Compensation Calculations Change

Published / Last Updated on 27/03/2017

Compensation Calculations Change

Just over a week ago the Financial Conduct Authority (FCA) issued proposals for changing the way investment compensation calculations are worked out for claims against financial advisers where unsuitable advice is given on defined benefit/salary related pension scheme transfers.

Way back in the 1990s there was a huge miss-selling scandal for types of pension scheme transfers resulting in £billions being paid in compensation redress and new rules where only financial advisers with a high level advanced pension qualification and a special permission from the FCA to advise on ‘Pension Transfers and Opt-outs’ are allowed to do so.

This is a complex area of financial planning given the fact that consumers are giving up ‘gold plated’ secure pension income with annuity risk, inflation risk and investment risk all taken by the scheme rather than the consumer.  Transferring away means the consumer takes on all those risks.

Compensation calculation rates were set a number of years ago and clearly markets and the economy has changed.  Inflation is lower than it was, investment returns are volatile and pension schemes are more flexible.  To give you an idea of how out of date the compensation calculation is, the interest rate that must be used is currently 8% per year for mis-sold investments compensation is increased with an assumed interest rate of 8% pa.  This is clearly out of date given that most people would not have earned 8% pa if the money had been left in the bank, meaning that compensation levels are simply too high.

The FCA has proposed as review of the following:

  • updating the pre-retirement discount rate so that it acknowledges the Pension Protection Fund (PPF)
  • updating the post retirement discount rate and acknowledging the likelihood that consumers will take a pension commencement lump sum
  • updating the mortality assumptions
  • making allowance for gender-neutral annuity rates
  • assuming that male and female consumers are the same age as their spouse to simplify the approach
  • simplifying the assumption about the proportion of people married or in a civil partnership at retirement
  • making allowance for enhanced transfer values (ETVs)
  • updating these assumptions on a regular basis to reflect the fact that markets are often volatile

Those terms explained:

  • Discount rate is an assumption of future investment growth
  • Mortality rate is your life expectancy
  • Annuity rates have reduced dramatically over the last few years meaning that the cash equivalent transfer value that you received is much higher than it used to be, there needs to be an allowance for this.

Comment

The review is long overdue and we believe this should be expanded to all financial complaints compensation calculation areas.  It is no wonder that financial adviser professional indemnity insurance is so high and why the costs of financial advice can be high given the liabilities involved and the huge compensation payment levels that must be paid if something goes wrong.

Explore our Site

About
Advice
Money MOT
T and C