It’s finally here – after five years of waiting, the FCA has now published the findings from its thematic review of retirement income advice. The review was only announced at the beginning of 2023, but it has been delayed for over four years initially due to a full agenda at the FCA followed by it having to deal with the fallout from the pandemic.
In a very readable 53 pages, the regulator sets out how advisers have been meeting the challenge of providing retirement income advice. While their findings do not give the sector a clean bill of health, they are set out in a way which clearly explains the regulators expectations giving examples of good and poor practise in relation to key principles.
In my last article, I expressed the hope that the review would be delivered in a constructive way, and we’ve certainly got that. But while the FCA has articulated its expectations clearly, it will be a lot harder for advisers to put them into practice than it was for the regulator to write its report.
It’s not that the FCA’s expectations are unrealistic, far from it. It is just that retirement advice is complex and full of uncertainty. It inevitably requires a lot of assumptions to be made not just about how the economy and markets will develop but also how client needs will change over what could be a period of 30 years or more.
The first challenge comes in really understanding a client’s objectives in detail. Clients may have some idea of what income they might want over the next few years though getting to a true understanding of this is no easy task.
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One of the real skills of giving retirement advice is helping clients understand what sort of retirement they want before understanding what it might take to finance this. Going beyond an initial expectation of income quickly becomes hazy as, like all of us, people find it difficult to imagine life beyond the next few years. Even if they could, the unpredictability of life means that future income plans may be nothing more than a guesstimate.
While greater use can be made of cashflow planning, it is by no means a given advisers will be able to build a wholly realistic plan of the future. Of course, we must start somewhere, and we absolutely need to have some view of the future to understand what is achievable today. The FCA sets out in some detail its expectations around the assumptions used in cash flow planning. However, if the initial inputs around income are inaccurate, the modelling assumptions become a bit of a red herring.
The next nut to crack is how these income plans are tested and forecast into the future. The FCA found many firms using stochastic modelling and other forms of stress testing to understand the sustainability of clients’ income plans. However, any future modelling is inevitably dependent on assumptions and the only thing we know for sure is whatever assumptions are chosen, these will be incorrect.
While we can try to look to the past to understand how markets might perform in the future, there will only be one future market outcome and that may be very different from an average expectation based on past experience.
A natural response to this uncertainty might be to ensure that client income needs are fully secured. However, it is often not feasible or desirable to fully secure income. Many clients will need to take some risk to achieve their goals and the uncertainty of future needs may make locking into any solution early in retirement counterproductive. The balance needs to be struck between providing a level of certainty whilst also providing the opportunity for growth and flexibility.
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This is where things get really tricky. For me the key takeaway from the FCA’s review is that we need to think about risk for retirement income clients very differently from how we think about risk for clients accumulating wealth. This means looking beyond investment risk to consider risk in terms of the client’s objectives. Investment volatility alone is not an effective measure for assessing income sustainability. Market performance in 2022 showed us that even “low-risk” funds can deliver unexpected results. A more nuanced approach to assessing sustainability is needed.
Building an advice model that can deal with all this complexity while still allowing for the significant variation in client needs is a huge challenge. Client management systems, cash flow planning and investment modelling tools can help, but combining these into a single consistent advice journey can be problematic. Even then, we must be wary of relying too heavily on assumptions about a world that reminds us everyday that we cannot expect the future to be the same as the past. The need for effective and efficient retirement advice is obvious. How we deliver it is much less so.
Richard Parkin is head of retirement at BNY Mellon Investment Management
