meet their income needs in retirement is an area where advisers can really demonstrate their value. This is a complex area where good advice has the potential to help clients prioritise the things that matter and use the assets they have in the best way possible to meet their needs. But this is reliant on you ensuring the way your approach to retirement advice is designed, delivered and monitored effectively.
Be clear on the types of customer your advisory service is right (and wrong) for: It’s important to have a clear view on the kinds of customers your retirement-focused advisory proposition is appropriate for and not appropriate for. This should include how factors like the scope of your advice, your charges, your investment solution and any ongoing services impact different groups of customers. If your service works really well for certain types of customer but not for others, ensure you have an effective triage process in place.
Document the rationale for the range of products and services you recommend from: You should be able to demonstrate how the selection of the platform, wrapper, product and investment solutions you choose from has been based upon the needs and objectives of your retirement income clients.
Don’t scrimp on the fact-finding: Knowing and understanding key information about your clients is the foundation of suitable advice. This isn’t just about how much time you spend gathering the information but also making sure you ask questions in a way that helps you collect the depth of information you need. It’s important this spans client needs and objectives, as well as other key areas like knowledge and experience, financial circumstances, and health.
Make sure your risk profiling approach is retirement income ready: Standard risk profile questionnaires often focus on assessing clients’ attitude to investment risk. But it’s also important to find out how each client feels about income security. One way to approach this is to assess how clients would feel about accepting loss and a reduced income. As ever, assessing capacity for loss is also crucial.
Cash-flow modelling needs to be robust and explained clearly: Cash-flow modelling can be an invaluable tool in comparing different retirement income solutions and demonstrating the likelihood of them meeting client needs. But that’s only so long as the assumptions underpinning the modelling – in areas like inflation, charges, investment growth and life expectancy – are robust. It’s also crucial to ensure clients understand the assumptions the model is based upon and that the outcomes from it are uncertain.
Make sure your withdrawal strategy stands up to scrutiny: There are a variety of methods and strategies available to deliver client income. Make sure you identify the risks of the approaches you use, test how they’re likely to perform in different scenarios, factoring this into your advice process. You should also think about the steps you can take to control and minimise these risks on an ongoing basis.
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