The Financial Conduct Authority (FCA), the UK's regulator, this morning banned the use of contingent charging in defined benefit (DB) transfer advice.
In a policy statement issued today, the regulator said the ban will remove conflicts of interest that arise when a financial adviser only gets paid if a transfer goes ahead.
The FCA said authorised firms were the group most likely to object to a ban on contingent charging, although it acknowledged there was some support within the industry for a ban too. However, it said those opposed to the introduction of a ban "did not provide any compelling evidence that an alternative approach would be more effective."
The FCA recognises that, while abridged advice will not appeal to all consumers, firms may be able to attract clients who would otherwise be unwilling to pay for full advice.”
The statement read: "We recognise that, while abridged advice will not appeal to all consumers, firms may be able to attract clients who would otherwise be unwilling to pay for full advice."
As for the "specific circumstances" where contingent charging will still be allowed when the ban comes into place, the FCA said these customers will have "certain identifiable circumstances". These are people who may be not be able to afford non-contingent advice charges and are more likely to benefit from receiving advice.
Specifically, the FCA said these vulnerable customers fall into two groups: "The first is those who have a specific illness or condition that causes a materially shortened life expectancy. The second is those who may be facing serious financial hardship such as, for example, losing their home because they are unable to make mortgage or rental payments."
However, the FCA said those specific customers, who are an exception to the ban, should not pay any higher charges than those who do not pay contingent fees. The watchdog also said some firms have previously charged less for advice where the decision was not to transfer. Under new rules, however, firms will have to set a total cost for their DB advice.
In a bid to prevent a ban coming into place, a number of people told the FCA a ban would have some unintended consequences. These included:
• an increase in the proportion of recommended transfers, as advisers would be reluctant to give ‘advice to do nothing' when having to charge significant amounts
• conversely, others felt there would be a growth in the proportion of recommendations not to transfer as it would be ‘easy money'
• a potential growth in insistent clients who may feel they have the right to transfer, having paid for advice, resulting in more standalone advice firms and providers making these transfers for insistent clients
Some firms also questioned whether there should be extra rules for vertically integrated firms. They argued that such firms that only recommended their own products post-transfer had an extra layer of conflicts of interest. Respondents to the FCA's papers suggested they could game the rules by charging more for their products and less for the actual advice once a ban was in place.
In respone to those worries, the FCA said: "We agree that VIFs should not be allowed to cross-subsidise charges for pension transfer advice with product charges, and undercut other advice firms due to their business model. We consider both our existing rules and the rules implementing the ban on contingent charging prevent this."
The FCA made several points to outline its reasoning in outlawing DB transfer charging. These include:
• There is a clear conflict of interest in charging on a contingent basis for DB transfer advice where the only two outcomes are transfer or do not transfer
• There is a coincidence of advice to transfer and contingent charging: most advice results in a recommendation to transfer and most firms contingently charge
• Most consumers will not be materially harmed by remaining in their existing DB scheme if they choose not to take advice, and the carve outs mean there will only be a small number of consumers who are likely to benefit from a transfer but cannot afford advice
• As most consumers would not benefit from a transfer, the FCA expected the ban to be effective in reducing both the number of consumers who proceed to a transfer following advice and the harm that unsuitable transfers cause
• A ban places a value on advice itself rather than on a transaction so helps to enhance market integrity
• A ban prevents cross-subsidies by those who transfer and pay excessive amounts, with up to £10,000 not being untypical, for advice which is free or low cost to those who do not transfer
• In the current charging model, consumers do not recognise or weigh up the cost of transferring as it is dwarfed by the transfer value on offer and only deducted after the transfer has taken place
Hugh Savill, director of conduct and regulation at the Association of British Insurers (ABI), said: "The ban on contingent charging is welcome and what we called for. It is the right thing to do. We welcome that exclusions are made for customers facing a shortened life expectancy or serious financial hardship. Some vulnerable customers who may benefit from a transfer and cannot afford financial advice up front may find the contingent charging model works best for them. In certain circumstances, transferring to a Defined Contribution scheme may be appropriate."
However, many in the sector were highly critical of today's announcement. Andrew Tully, technical director at Canada Life said: "Contingent charging has been a contentious issue for a while and the FCA is introducing a ban with rules in place to prevent firms gaming the system. It is almost impossible to show a link between contingent charging and unsuitable advice. But advisers only being paid if a transfer proceeds creates a conflict of interest and a perception they may be more inclined to recommend a transfer."
Tully added, "Abridged advice should allow firms to offer advice at a lower cost than through a full advice situation, and may help filter out clients for whom a transfer is unlikely to be suitable. It's worth highlighting abridged advice can never lead directly to a recommendation to transfer. The outcome will either be a ‘don't transfer' recommendation, or a move onto full advice. In the latter case, advice fees which the client has paid for abridged advice should be offset against fees for full advice."
Andy Bell, chief executive at AJ Bell, was highly critical of the move, describing it as "a waste of time."
"The FCA's focus should be on making sure advice is tailored to the pension saver and delivered in a form that they can understand. Banning contingent charging swaps one set of problems for another and doesn't get to the heart of the issue. Most importantly, DB transfers will now become an option only available to the wealthy.
"DB advice rules need a root and branch overhaul. Too much of the advice process involves trying to work out whether the transfer value on offer is good value for money. Frankly, this is a waste of time as there is an obligation on the ceding scheme actuary to certify that the transfer value fairly reflects the defined benefits being given up," Bell said.