Implementation of ‘red and amber flag’ regulations reveals pension transfer risks

Since then, many pension trustees and providers have had a busy few weeks getting to grips with the new regulations, which formally become law on 30 November. 

However, what started out as a plan to stop transfers to pension scams has ended up having a more far-reaching impact on the pension transfer market. While the regulations should have a positive effect in stopping scam transfers, the last few weeks have revealed some potential pitfalls and risks to consider when handling transfer requests more generally, including those that might have been thought to be more straightforward.

Amber flag disconnects

The regulations are designed to discourage transfers to scam scheme, but a strict interpretation of the new regulations could lead to some straightforward transactions being ‘flagged’. This suggests a potential disconnect between the regulations and the policy intention.

Identification of an amber flag requires referring the transferring member to government advice service MoneyHelper. Under the new transfer regulations, there is an amber flag when the scheme the member wishes to transfer to includes overseas investments. Since most pension schemes include overseas investments far more requests could be referred to MoneyHelper than the government anticipated.

Some trustees or providers may interpret the amber flag in this way. Although the Pensions Regulator’s guidance suggests the flag was not intended to extend to conventional low-risk overseas investments such as global equity funds, the regulations do not narrow down the meaning of “overseas investments”.

Other amber flags give rise to similar difficulties. ‘High fees’ are defined as being potentially merely at the high end of the normal range of fees in the current financial market. There is the same problem with ‘high risk’, which is defined as the “high end of the normal range of risk in the current financial market”.

The breadth of these flags was deliberate, given a desire to allow as much leeway as possible to those looking to stop suspicious transfers. But there is no carve-out within the regulations to allow straightforward transfers without having to assess these flags.

There is a risk that trustees will face complaints if they fail to refer transfers to MoneyHelper, even if there are no conventional scam warning signs. Complaints might not materialise for some time but could happen, for example, where there has simply been underperformance within a legitimate scheme.

Members bringing a complaint may not be able to establish any loss deserving compensation if they probably would have gone ahead even had they had guidance from MoneyHelper. But they could still be a nuisance to deal with.

The breadth of the regulations may also pose challenges for MoneyHelper. If it is expecting to spend 45 to 60 minutes per guidance session, it would be unfortunate both for its resources and for affected members if transfers that seem fine from a scam risk perspective are referred to it because of a strict application of the regulations.

Time will tell how cautious trustees will be, and that might create a need to revisit the wording in the regulations sooner rather than later. Changes could be made to definitions to match more closely the policy intention for the amber flags.

Alternatively, if trustees had the flexibility not to consider the amber flags when assessing a transfer that would previously have gone through smoothly and quickly because of, say, their ‘clean list’, this could alleviate the situation.

Other points arising

Other areas that trustees should look out for as they prepare for the regulations to come into force include the changing standards of proof within the regulations.

These potentially might not make much difference in many situations, but trustees should assess what standard applies and document this as part of the paper trail for a transfer request. This will depend, for example, on whether a transfer request is being considered without any formal request for information from the member.

Transfer paperwork should be updated with the same thinking in mind, considering whether it raises questions at the outset and, if so, whether these mean a formal request is being made of the member.

Once a request has been made of a member, care needs to be taken in considering any response. If the member has failed to provide a substantive response, it amounts to a red flag and yet a substantive but incomplete response is merely an amber flag. The difference between the two might not always be obvious, but makes quite a difference in terms of outcomes.

Thought needs to be given too to the red flags and potential pitfalls if questions are not raised of the member around those. It might not be reasonable for assumptions to be made about advice or incentives members have received or how pressured they may have felt.

The notification requirements are also new, so processes will need to have been adapted to ensure compliance.

Approaches governed by appetite

The intention behind the regulations was never to slow down or cause problems for straightforward transfers without any scam concerns. However, there is a genuine risk that the literal reading of the regulations will need to be followed by the Pensions Ombudsman and the courts in the event of a dispute and in preference to any guidance to the extent there is a conflict.

The chances are that the vast majority of straightforward transfers will result in no grievances, complaints or claims in years to come, but the new requirements will take some careful thought and navigating. The precise approach of any given trustee or provider may depend upon its own personal risk appetite.

The regulations need time to bed in and for schemes to discover how well they operate in practice.

In the shorter term, if trustees or providers have concerns and, in particular, if unsure what to do in cases where the guidance appears to conflict with the regulations, they should consider taking legal advice.