Chris Read discusses the potential challenges around pension illustrations
Providers have many concerns in the run up to RDR but our annual provider survey showed accurate disclosure of "effective deductions on illustrations" is proving a major issue.
According to the survey commissioned in March,38% of providers saw ‘disclosure of effective deductions on pensions illustrations' as both the most expensive and onerous administrative change they had to make pre-RDR.
It dwarfed concerns around preparation for auto-enrolment which only 21% pinpointed as the most expensive and onerous change this year.
So why are providers struggling so much with this issue? The reasons are linked to imminent reduction in projection rates that have been promised by the Financial Services Authority (FSA) to be implemented in illustrations early next year.
Let's take a step back to look at the original intention of projection rates in illustrations as laid out in the FSA's Conduct of Business Sourcebook (COBS) projection requirements. They are:
1. To enable consumers to see what returns they might get on their investment
2. To compare product charges
3. To see how charges could affect returns.
The main problem is projection rates and the effect of charges on them is clearly inter-dependent. So when the FSA demands the use of lower projection rates as the economy deteriorates moving the mean growth rate from 7% to 6%, this fall has a knock-on effect on how charges affect these lower projected returns. If customers weren't feeling poorer in retirement at 7%, take a look at PwC's recent recommendations for projections to be set at between 5.25% and 6.5% to bring them closer to reality. We won't know the actual numbers until the end of 2012.
Uneven playing field
So in the meantime, an uneven playing field is being created because some providers have moved faster than others to make anticipated projection rate changes. During this hiatus period the projection valuations become useless for the purposes of comparing products.
The problem is being compounded further by the FSA's enthusiasm for asset-class based return projections which are naturally not yet standardised. Again some providers move faster than others to create asset-class and portfolio-specific illustrations.
So within a few short years we have moved from a world of standardised projections expressed in Key Features Illustrations (KFIs) and Statutory Monetary Purchase Illustrations (SMPIs) which enabled easy comparisons to one in which it is almost impossible to compare two products based on growth projections and the impact of charges alone.
The upside is that the illustration customers will receive in the future will more closely resemble real growth, certainly if an inflation calculator is added. The downside is that it may look nothing like a different provider's illustration. Or at least this is the danger at present.
The need for change
As if things weren't difficult enough for ‘old guard' life assurers and providers used to operating with KFIs and SMPIs, March 2012 saw the publication of the FSA's CP12/05 which charges SIPP providers with the same level of disclosure as other retirement product providers. All providers are in it together now.
Except that SIPP operators also need to disclose whether they retain bank interest or commissions and articulate the impact of these ‘secret profits' on member projections .
This issue was raised as a concern more than a year ago when CP 11/3 was published but the FSA is now demanding full disclosure in this area to be in place by the end of the year.
Furthermore full KFIs, including projections, effect of charges and reduction in yield calculations, will be required of SIPP providers on top-ups and other asset changes in investors' pots, even when no income drawdown is being taken.
The SIPP provider community has been vocal in its concern. Steve Cameron, head of regulatory strategy at Aegon recently went public to ask the FSA to delay changes to SIPP projections that will require non-insured SIPP assets and their charges to be included in projections.
He said: "The cost and complexity of projections will go up dramatically and it will be risky for us to integrate changes to charges in the system while there are other things happening with the projection rates."
Getting illustrations right will not be easy. Pension providers now walk the tightrope between using new projection rates while altering charges in response to market conditions and still offering illustrations which are standardised enough to be of use for comparison purposes in product selection.
Clearly the timing of these changes is very tough for providers given their proximity to RDR and auto-enrolment. However it is our firm belief that illustrations must continue to be evolved. Without this evolution illustrations will fail to properly inform customers about whether they remain on track to reach their target retirement income, given changes in market conditions.
Chris Read is chief executive of Dunstan Thomas
Putting the tech into protection
Square Mile’s series of informal interviews
Fallout from Haywood suspension
Launching later in 2019
£80bn funds under calculation