Natanje Holt looks at some of the latest changes in the Disclosure landscape detailed within CP 12/10 as changes become enforceable from 21st December
In May this year the FSA published its consultation paper CP 12/10 which outlines changes needed in retail investment product disclosure.
CP12/10 focuses on ensuring uniform implementation of four key adjustments to both Key Features Illustrations (KFIs) at point of sale and Statutory Money Purchase Illustrations (SMPIs) issued at review points.
Principal changes covered include use of new mortality tables, fixing of retail and consumer price indexation and inflation percentages and lowering of projection rates. The overall intention is to ensure illustrations remain relevant and accurate in view of market changes and other external events.
Specific disclosure requirements are as follows:
1. New mortality tables will be applied now across KFIs as they already have been for transfer value analysis calculations (for DB to DC transfers).
Mortality tables have had to be adjusted to reflect the continual trend for increased longevity as well as the European Court of Justice (ECJ) gender equality ruling. This forces implementation of male and female gender ‘equalisation' of mortality rates by 21st December 2012. The CP specifically proposes how these changes should be implemented.
2. Introduction of new lower projection rates on KFIs and SMPIs. So broadly this is a move from 5-7-9% to 2-5 and 8%. Perhaps most significant in this is the intermediate rate which drops 2% to reflect current and future prospects for asset performance as the economy drags into its fifth year of recession.
3. In recognition of the fact that more pensions are CPI index linked rather than RPI linked, for benefits based on RPI the retirement limited price indexation revaluation is 2.5%, whereas for CPI index linked pensions it will be fixed at 2% in illustrations. Inflation is fixed at 2.5%.
Let's look at the first two areas of change in more detail as we are now implementing these changes to illustrations for clients ahead of deadlines which are rapidly approaching.
It is worth noting that CP 12/10 is a joint collaboration between the FSA and the FRC (Financial Reporting Council). So what we have here is a series of recommendations for changes and the opportunity for rapid implementation of those changes in SMPIs as well as KFIs.
Historically the FSA's Conduct of Business Sourcebook (COBS) lays out interest rate, mortality basis and expenses to be assumed in projecting future annuity income.
But the technical detail within SMPIs is governed by Actuarial Standard Technical Memorandum 1 (AS TM1) published by the FRC.
The idea is that an individual who purchases a personal pension and receives a projection of its potential at point of sale should continue to receive annual statements indicating future benefits in a way that is consistent with the original projection received.
There is recognition that annuity providers are no longer using Continuous Mortality Investigations (CMI) 92 series of mortality tables as they are widely believed to understate longevity as people, on average, are living longer each year.
This fact, combined with the need for gender equalisation by 21st December 2012 as a result of the ECJ's judgement in the Test Achats case in March 2011, has pushed up longevity markedly. Future annuity projections will be based on a 50/50 blend of male and female mortality tables.
The FRC's new version of AS TM1, published back in December 2011, introduced a new ‘gender equal' rate based on an equal blend of male and female mortality numbers and this will now be applied for KFIs and SMPIs alike.
The new mortality table is called 2000 series. It is based on the most recent CMI model which looks like this:
50% of PCMA00 including improvements based on CMI (20yy-1)_M[1.25%]
+ 50% of PCFA00 including improvements based on CMI (20yy-1)_F[1.25%] where 20yy is a 12-month period starting 6 April 20yy.
The overall effect of this is that a single man will experience a reduction in annuity income because gender equalisation means his mortality figures will improve when averaged up by a woman's higher longevity. But by the same token a woman's annuity projection will improve as her longevity expectations deteriorate through gender equalisation.
The total variation for men will be between 10 and 17% depending on age. For the youngest women the overall illustrated annuity income will fall by up to 8%.
All firms need to apply gender equalisation across annuity projection in KFIs and SMPIs by 21st December in order to comply with the ECJ's deadline.
Projection rate changes
Chapter 4 of CP12/10 is definitely worthy of closer examination also as it affects investment return assumptions that appear in COBS 13 Annex 2.
The proposal is to reduce the intermediate projection rate in illustrations from 7 to 5% and to reduce the adjustment of tax-advantaged products for 1% to 0.5%. So the new projection rate spread moves from 5, 7 and 9% to 2, 5 and 8% with ISAs and other tax-advantaged investment products move to 1.5, 4.5 and 7.5%.
The establishment of the new projection rates follows a PwC report last year which recommended a lower intermediate rate of 5.25-6.5%. The PwC report went further to base its typical portfolio on a more up-to-date asset mix of 50% equities, 30% government bonds and 10% corporate bonds and property - reflecting a trend towards fixed income investments and away from equities.
There is a suggestion that these rates can be adjusted downwards where a product is unlikely to achieve returns in line with these rates. Historically these projection rates have been based on 67% equities and 33% bond investments and a time horizon of 10-15 years because this was considered the average for many products in scope.
The ‘flanking rates', the ones either side of the intermediate rate, are designed to illustrate the uncertainty of potential outcomes over that timeframe. But over a shorter period an investment is likely to be far more volatile than this range of course.
CP12/10 encourages providers to adjust projection rates downwards if they regard the standard ones to be too generous. Stochastic projections are rejected in favour of a widening of the span of the flanking rates in line with worsening market sentiment and increased uncertainty. Sounds familiar...
What has not been properly grappled with is tying projections more closely with the actual asset mix in the product being illustrated?
Surely it would make absolute sense, given that most products offer options which loosely place them in the high risk/ high return; balanced or cautious; or low risk/low return groupings; to align the actual portfolio mix with higher or lower intermediate return so that an investment in 100% commercial property-based SIPP might attract an intermediate projection rate of 8% but also flanking rates of say 3% and 13%.
This would mean that similar products with similar mix of assets would still be comparable; the illustration would achieve its central purpose of showing likely outcomes.
But illustrations are also helping the customer decide if that product is suitable for him or her at outset as well as indicating the impact of charges on the investment.
Surely now is the time to step back and have a genuine debate about what illustrations are supposed to be delivering.
It's not just about moving projection rates downwards as markets deteriorate but working out what purpose these documents now serve and asking the question has their purpose changed in the last 10 years since they came into being.
My hunch is the time may be right to stop applying the sticking plasters and look at the health of the body those plasters are being stuck onto.
Natanje Holt is managing director of Dunstan Thomas
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