Speaking at the European fee-based advisory network’s conference in Dublin, Lean raised the issue of the use of insurance bonds and wrappers within a pension at the point clients are starting to transition from accumulation to decumulation.
Products such as funds, ETFs and collectives can provide a natural income with a reduced requirement to encash any capital units, the chartered financial planner argued.
This creates flexibility and is tax efficient within a pension product, meaning a variable or fixed income stream can be paid out.
In contrast, insurance bonds, even where they hold the same assets, have to encash units or surrender segments leading to potential short-term surrender penalties.
Structured notes
In addition to insurance bonds and wrappers, Lean highlighted the unsuitability of structured notes within insurance bonds, which he says can exacerbate the problem as the coupons may be dependent on the underlying assets.
If the underlying assets do not reach certain prescribed levels, then there is no income received and potential loss of capital.
In the long term, he said, structured notes are simply a return of capital.
This is compounded by the risk that if a structured product has failed to qualify, there are short-term liquidity issues or further surrender penalties, he added.
Regulatory viewpoint
The UK’s Financial Conduct Authority, and recently the Malta Financial Services Authority, have stipulated that a maximum of 30% of any fund, after the pension commencement lump sum (PCLS) has been assessed, should be considered for structured products.
The watchdogs regard them as complex investment structures that only Mifid-based advisers should be advising on, Lean said.
This is due to the complexity of any risk being taken, which the regulators believe both retail clients and trustees are unlikely to understand.
Fees versus commission
James Pearcy-Caldwell, chief executive of OpesFidelio, highlighted the difference that fees and commissions, even when identical figures, can make.
He said that, even at low levels of commission, insurance bonds or structured products will have early access penalties. This means that those taking a PCLS or income in the early years face one of two alternatives:
- Take encashment through surrender and incur penalties; or,
- Withdraw funds BUT the remaining value continues to accrue charges at the greater of the current value or the original investment value.
Pearcy-Caldwell offered a case study to illustrate the second option.
A client with a bond valued at £100,000 ($135,372, €113,346) makes a £5,000 withdrawal in year one.
The bond grows at 5% (minus charges), meaning it is now worth around £95,500.
However, initial charges linked to a commission bond remain based on the greater of initial value or current value – which means that some charges are based on the sum of £100,000 and not £95,500.
The escalation of this can lead to a downward spiral of fund value, he warned.
The general consensus among the OpesFidelio members attending the second annual conference was that platforms provide a better decumulation solution to those planning to take an income within five years.
Clive Moore says:
The UK’s FCA certainly hasn’t stipulated that any fund should be limited to 30% consideration for Structured Products, they are classed as Standard Assets. SPs are used very widely indeed by professional investors and advisers, in the UK and internationally, to deliver fixed or variable income in a more efficient way than most traditional methods.
Conflating the issues around charging via commission or fees with the use of Structured Products is pretty odd – they can easily be bought with no commission loading. If the pitch is to use preferred platform and investment options ahead of alternatives that don’t deliver income and value to OpesFidelio, that’s fine, but probably better to use a different argument.
Bethell Codrington says:
If anyone believes that overseas advisers don’t take commission (undisclosed) on Life Wrappers and Structured Products, they will also believe the ‘Cow jumped over the Moon’!
*Clive – as a distributor of such products, what %age of your International IFAs don’t take commission, up front and trail?
Chris Lean & James P-C are spot on.
Christopher Lean says:
Clive,
You are right. The FCA’s predecessor, the Financial Services Authority, conducted a review and provided guidance that no more than 25% of a portfolio should be in structured products, and PII questionnaires request data on these complex vehicles. The FOS rules against advisers that abuse guidelines. However, if you feel that retail pension clients should be investing more into derivative based complex structured products then what level would you suggest?
Structured Products in bonds in pensions for decumulation? You state that they can deliver income efficiently, but structured products in a bond are not providing the investor with an income as such as the bond itself is not income producing- surely this is just adding to the capital value of the bond. The issues around the use of Structured Products, however, are far greater than a discussion about the percentage used.
Angela Brooks says:
Fortunately, most good IFAs in the UK wouldn’t touch structured notes with a barge pole. Unfortunately, my experience is that expat investors, especially in Spain, commonly have over 50% of their portfolio, or even as much as 100%, in these toxic, high-risk products; many of them with underlying assets that are so volatile that placing capital in a Note is nothing more than gambling. I welcome the Malta regulator’s limit of 30% of notes in a pension fund – but personally I think the ethical sector of the financial services community will reduce this voluntarily to 0%. Let William Hill sell this rubbish.
James Caldwell says:
Clive, totally agree that OpesFidelio does not and will not recommend the use of complex derivative products within a bond in a pension, either to retail clients or trustees. We are always open to arguments to the contrary as long as such arguments are based on client outcomes.
You are also correct that, as we are not commission based, the only incentive we (OpesFidelio) have to recommend products is best outcomes for clients, rather than commission earnings. If that is “conflating” then, guilty as charged.
Angela Brooks says:
I’ve been looking at this Clive Moore’s comment that structured products are “Standard Assets”. But standard for who? Certainly not for pension scheme members. Maybe for jolly jack the lads with more money than sense!
Simon Pettitt says:
I worked in the European private banking and investment banking arena for many years. Structured products were fantastic – for the banks, less good for the clients. Everybody knew this except those poor investors who gave discretion for their funds to be managed. If the programme worked well for the investor, more often then not the product would be called. If it worked badly, then the investor (you guessed it) was allowed to carry on owning the product to be redeemed at 100 but generally with no income or capital uplift. Similarly insurance structures like CPPI where you would get cash-locked.