COB 5.3 Suitability

A

Pension Transfers and Pension Opt-outs

1

When advising a customer who is, or is eligible to be, an active member of a defined benefits occupational pension scheme whether he should opt out or transfer, a firm should:

(a)

start by assuming it will not be suitable; and

(b)

only then consider it to be suitable if it can clearly demonstrate on the evidence available at the time that it is in the customer's best interests.

2

When the firm is recommending a customer to transfer or opt out of any other type of occupational pension scheme, the suitability letter should include:

(a)

a clear explanation why transferring or opting out is more suitable than remaining in the occupational pension scheme;

(b)

a request for the customer to contact the firm immediately should clarification or further information be needed or if the letter does not match the customer's understanding of why the transfer or opt-out has been recommended;

(c)

a statement to the effect that the firm has relied on information supplied by the customer and the occupational pension scheme;

(d)

particularly with pension opt-outs, an arithmetical analysis setting out the financial implications of leaving the scheme;

Pension Opt-outs only

3.

When advising on a pension opt-out from an occupational pension scheme, a firm should:

(a)

identify all the rights and benefits available to the customer under the occupational pension scheme and carefully consider the effect of replacing them with the very different benefits of a personal pension; the following factors should be taken into account relating to the occupational pension scheme:

(i)

spouse's, civil partner's, 12dependants' and children's pensions;

(ii)

early retirement provision, including retirement in ill-health;

(iii)

revaluation rates both in deferment and payment, and whether they are guaranteed or discretionary (and if discretionary, whether likely to continue);

(iv)

ancillary benefits (for example, tax-free cash or lump-sum death benefits);

(v)

transfer club arrangements, where applicable;

(vi)

the customer's contribution and the employer's contribution;

(vii)

benefits on leaving service;

(viii)

whether or not eligibility for other benefits, such as permanent health insurance, is dependent on being a member of the occupational pension scheme;

(ix)

the financial security of the occupational pension scheme, by reference (for example) to the last actuarial statement or the most recent trustee's report and accounts; and

(b)

take into account the following additional factors:

(i)

whether or not the employer would contribute to the personal pension scheme;

(ii)

the charging structure of the personal pension and its impact on transfer values in the early years;

(iii)

subjective factors relating to the customer's personal circumstances such as;

-

future career plans and earning prospects (including any reasonable likelihood of career progression making better occupational terms available) and intended retirement date;

-

attitude towards earnings-related compared with money-purchase benefits;

-

attitude to financial risk and security;

-

a possible wish to make pension arrangements separate from employment (for example, because the customer is on a short-term non-renewable employment contract or does not expect to stay in his current employment for more than a short period);

-

any value the customer attaches to personal control;

-

the customer's cash needs;

(c)

if the customer is about to change, or has just changed, employment, consider the issues in (ii) and (iii) in relation to any scheme of the new employer for which the customer is eligible now, or will become eligible in the near future;

(d)

if the customer is an active or prospective member of a money-purchase occupational scheme, follow 1- 3 to the extent that the factors listed are relevant to such schemes taking particular account of differences in costs and charges.

Pension Transfers only

4.

(a)

Advising a customer on the suitability of transferring deferred benefits from a defined benefits occupational pension scheme requires detailed consideration of the ceding scheme compared to the individual pension contract to which the transfer would take place. A process will be needed which should include procedures:

(i)

for gathering ceding scheme information as detailed in (b);

(ii)

to assess the customer's attitude to risk and security; this is relevant not merely to the choice of contract or fund, but also (and more fundamentally) to the initial choice between an occupational pension scheme and an individual pension contract;

(iii)

to ascertain the customer's career aspirations and desired retirement age and to consider what a realistic retirement age would be, having regard to the size of the transfer value and the extent to which it can be converted into a stream of income before State pension age;

(iv)

to ascertain whether the customer's new employer (if any) has arrangements to accept transferred benefits, as if so a further analysis may be necessary;

(v)

enabling the representative to look at other pension options, if available;9

(vi)

for carrying out a transfer value analysis;

(vii)

for enabling the customer to receive sufficient, clear information to make an informed investment decision (see (iii)).

(b)

The following information as a minimum will be needed from the ceding scheme in respect of the customer:

(i)

spouse's, civil partner's, 12dependants' and children's pensions;

(ii)

early retirement provision, including retirement in ill-health;

(iii)

transfer value quotation detailing:

-

guarantee period;

-

pre- and post- April 1988 Guaranteed Minimum Pension and Excesses;

-

revaluation rates in deferment and payment and whether they are guaranteed or discretionary and if discretionary whether they are likely to continue and how far they are reflected in the transfer value;

-

tax-free cash arrangements;

(iv)

lump-sum death benefits;

(v)

transfer club arrangements, if applicable;

(vi)

relevant earnings;

(vii)

period of service;

(viii)

scheme details (for example benefits, bridging pensions, guarantee periods, position pre- and postnormal retirement date, history of discretionary increases);

(ix)

whether members' benefits have been equalised for service from 17 May 1990;

(x)

ill-health benefits;

(xi)

a consideration of the scheme's financial position and whether the transfer value has been reduced because the scheme is underfunded.

(c)

Relevant items of information about the customer include:

(i)

the different risks of personal pension schemes and defined benefit pension schemes;

(ii)

the impact of fluctuations in annuity rates on the size of the eventual pension;

(iii)

the impact of protected rights on the planned retirement date;

(iv)

any changes to the tax-free lump-sum;

(v)

any reduction in immediate death benefits;

(vi)

the transfer value analysis including an indication of the rate of growth needed to ensure the investor is no worse off as a result of any transfer;

(vii)

the position and interests of the customer's spouse , civil partner 12and dependants.

(d)

(a) - (c) also apply to prospective money-purchase benefits transfers where appropriate; and additional information concerning the customer should be considered, including:

(i)

the possibility of incurring early transfer penalties and new front-end charges;

(ii)

how the transfer affects the investment risk;

(iii)

how the effects of charges and expenses differ between the schemes;

(iv)

changes to the tax-free cash;

(v)

any reduction in immediate death benefits.

B.

Personal Pension Schemes and FSAVCs compared to Stakeholder Pension Schemes

1.

A particular feature of the personal pension scheme market is that a potential investor in a personal pension scheme will always have the option of a stakeholder pension scheme and may find that equally suitable for his or her needs.

2.

Representatives will need to undertake the comparison between personal pension schemes and stakeholder pension schemes and, as required by COB 5.3.16 R (3), explain in the suitability letter why, if they have recommended a personal pension scheme, it is considered to be at least as suitable.9

3.

There are some circumstances where a potential investor in an FSAVC will have the option of a stakeholder pension scheme, in addition to the option of an in-house AVC.

4.

Representatives will need to undertake a comparison between the three options and explain in the suitability letter why, if they have recommended an FSAVC, it is considered to be at least as suitable as a stakeholder pension scheme or the in-house AVC.9

5.

If a representative without access to a stakeholder pension scheme makes a comparison with a stakeholder pension scheme, the comparison may be with a stakeholder pension scheme on the minimum product standards unless the representative is or ought to be aware that the customer has access to a stakeholder pension scheme on more advantageous terms.

6.

The guidance in this section of the table applies equally to recommendations for individual and group personal pensions, even though the latter may, in accordance with Regulation 22 of the Stakeholder Pension Scheme Regulations 2000 (SI 2000/1403), exempt an employer from having to designate a stakeholder pension scheme for his employees.

7.

Firms are reminded that key features documents for personal pension schemes should signpost the availability of , as set out in COB 6.5.21 (5).

8.

Firms promoting a personal pension scheme (including a group personal pension scheme) to the employees of a particular employer through direct offer financial promotion are reminded of the provisions of COB 5.3.28 R. Accordingly, firms should take reasonable care to ensure that the personal pension scheme is likely to be at least as suitable as a stakeholder pension scheme for the majority of employees to whom the personal pension scheme is being promoted, and that this is adequately evidenced.

C.

Hybrid Products

1.

A 'hybrid product' is a product which results from combining a package of products to create one recommended solution. An example is a 'back to back' contract which takes a lump sum investment and splits it into two amounts; one part is used to provide income through the purchase of a temporary annuity and the other part is invested in a unit trust or life insurance bond so that by the end of the annuity term the growth may produce the return of the original lump sum invested.

2.

The requirements for suitability and best investment advice apply to all elements of a hybrid product:

(a)

if appropriate, representatives need to scrutinise ready-made packages from a single product provider to make sure that each element is competitive and that a better solution is not available by combining elements from different providers;9

(b)

simplicity or administrative convenience is not sufficient reason for using one provider for all elements.

D.

Industrial Assurance Policies

If an industrial assurance policy is recommended to a customer and a comparable policy (which is not an industrial assurance policy) is available which is at least as suitable, the suitability letter should explain clearly the reasons why the industrial assurance policy is being recommended.

E.

Income withdrawals and short-term annuities

When a firm is advising a customer about personal pension fund withdrawals or purchase of short-term annuities13:

(a)

the customer's personal and financial circumstances should be considered carefully, in particular:

(i)

the customer's investment objectives, need for tax-free cash and state of health;

(ii)

current and future income requirements, existing pension assets and the relative importance of the plan, given the customer's financial circumstances;

(iii)

the customer's attitude to risk, ensuring that any discrepancy between his attitude to risk relating to pension fund withdrawals or purchase of a short-term annuity13 and that in relation to other investments is clearly explained;

(b)

the suitability letter should explain:

(i)

the purpose of the contract for the customer;

(ii)

the relative importance of the contract, given the customer's financial circumstances;

(iii)

the customer's attitude to risk; and

(iv)

the risk factors involved in entering into a pension fund withdrawal or purchase of a short-term annuity13, which include13:

-

the capital value of the fund may be eroded, especially if investment returns are poor and a high level of income is taken; this could result in a lower income in the future;13

-

the investment returns may be less than those shown in the illustrations;

-

annuity or scheme pension rates may be at a worse level in the future;13

-13

when maximum withdrawals are taken or the maximum short-term annuity is purchased, high levels of income may not be sustainable;13

-13

the maximum income that can be withdrawn under an alternatively secured pension after age 75 is significantly less than the maximum that applies before age 75.13

F.

ISA, PEP or CTF transfers8

When a firm is advising a customer on whether to transfer existing ISA, PEP or CTF holdings, COB 5.2 (Know your customer) and COB 5.3 (Suitability) apply. All the advantages and disadvantages of transferring should be considered. In particular the following information (which is not exhaustive) should be considered and provided to the customer, usually as part of the suitability letter, before the transfer takes place:8

(a)

exit charges and any other costs associated with the transfer;

(b)

initial start-up charges;

(c)

transaction details (that is, whether holdings are liquidated or transferred intact, as permitted by the terms and conditions);

(d)

possibility (and likely effects) of shortfall, following cancellation;

(e)

potential for loss of income or growth, following a rise in markets, while the ISA transfer, PEP transfer or CTF transfer remains pending.8

G.

Contracting out of SERPS

When a firm is advising a customer on whether to contract out of SERPS in favour of an appropriate personal pension or contracted-out money-purchase scheme ('COMP'):

(a)

representative should give careful consideration to:9

(i)

the range of pivotal ages outside which it will generally be in the best interests of customers to remain in SERPS;

(ii)

the level of earnings below which it may not be in a new customer's interests to contract out;

(iii)

the minimum length of time for which a customer may benefit from being contracted out;

(b)

factors to be taken into account when making this assessment include:

(i)

customer's age and sex;

(ii)

State pension age for females (where different from males);

(iii)

customer's level and stability of earnings and tax position;

(iv)

customer's career prospects (including the likely period for remaining contracted-out);

(v)

customer's existing pension provision or opportunity to participate in an occupational pension scheme;

(vi)

potential loss of rights compared to SERPS benefits;

(vii)

terms of the personal pension scheme or contracted-out money-purchase scheme with particular reference to the level of charges;

(viii)

customer's attitude to risk.

(c)

The suitability letter should clearly explain any risks in contracting out.

H.6

Borrowing to invest

When considering the suitability of a particular investment product which is linked directly or indirectly to any form of loan or mortgage, a firm6

(a)6

should take account of the source of the funds being invested and the suitability of the overall transaction; and6

(b)6

must follow any relevant suitability and other rules in COB and MCOB.6

For example, the circumstances in which a recommendation to enter intoa regulated lifetime mortgage contract and invest the funds into a long-term care insurance contract might be appropriate are limited, and both COB 5.3 and MCOB 8.5 apply.6

Introduction

1.

COB 5.3.14 R requires a written explanation of a recommendation relating to a product to be provided to a private customer. This is commonly referred to as 'the suitability letter' although it does not need to take the form of a letter, for example it might form part of:

(a)

a financial report to the customer (provided that it is prominent); or

(b)

a fact find document (a copy of the whole fact find or just the recommendation section could be given to the customer); if a copy of the fact find or the recommendation section is sent, the copy should be of sufficient quality to be clearly legible.

2.

A suitability letter, to be successful, should explain simply and clearly why the recommendation is viewed as suitable having regard to the customer's:

(a)

personal and financial circumstances;

(b)

needs and priorities identified through the fact finding process;

(c)

attitude to risk in the area of need to which the recommendation relates.

When a suitability letter is needed

3.

COB 5.3.14 R sets out the occasions when a suitability letter is required. COB 5.3.19 R sets out the exceptions to this rule. A letter is required in all cases where pension transfers or pension opt-outs are recommended.

Style and presentation

4.

The style and presentation of a suitability letter is left for firms to decide so that they can design a document which works best for the market in which they transact business. A suitability letter is more likely to be effective if it demonstrates these features:

(a)

personalisation - the more personalised the suitability letter, the more effective it is likely to be;

(b)

simplicity and plain English - when technical terms need to be incorporated, they should be explained if the customer is unlikely to understand their meaning;

(c)

concise and clear messages - lengthy explanations in extensive letters are likely to reduce the effectiveness of the letter with the customer disinclined to read it properly.

5.

Ideally each suitability letter will be different, reflecting the approach of the representative, the customer's profile, subjects discussed and the considerations on which the advice was based. Some firm may wish to introduce a degree of standardisation to suitability letter production to aid quality control. When using a standardised approach the firms should take the following into account:9

(a)

standard paragraphs are best limited to the description of the most common needs and the products which will satisfy those needs;

(b)

the firm should clearly link the customer's own needs, priorities and attitude to risk to the product recommended rather than just setting out stock motives that may apply to all customers;

(c)

tick box, pre-printed forms should rarely be used, and when they are it should only be in the simplest and most straightforward advice situations.

Content

6.

A firm should take the following into account when constructing a suitability letter:

(a)

the letter should explain why the customer's needs, priorities, attitude to risk and financial situation all combine to make the recommended product suitable for the customer. It should not merely state what product is being recommended with no link to the customer's personal circumstances;

(b)

other needs discussed during the factfind process which the customer does not wish to consider do not need to be included in the suitability letter (although they should be recorded in the factfind); they should be included if they assist in demonstrating why the product recommended is considered suitable;

(c)

alternative products which were recommended but rejected by the customer should be mentioned;

(d)

only the available options under a contract which have been recommended, whether accepted or rejected, need be mentioned in the letter;

(e)

where the range of packaged products from which advice on investments has been given contains the products of more than one product provider in respect of the same type of packaged product, the letter should include (the list is not exhaustive) why a particular product provider has been recommended; reasons may include product features not available elsewhere, price, service levels, performance track record, investment prospects, medical evidence terms, reputation and financial strength.9

Signing

7.

Each suitability letter should be signed by a person authorised by the firm to advise on the type of product which is being recommended. Ideally this will be the representative who gave the particular advice but, if not, both the signatory and the representative should accept responsibility for the letter and the recommendation.9

Timing of suitability letters

8.

Suitability letters should be issued to customers at the time that the recommendation is made or as soon as possible afterwards, to allow as much time as possible for the customer to consider the recommendation before any cancellation period ends. In any event the letter should be issued no later than the issue of the cancellation notice or, in situations where no cancellation notice will be issued, for example in the case of personal pension income withdrawals, before the transaction is put into effect.