By Simon Goryl - Advisory Director & Sara Haworth - Senior Consultant | 05/09/2023

Could retirement income advice be the next major area of regulatory challenge?

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The FCA’s retirement income advice thematic review clearly highlights the importance, particularly in this new Consumer Duty world, of firms ensuring good outcomes for retail customers. Although ‘discovery’ in nature, the FCA is clear in its purpose – that consumers get good advice at the point they first access their pension savings and, where relevant, on an ongoing basis.

Outside of RDR and Pension Freedoms, the retail advice sector has received less scrutiny in recent times when compared to other sectors across Financial Services. Of course, the FCA has had a sharp focus on the suitability of defined benefit pension transfer advice, introducing supplementary suitability provisions, a ban on contingent charging, and the Section 404 consumer redress scheme for British Steel pension scheme members. That all considered, significant differences in the suitability rules remain between defined contribution and defined benefit pension transfer advice.

Now the Consumer Duty has been implemented, the regulator will be keen to see if there has been a shift in standards with regard to consumer outcomes and how firms and advisers are demonstrating this. And perhaps crucially, how in this complex area, firms are supporting customer understanding and justifying that the retirement products advised on, and the associated costs, are delivering the requisite benefits and value for consumers.

The Consumer Duty factor

On 19 July 2023, the Treasury Select Committee questioned the Chief Executive (Nikhil Rathi) and Chair (Ashley Alder) of the FCA as part of its ongoing scrutiny in a wide-ranging session. When asked by the Committee about how the board of the FCA has made itself comfortable that the industry is ready for the rollout of the Consumer Duty, Ashley Alder replied ‘We will be interested, from a board perspective, in how it is supervised and enforced, the degree to which firms actually implement, the degree to which firms, particularly small firms, operate the duty and the intersection with financial advice in particular.’ Nikhil Rathi added that firms need to ‘think about how they are placing consumers at the heart of the journey’ from ‘the manufacture of products to the distribution, the pricing and the customer service support’. It is clear therefore that the FCA will be focusing on the implementation of Consumer Duty and how this intersects with financial advice, particularly within smaller firms.

In the same session, Nikhil Rathi was keen to point out that the FCA is moving intentionally to outcomes-based regulation rather than detailed rules, and they are ‘requiring boards and firms themselves to look at how they are treating their customers against the different pillars we have set out, demonstrate to us that they have taken those points into account—fair value, customer service and all of the points that I mentioned—and not rely every single time on us having to produce a detailed rule, a piece of guidance or an intervention to regulate what they are doing.

As Nikhil Rathi summarises, the Consumer Duty is a ‘really significant piece of regulationand the most significant horizontal intervention for 20 years.’ However, the question remains whether firms and advisers, including those in smaller firms, have done enough to demonstrate suitability and good consumer outcomes with regard to retirement income advice, and have raised their standards in line with Consumer Duty, to avoid a repeat of systemic mis-selling issues such as British Steel defined benefit pension transfers.

The price of freedom

2015 saw the introduction of the Government’s pension freedom reforms, which revolutionised the way consumers could access their retirement savings. While these reforms offered far greater choices for consumers, this freedom came with difficult decisions, which many consumers were not equipped to make without the need for financial advice. As well as providing consumers with more choice, pension schemes were also now able to de-risk their book by way of offering scheme members cash equivalent transfer values in exchange for the guaranteed income stream for life that the scheme would have paid – which often on the face of it, looked attractive for both parties. As a result of the changes, the number of consumers drawing income from non-guaranteed investment-backed pension funds (drawdown) has increased significantly. In the ‘Defined benefit pension transfers market data October 2018 – March 2020’ the FCA found that over the period 1st October 2018 to 31st March 2020, 57% of consumers who held a DB pension and sought advice were recommended to transfer or convert their pension. In addition, the latest retirement income market data from the FCA shows there was a continued increase in drawdown sales of 24% between 2020/21 and 2021/22, and that 40% of regular withdrawals were withdrawn at an annual rate of over 8% of the pot value – begging the question whether the average customer’s pension pot will last their full retirement.

At the same time, in the post-RDR world, access to advice has become more challenging for the average retail consumer, who may find typical financial advice fees unaffordable. As Sarah Pritchard (FCA Executive Director, Markets) stated in a speech in September 2022, ‘Offering advice on what to invest in carries with it a heavy regulatory burden. A full suitability assessment – in effect an in-depth MoT of a customer’s personal financial situation – is needed from a qualified financial advisor. Because of the costs involved, only the relatively well-off can access advice on what to invest in. Mass market consumers are often left to navigate a bewilderingly large choice with little support.’

Given the much wider range of options available due to the pension freedom reforms, it is more vital than ever that consumers get access to sound advice at the point they first access their pension savings and, where suitable, on an ongoing basis from a qualified financial adviser. However, this often comes at a cost that many people simply cannot afford, leading to the creation of the ‘Advice Gap’.

The FCA is keen to bridge the advice gap for mass market consumers, however, it hasn’t proven straightforward. In their Evaluation of the impact of the Retail Distribution Review and the Financial Advice Market Review, the FCA stated that ‘Robo-advice services, offering automated digital or online advice, are becoming more common but remain only a small fraction of the overall market’. Many firms have pursued robo and hybrid advice offerings, however, the risk of unsuitability and technology costs increase as the advice becomes more complex and requires personalisation. Therefore, many have failed to create a service that is adequately appropriate for the majority.

The result is, that there is little choice for the average consumer right now to be able to access quality advice without the costs associated with paying for a qualified financial adviser. In addition, with the results of the FCA’s thematic review of retirement income advice as yet unknown, it’s unclear whether those consumers who have sought advice have in fact received good outcomes and appropriate value for the service they have paid for.

Assessing suitability resurrected

In 2020, the ‘Assessing Suitability Review 2’ was halted by the FCA in response to the Covid-19 Pandemic, but given pension freedoms, the cost-of-living crisis, and the suitability issues surrounding British Steel defined benefit pension transfers, it was always likely that the FCA would re-prioritise a review surrounding retirement income advice. It was no surprise then when in January 2023, the FCA announced its Thematic review of retirement income advice as ‘a piece of discovery work to explore how financial adviser firms are delivering retirement income advice and assess the quality of outcomes consumers are getting.’

In June 2023, the FCA sent out an initial survey to some 1,300 adviser firms with 87 questions, focusing on a wide range of information, including, but not limited to; fees, adviser remuneration, vulnerable clients, numbers of clients in decumulation and target market, alongside relevant data, MI, and internal controls information. Firms had three weeks in which to respond to the survey, some of which were then selected to submit client files to the FCA. As the review gathers momentum, those firms contacted should be prepared for additional scrutiny by the regulator, along with the higher expectations that have been brought in with the Consumer Duty.

What can you do?

Retirement income advice is, by its very nature, a complex area. Few consumers have the knowledge and experience to fully understand their options in retirement and what may be the best approach to take for their individual circumstances and needs. Coupled with this, are their behavioural biases such as ‘short term horizon’ – considering and valuing immediate needs over later life needs, and ‘over-confidence’ – confident that they ‘will be fine’ in retirement, that state income will provide adequate support, or that investment returns will move in their favour. Consumers often don’t know how far their pension will stretch, how reliant they are on the funds, or how much taking lump sums will impact the fund’s longevity. A qualified financial adviser can be crucial in enabling a client to understand what their best options are in relation to their pension savings to support their specific needs in retirement. However, this advice must be designed, delivered, and monitored effectively to ensure good consumer outcomes.

Know your audience

One of the key requirements for Consumer Duty is to deliver products and services effectively to a pre-defined target market. A firm’s products and services (including the scope of advice, fees and charges, any ongoing service, and investment solutions) should be designed to meet the needs of a clearly defined target market. The FCA then expects firms to monitor and test this on an ongoing basis to ensure consumers are receiving good outcomes. Firstly, to ensure that products and services work as expected, and then secondly, to ensure that products or services are being distributed to the right consumers – i.e., those consumers within the firm’s clearly defined target market. The target market should be defined in enough detail to avoid including any groups of consumers who would suffer detriment from that product or service. Firms should also consider whether their products or services have features that could risk harm to any particular group of consumers, including those with characteristics of vulnerability. If it does, the firm should consider how best to mitigate those risks. Firms should avoid vague or very broadly defined target markets that might include groups who actually wouldn’t benefit from the product or service being offered. Crucially firms need to put in place good governance and oversight of their products and services, inclusive of effective outcomes monitoring and MI with timely and appropriate action on any issues identified.

The products and services you offer

Manufacturers must regularly review whether their product or service meets the identified needs of the target market. Secondly, whether the distribution strategy remains appropriate for the target market. Thirdly, whether the product or service has actually been distributed to those consumers in the target market correctly. Distributors must undertake their own regular review and consider whether their distribution arrangements are appropriate, fit for purpose, and whether products and services have actually been distributed to customers in the target market. To summarise, both manufacturers and distributors of products and services need to undertake their own reviews to make sure they are meeting the products and services outcomes.

The value customers receive

Value is the relationship between the amount paid by a retail customer for the product (or service), and the benefits they can reasonably expect to receive from the product. A product provides fair value where the amount paid for the product is reasonable relative to the benefits of the product. It is important your total charges represent fair value to the client and are not excessive. The outcome applies to closed products as well as new and existing products. Firms must regularly review the value assessment to ensure their products and services continue to provide fair value. It is prudent for firms to consider the value of each element a customer is being charged for (as well as the total cost). For instance, what is the cost of the initial advice, and is this commensurate with the service being offered? Do customers need advice to achieve their objectives? Is the cost of the ongoing service commensurate with the value customers receive from it? Do customers need ongoing reviews? How do annual management charges, platform charges and any other product charges compare across the market? Where costs are higher, is there appropriate justification for a customer incurring them? A typical example might be where consumers are being advised to switch to a more expensive DFM proposition over a low-cost passive/tracker fund. Is it appropriate and justifiable for the particular consumer when the higher charges are going to erode the potential returns?

Effective fact-finding and suitability reporting

Effective fact-finding, disclosures and articulation of the recommendation are crucial to ensuring good consumer outcomes. As the old saying goes, it’s not about the quantity, it’s the quality that matters. Effective capture of your client’s specific objectives in retirement, a breakdown of their income and expenditure needs, assets, liabilities, health, current and future financial situation, and financial capacity and capability, are the bare minimum requirements. This isn’t just about gathering information, but also a chance to clarify the information provided. For example, does the client have any characteristics of vulnerability? Is there anything unknown that might impact the recommendation? Both the fact find and suitability report provide an opportunity to educate customers, to put them in an informed position, and to ensure good outcomes. The suitability report gives consumers the ability to reflect on the information and think through their retirement plans. Where possible, firms should use diagrams, illustrations, cash flow models and scenario analysis techniques to really support customer understanding.

The risk your client is willing and able to take

A firm’s approach to risk profiling should be robust and fit for the purpose of ensuring customers are invested in funds that match their risk profile and capacity to endure losses. As well as ensuring the ‘Attitude to Risk Questionnaire’ is fit for purpose, it is vital that advisers are not solely reliant on the questionnaire as a means to assess the risk a client is willing and able to take. Any inconsistencies in consumer responses or inaccuracies in their understanding need to be explored, considered, rationalised and documented.  Firms should really test how comfortable consumers are with seeing investment losses, how much, and over what period. How would this affect their lifestyle? Recent pandemics and economic crises have seen consumers incur investment losses in times when their money doesn’t go as far. A situation that many may have not foreseen or really accommodated for.

Evidencing outcomes

The above is a small snapshot of some of the areas that firms and advisers can focus on to demonstrate good consumer outcomes, which has been brought into much sharper focus by the implementation of the Consumer Duty. It is critical that firms are able to evidence the outcomes being achieved from the good work and efforts put into having practices that are robust, fit for purpose, and support effective advice and good outcomes that demonstrate value for their customers. The FCA is on the path to becoming a ‘data-led regulator’ and expects firms to harness the data available across the business to act as evidence. Outcomes Monitoring is a key component of the Consumer Duty and plays a vital role in supporting a firm’s case in complying with the Duty. It is therefore a given that implementing a robust Outcomes Monitoring Framework and reporting mechanisms to enable visibility of outcomes throughout the customer journey should be an important element of any firm’s risk and control framework. This will not only support good governance and decision-making but also a firm’s attestation that it is compliant with the Duty.

How can Square 4 help?

Square 4 was founded with the vision to support people and businesses to grow and thrive. We can support your first, second, or third-line teams, enabling you to combine your in-house knowledge with the breadth of experience and expertise from our specialist team of Wealth Management consultants. Our goal is to work closely with our clients to help them identify and manage risk whilst also supporting with implementing solutions that help firms achieve their business goals. We combine our in-depth technical capability, and industry and consulting expertise, with technology and innovation to deliver proportionate and pragmatic solutions across an evolving spectrum of conduct, financial crime, and operational risk. In addition to our consulting expertise, we also boast an extensive network of highly skilled associates who we leverage to support us with casework, such as; file checking, suitability assessments, complaints handling and remediation activity.

Our dedicated Pensions and Investment specialists at Square 4 have significant insight into the FCA’s approach to the retirement income advice thematic review, and we are currently helping our clients in this area, as well as many of the other areas discussed in this paper.

We have a tried and tested approach to Outcomes Monitoring and have also developed a simple five-point Consumer Duty implementation health check to provide assurance, on a review and recommend basis, to determine whether the work firms have undertaken to date is complete and aligned with industry and regulatory expectations.

If you would like to discuss any aspect of your firm’s retirement income advice, Consumer Duty activity, or any other conduct-related issues you are facing currently, please get in touch at:

Alternatively, you can contact:

Simon Goryl – Advisory Director

Sara Haworth – Senior Consultant



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