The use of projections as part of the advice process is undergoing a major transition. The FSA has placed new emphasis on the need for all providers to assess likely returns on each of their funds and to use lower rates in projections if the ’standard’ mid rate of 7 per cent for tax favoured products such as pensions (6 per cent for others) is unlikely to be achievable.
This isn’t a new requirement, but it was given renewed focus when last year’s Sipp review showed 7 per cent projections were sometimes being given to those invested in cash funds. This prompted a letter to chief compliance officers in late 2009.
Until recently the vast majority of providers have used the standard rates (5, 7 and 9 per cent for pensions). Why? Most products offer a range of funds which customers can choose and switch between, meaning the product (if not every fund) has a good chance of delivering the 7 per cent rate. And providers recognised that using a common rate allowed advisers to use projections to compare the impact of charges between products and providers.
That’s all changing. All providers are now under very clear instructions from the FSA to develop a robust methodology for determining fund specific projection rates, based on each fund’s underlying asset mix. The resulting rates must then be used in all point of sale illustrations. The FSA will be reviewing all providers’ approaches before the year end and those that are not fully compliant can expect regulatory censure, which could mean anything from a fine to being barred from writing new business.
I understand some portals are planning to use RIYs to rank products in future rather than projected values. Where this is feasible, we’d recommend advisers move to this basis from now on.
My own company introduced this change in late September. Our methodology is based around realistic estimates of the likely long-term returns on different asset classes – equities, property, corporate bonds, gilts and cash. We consider the typical mix of assets within each of our funds and calculate a weighted average return. We round that down to the lower quarter of a percent, make sure it’s not above the FSA maximum (7 per cent) and use this as the mid projection rate. We also show projections at rates 2 per cent above and below the mid rate.
Because not all providers are implementing changes at the same time or indeed in the same way, it’s not surprising that we’ve had a number of queries from advisers. The conversation can go something like this.
Adviser: “Why have you changed the rates you use in projections?”
Us: “We want to make sure we comply with FSA requirements”
Ad: “Other providers haven’t changed”.
Us: “All providers will be changing very soon or risk fines from the FSA”
Ad: “OK. But those who’ve already changed all seem to be using different projection rates for the same type of fund”
Us: “Yes, we know. It’s because providers are making different assumptions about future returns on underlying asset classes. They may also use different rounding conventions”
Ad: “But if you’re all using different rates, how can I compare products using projected values?”
And that’s the tricky question. Using projected values to compare the impact of charges is common market practice. One alternative is to compare charges using Reduction in Yield (RIY) figures. These are rarely impacted by whether you start with a 7 per cent mid growth rate or some lower figure so remain relatively reliable.
I understand some portals are planning to use RIYs to rank products in future rather than projected values. Where this is feasible, we’d recommend advisers move to this basis from now on.
There is one key area where RIYs don’t provide an answer – where advising on transferring from an existing pension scheme or provider into a new arrangement. Potential future benefits from the existing scheme might be taken from a yearly statement which is most likely to include a 7 per cent projection alongside an inflation adjusted figure. But an illustration for a new contract may not include a 7 per cent projection unless the chosen fund is primarily equity-based. And statements don’t include RIYs. This means advisers may struggle to make like-for-like comparisons unless providers can offer additional 7 per cent projections for the adviser’s use.
These changes are not optional. The FSA has made that absolutely clear. And it has to be a good thing if customers are given more realistic indications of what they might get back depending on their investment strategy. But as we work through this transition, providers and advisers need to work together to find other meaningful ways to support the advice process.