The FSA has admitted consumers may 'misunderstand' today's use of projected returns and laid out a huge array of options for the future of financial product projection rates.
Latest discussion paper from the Financial Services Authority - DP04/01 Projection reviews: the case for change - recognises the current system of allocating three different projection rates for pension products to those for collective investment schemes, for example, and which has been used over the last 15 years may have contributed to the consumer’s misperception of potential returns on their investments because they do not highlight the possibility of losses.
Moreover, the FSA argues consumers need a better system of understanding the potential returns on any product they may select, while at the same time recognising a 'one-size fits all' system does not work because each individual's return potential is altered according to premium, term of product and variability among other factors.
In order to assess whether the current system should be replaced by another, the FSA has unveiled a range of alternative projection ideas which include require companies to issue more personalised – and costly - yet simplified information and, more radically, proposals to scrap or ban the use of projection rates.
At the same time, however, the FSA points out it has concerns about scrapping the use of projection reviews, because experience prior to 1988 – when projection rates were introduced – suggests financial companies are likely to promote high projections of future returns than might be attainable and thus render it impossible for companies to work out which product or investment is best suited to their needs.
The FSA also suggests the consumer's understanding of potential returns may still be blighted by what it sees as intermediaries' "commission bias".
Industry experts have welcomed the discussion paper’s handling of the review, largely because it lays out virtually every conceivable idea or option as to how to handle this issue and basically tells the industry to ‘get on with it’ and find a suitable solution.
Paul Smee, director general of the Association of IFAs, says the complexity of dealing with projection rates should eventually work in the favour of intermediaries, as any decision shows the need for regular post-advice conferences between clients and advisers.
"Projection rates should not be set in concrete for all time. It does strike me the idea, that information given to clients changes, is a fair one. 25-year projections cannot reflect the reality of a product’s return. Endowment problems were perhaps caused because projections were spelled out once," says Smee.
"It does bring home the fact that if the projection rates are not set in stone, after care service becomes very important and IFAs are therefore in a perfect position to deal with this.
"We want projection rates to inform rather than mislead," adds Smee.
Although there is no indication of a preferred solution at this stage, the Association of British Insurers’ head of life and pensions, Chris Kenny, adds any selection has to be tested on consumers to ensure it both informs both the consumer and does not impose heavy costs on providers.
"All stakeholders recognise the shortcomings of the current projection system and the importance of delivering relevant and accurate information to customers. That’s why the industry fully supports the FSA’s review.
"However we must not lose sight of the costs involved. The FSA must ensure that its final proposals are thoroughly tested with customers through a properly developed pilot so that the costs are proportionate to the benefits," says Kenny.
A spokeswoman for the Investment Management Association says the body will be consulting its members to present a "realistic and workable solution" which hopefully removes the rigid framework and points out to consumers projection rates are not a guarantee of investment returns.
Examples of projection illustrations are supplied by the FSA within Annex 5 of the 67-page document.
Responses to the discussion paper must be filed with the FSA by 5th October 2004.
But what do you think is the solution to the ‘projection rates’ review? Would it be better to scrap or ban their use? How do intermediaries ensure consumers do not view projection reviews as a ‘hard and fast’ rate of return rather than short-term POTENTIAL return?
If you have any comments you would like to add to this or any other story either email the editor or post your thoughts on the IFAonline discussion board.
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