FCA redefines retirement income advice suitability rules...

...and makes cashflow modelling (almost) compulsory

When the FCA published the results of its thematic review of retirement income advice on 20 March 2024, it also published a Dear CEO letter in which it set advice firms three objectives.

1. Take steps to address the review's findings in your firm
2. Use the FCA’s Retirement Income Advice Assessment Tool (RIAAT)
3. Adopt cashflow modelling

In other words, it's asking advice firms to update their processes and management information and check existing clients for suitability using the RIATT.

What is RIAAT

The RIAAT is a list of requirements to give suitable advice. Completing it allows cashflow modelling to be undertaken, and together they can help evidence suitability.

The FCA states that cashflow modelling “can be a key step in providing suitable advice. It is used to project the income flows that different assets could generate and compare these with the client’s estimated retirement needs.”

At Defaqto we welcome the FCA embracing cashflow modelling as it creates benefits for both the advice firm and its clients. Specifically, it helps evidence the suitability and longevity of the level of income being recommended in a pictorial format which helps improve consumer understanding, a stated consumer duty outcome.

It's worth noting that not all modelling tools are the same and advisers need to understand which they are using. A true cashflow modeller considers many factors including growth, risk, taxation, and inflation. It will also produce a comprehensive and accurate illustration that can be fine-tuned and altered in real time.

The underlying calculations can be based on two approaches, stochastic or deterministic. They each have their merits, and the best tools tend to use deterministic as a structure with stochastic powering their accumulation and decumulation illustrations.

That said, the way cashflow modellers are used can also impact on the suitability of the advice given. Mindful of this the FCA published an article entitled ‘Undertaking cashflow modelling to demonstrate suitability of retirement-related advice’. Within this they state some of the poor practices they have observed so advice firms can avoid making them too.

Finding 1: Firms relying on information without considering accuracy

This is an issue relevant to all advice processes. However, cashflow modellers can magnify the impact of inaccurate information, potentially making unsuitable advice look suitable.

Using the RIAAT within your factfind and using probing questions will mitigate this problem.

Finding 2: Using justifiable rates of return

Cashflow modellers are pre-populated with evidence-based assumed rates. If you overwrite them be sure to evidence base your numbers and record your rationale for the change.

It's important that you do not use the same rates for all outcomes. For example, different growth rates should be used for different risk levels.

Where solid economic rates are used, such as for inflation, it's good practice to use the same rate for all similar clients.

It's also important to include all charges.

Whatever rates you use, whether pre-programmed or personally input you must periodically review them for ongoing suitability.

Finding 3: Planning for uncertainty

The FCA requires firms to plan beyond the average life expectancy.

Over the last year many users of the Defaqto cashflow modelling tool have not done this. We have therefore introduced a new default age of 99 to prompt users to plan beyond the average age, although they can still select any age from 55 onwards.

As part of the suitability process, the FCA is looking for advisers to illustrate four unexpected events to demonstrate how stresses impact on the recommendation. Firms should:

1. illustrate a rare but feasible fall in asset values at the start of any income withdrawal period, such as actual drops in benchmarks for the recommended investments
2. reduce net of inflation rates of return to show the impact on how long funds will last
3. highlight the lower percentile outcomes in stochastic modelling outputs
4. show how higher withdrawals will deplete the fund sooner

These illustrations can be saved on the Defaqto cashflow modeller and downloaded to the client’s compliance file.

Finding 4: Consumer understanding

Across the UK population, 6 out of 10 are visual learners. This indicates that the majority will gain a better understanding when their advice is illustrated.

When clients are provided with a simple explanation of what they are looking at, including the pros and cons, their understanding increases. Interestingly, according to the FCA, this leads to clients being more open to ongoing reviews and to be more realistic in their expectations, such as withdrawal rates.

Cashflow modelling works best when the illustration is shown on screen and changes as the conversation between the client and their adviser evolves. This improves both the client’s experience and their understanding, especially when this is part of the ongoing review process.

Finding 5: Consider the output

The FCA states, “Firms need to review the cashflow modelling outputs to draw conclusions about the client’s potential financial position before and during retirement. These outputs are key factors to consider in the firm’s suitability assessment.”

Failing to review outputs can create incorrect or misleading outcomes, resulting in inappropriate risk and actions being taken, including unsuitable advice.

The scenarios illustrated to a client now form part of the advice process and so should be kept on file. Some modelling tools make this much easier than others and importantly do not detract from the client experience.

Circumstances and goals evolve and therefore it's important to revisit the outputs periodically, (at least annually), to help evidence ongoing suitability. More importantly to help clients understand how their financial future is evolving. Selecting a tool that enables you to pick up from where you left off is a considerable time/cost saver, but also helps with client understanding.

In summary

While falling short of making cashflow modelling compulsory, the FCA expects to see the outputs and stress tests that a modeller can create being part of every firm’s retirement income advice proposition. Therefore, giving compliant advice without cashflow modelling is near impossible.

When looking to meet the FCA’s expectations, we suggest six steps for advice firms to follow:

1. Make cashflow modelling part of your advice process, including demonstrating the outcomes of the four unexpected events listed in ‘findings 3’.
2. Choose a modeller carefully as it will be a long-term partner.
3. Train advisers on cashflow modelling, how to present using it, and require CPD to be undertaken on it.
4. Centrally control the assumed rates in use and regularly review them for ongoing suitability.
5. Regularly review outputs for accuracy and suitability.
6. Review advice provided to existing income in retirement clients using cashflow modelling to help check for suitability.

Selecting a Cashflow Modelling tool

It's worth highlighting that the bulk of the cost is not in licensing the software, but in the time taken to load clients onto it, create illustrations, and save outcomes. For example, some take a few hours to load clients, while others can take an age to save each scenario considered.

Defaqto Engage cashflow modelling module creates one of the best user experiences and is proven to help demonstrate suitability of retirement income advice.

You can read the full FCA guidance issued on 20 March 2024 at:

FCA Thematic review of Retirement Income Advice

www.fca.org.uk/publications/thematic-reviews/thematic-review-retirement-income-advice

FCA Dear CEO letter

www.fca.org.uk/publication/correspondence/dear-ceo-letter-thematic-review-retirement-income-advice.pdf

FCA Undertaking cashflow modelling to demonstrate suitability of retirement-related advice

www.fca.org.uk/firms/undertaking-cashflow-modelling-demonstrate-suitability-retirement-related-advice

Author: Richard Hulbert, Defaqto Insight Consultant