Pension review enters Phase 2

In Consultation Paper 7, the FSA has confirmed that the Pension Review is to be widened to include non-priority cases. Some commentators had considered that widening the review would prove to be too difficult for firms to undertake and for the regulators to police. The FSA has not been deflected by the obvious difficulties, both to itself and the firms which it regulates, but has explained that its logic is that "redressable losses arising from mis-selling by firms are existing liabilities which could otherwise be pursued either through regulators' complaints procedures or through the courts". The FSA considers that forcing firms to review non-priority cases will not increase their liabilities, but will assist firms to crystallise them. Therefore, the FSA has issued a Consultative Document containing draft guidance and model letters and expects to issue final guidance later in the summer.

Reviewing non-priority cases

The FSA expects firms to use the same methods and processes to review non-priority cases as they use to review priority cases (with one important exception, see below). This means that firms will be expected to undertake:

• information gathering from their own records, occupational pension scheme records and investors questionnaire replies (see new identification procedures below);
• a loss test;
• compliance/causation tests (it is expected that some firms will continue to waive these tests altogether);
• redress for investors who have been financially harmed by non-compliant sales.

The FSA does not propose to make any alteration to most of these key components of the review process. This will enable firms to benefit from using the systems and procedures which they have already set up, and the staff which they have already trained to use those procedures. In addition, the work undertaken over recent months to simplify the review in order to speed it up should also make the review of non-priority cases a quicker process than the review of priority cases has been.

The exception - identification of investors

For a number of reasons, the FSA has decided to alter the process by which investors are identified. This is because:

• unlike priority cases, many non-priority investors will already have returned an identification questionnaire (and been informed that they do not fall within a priority category); and
• non-priority investors are typically younger than priority investors, and may now have taken out their pensions some time ago and the identification process therefore requires alteration.

The FSA has accordingly decided on a new approach to investor identification.

Firms are required to write to all non-priority investors inviting them to request a review (the FSA refers to this as a "direct invitation"). This will be accompanied by a checklist for the investor in order to help them decide whether they should request such a review. The checklists typically ask a number of questions, such as:

• Did you understand that your personal pension depends on how well investments perform?
• Did you understand that your employer's pension scheme did not depend on how well investments perform?
• Did you understand that you could get less from your personal pension than from your employer's pension?

If the investor answers "no" to any of these questions, it is suggested that they request a review of their case. Investors are provided with a questionnaire to complete and return in order that they can supply missing information.

As a minimum, investors must receive one follow up letter or other form of communication if they do not reply to the original invitation. It is not clear whether or not firms must be satisfied that these letters have actually been received by the investor, or whether they can simply mail them to the address which they have on record. However, as follow-up communication can be by telephone call (which would make it clear whether or not a firm was sending letters to the correct address) or letter, and as the FSA has stated in relation to initial identification that "the possibility is left open that further action might be required of firms in due course in light of practical experience", firms should take all reasonable steps to ensure that the communication has been received by the investor. If firms fail to satisfy themselves of this, it will be open to the regulator to come back at a later date and claim that the original identification work has not been carried out satisfactorily as the firm would not have taken reasonable steps to attempt to identify investors. For example, using the DSS direct mailing service, or insisting upon telephone contact, or employing a specialist research company, could be ways in which a firm could discharge its responsibility to take reasonable steps to identify potential non-priority cases.

The FSA's model documentation properly differentiates between transfers, opt-outs, and non-joiners and whether or not the investor has already been identified as being a non-priority case or whether no identification work has yet been undertaken. However, in order to use these standards, firms will need to devise and implement systems in order to identify which type of documentation will need to be sent to each investor.

Project plans

Given the extent to which firms were often slow to design and implement adequate and realistic project plans in relation to the priority review, and in order to avoid reviews being under resourced, the PIA intends to require all but the smallest firms to prepare and maintain up-to-date project plans for Phase 2 of the review, and to submit those plans to PIA on request. Many firms will already have experience of how to produce such plans, and of the importance in documenting the thought process which led to the firm carrying out the review in the way in which it did. For example, in relation to tranching (see below) it will be crucial that firms not only document that they have decided to carry out the review in tranches, but why they thought that their chosen method was appropriate and what benefits using particular tranching methods would bring to the firm and its customers. The plan should also document how the Phase 2 review will run alongside the work already being undertaken in relation to Phase 1.

Target dates and tranching

The FSA has proposed that the target dates for Phase 2 will run alongside (and beyond) those already set for Phase 1 of the review. The project plans (see above) must show how the two reviews can most effectively be managed side by side, in order to make best use of the skills and resources available and to avoid the requirements of priority and non-priority reviews conflicting.

The FSA proposes that the first target date will be the identification of Phase 2 cases which require review. This will encompass the identification of cases which require the issue of a direct invitation, the completion of the invitation stage (including any follow up), and the categorisation of respondents. It is proposed that this stage be completed by no later than 31st March 1999. This is a short timetable which will require firms to draw up and implement project plans very quickly, certainly by the autumn. Further target dates (for example, for the completion of the assessment stage, or the gaining of acceptance of offers) will be set in due course.

As most Phase 2 cases will involve investors for whom retirement is many years ahead, the FSA proposes that a standard tranching system be used.

• tranche 1 would be all those over 45 at the time of the transaction
• tranche 2 would be all those aged between 35 and 45 at the time of the transaction; and
• tranche 3 would be any remaining investors.

The FSA is also considering alternative approaches which would allow firms to group together all cases which relate to certain large occupational schemes. This would certainly be useful in enabling firms to carry the heavy administrative burden of reviewing non-priority cases. If the FSA allows tranching to be used, it will be important for firms to demonstrate why they chose the system of tranching which they did and why they thought it was appropriate.

Cut-off dates

In the original 1994 guidance the SIB indicated that "cut-off dates" for the review would be set, beyond which the retirement or death of an investor would not, in itself, lead to a requirement on the firm's part to conduct a full review of the investor's case.

The FSA now proposes that the cut off date be set in relation to each individual firm (rather than for the review in general) and that this should be three calendar months from the date at which a firm completes the identification and mailing procedures explained above in relation to the Phase 2 review. After this date, firms will be expected to deal promptly and reasonably with any requests for review which the death or retirement of an investor may bring.

Professional indemnity insurance

The FSA has confirmed that its proposals are not intended to require any firm to take any step which would invalidate its insurance cover. The PIA considers the non-priority review to be consistent with the Accord reached in relation to the priority review, although it remains to be seen whether or not the insurers concur with this view.

Limitation

The FSA has made it clear that it does not expect firms to enforce limitation if they have already given undertakings not to do so in relation to priority cases.

Conclusion

It was widely considered inevitable that non-priority cases would eventually have to be reviewed, as a large number of non-priority investors had suffered loss and the original distinction between priority and non-priority cases was somewhat arbitrary. The FSA has estimated that total prospective losses are around £6,650 million, and associated administrative costs may be around £750 million. Whilst undertaking the review of non-priority cases will clearly be a great financial burden, the FSA is keen to point out that this burden should be shared between shareholders, proprietors, indemnity insurers, policyholders and the industry as a whole via the investors compensation scheme, rather than solely by mis-sale victims.

The regulators are likely to see the successful conclusion to Phase 2 of the pension review as crucial in order that the pension review can finally be concluded. Failure to carry out the review to the required standards will undoubtedly receive regulatory criticism. Given the rigour with which priority cases were eventually reviewed by the regulator, it is expected that few firms will be in any doubt as to their responsibilities to carry out the Phase 2 review effectively. The recent announcement by PIA that it has expelled a firm for pension review failures, together with earlier disciplinary action cases and widespread requirements for reworking, should leave firms in no doubt as to the regulators attitude to the review.