Replacement business: Your guide to best practice – The FSA today identified the good and bad practices when it comes to replacement business.
Although the findings came following a thematic review into the use of centralised investment propositions, it said its recommendations were relevant to all firms providing investment advice.
The FSA said poor outcomes can occur if firms fail to:
•consider objectively their clients’ needs and objectives.
•collect necessary information on their clients’ existing investments and the recommended new investments, such as the product features, tax status, costs and the performance of the underlying investments
•implement a robust risk-management system to mitigate the risk of unsuitable advice and poor client outcomes.
Considering cost
Good practice
Several firms used reduction in yield (RIY) figures in cost comparisons which also considers the initial cost associated with the recommendation. The FSA also saw firms using comparative projections to demonstrate, on a pound for pound basis, the impact of cost differences on the value of the pension at retirement.
Poor practice
One firm provided a cost comparison in its suitability report when recommending replacement business. The annual cost of the recommended investment was based on the annual management charge. However, the product provider’s illustration highlighted additional charges on some of the recommended funds which were omitted from the cost comparison. This increased the annual charge of the new investment by up to 1% which the firm did not consider.
Poor practice
One firm offered a CIP via a discretionary service, but its replacement business cost comparison did not assess the overall impact of all the charges of the new investment. The firm disclosed the specific portfolio and underlying fund charges. Although it highlighted that additional charges were levied as a result of trades, it did not pay due regard to the typical volume of trades that may be expected within each portfolio, and hence what the typical overall costs would be. Members of the senior management team and the compliance department were unaware of the impact that the volume of trades may have on the portfolios’ overall costs.
Considering performance
Poor practice
One firm stated in its suitability reports that factors affecting its choice of investment partner included investment options and performance. However, there was no evidence that it considered and compared the options and performance of each client’s existing investment with the recommended CIP solution.
Poor practice
One firm sought to explain improved performance prospects by highlighting that the client would benefit from their investments being ‘actively managed’ in the recommended solution, implying that the existing investment was not actively managed. However, in most cases, the client’s existing investments were already actively managed.
Considering the tax position
Poor practice
One firm did not consider the impact of taxation on its replacement business recommendations. It made recommendations which triggered liabilities to capital gains tax (CGT) but gave no consideration to mitigating the level of tax payable. By staggering the sale of existing investments over two tax years, clients would have been able to reduce or remove this tax charge by using their annual CGT allowance for two years.
Collecting and assessing appropriate know your client information
Good practice
One firm’s client files included detailed notes taken during the ‘fact-find’ meeting. Not only did these detail the client’s specific investment objectives, but also the underlying motivation behind the client’s objectives. By providing this level of detail, the firm was better able to demonstrate that its replacement business recommendations met the needs and objectives of its clients.
Collating and assessing information on existing investments
Good practice
In one firm, details of each of the client’s existing investments were clearly presented in the suitability report. This included details on the features and benefits of the existing investment along with the performance of the individual funds. The adviser clearly documented their recommendation for each investment, including their specific rationale for each recommendation. This included recommending retaining existing investments that already met the needs and objectives of the client.
Controls and oversight
Good practice
One firm placed a limit on the additional acceptable cost of replacement business at 0.5% per annum. Recommendations could only exceed this limit in exceptional circumstances after a discussion with, and approval by, the advice manager.
Note: Another firm had a range of cost levels on a traffic light scale (red/amber/green ratings) with different requirements for each. The appropriate level may vary between firms and clients. For example, a lower additional cost may be appropriate for cautious investors.
Poor practice
Several firms had not clearly defined the level of additional costs they considered acceptable for their clients. As a result, their file reviewers were not consistent in their view on when recommendations that imposed additional costs were justified. As a result we failed several files that had been reviewed and passed by these firms’ file review function.
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