Our work on reviewing defined benefit transfer advice and our ongoing supervisory work identified concerns about how firms prepare and use cashflow modelling. Read how to improve the quality of cashflow modelling.
Many firms use cashflow modelling in retirement income planning. It 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.
Cashflow modelling can project a variety of outcomes, depending on the inputs and assumptions used. When used effectively, these outcomes can help clients understand how different economic circumstances could affect their retirement income. But if used incorrectly, it can create misunderstanding and unsuitable advice.
Cashflow modelling can give clients information to help them understand the recommended product or service and the potential drawbacks and risks of the recommended approach. This helps clients make effective decisions and take appropriate action. Foreseeable harm can be caused if firms:
- do not consider how clients will interpret the output
- project forward using returns that are unjustified and don’t result in realistic outcomes
- do not consider the inputs and outputs objectively
Each of these has a profound impact on client understanding and could have an impact on the suitability of any recommendation based on the model.
Who this will be of interest to
These examples will be of interest to:
- firms giving retirement income advice, including defined benefit transfer advice
- firms giving advice on investments more generally
- regulatory compliance consultants
- providers of cashflow modelling software
Our findings
Finding 1: Firms relying on information without considering accuracy
A firm is entitled to rely on information provided by clients unless it knows the information is clearly out of date, inaccurate or incomplete. We would expect firms to consider if the information clients give them is consistent with their stated goals or expectations for retirement. This information is key to providing suitable advice.
What we found
Examples we have seen are firms:
- not challenging clients on figures provided: for example, where income and expenditure indicate savings are available, but the client has no savings
- not thinking about future lump sum needs: for example, to replace cars or carry out home maintenance
How can firms improve
Finding 2: Using justifiable rates of return
The returns used within cashflow modelling are one of the most important parts of the model. We expect firms to have a reasonable and justifiable basis for all assumptions they use in the model.
A client’s investment objective may rely on their investments achieving a certain rate of return. So, if the firm’s modelling is based on incorrect assumptions, there is a higher risk of poor consumer outcomes. The client is not likely to understand the risk that they will not achieve the returns they need to achieve their objective and so will not be in an informed position.
What we found
Examples we have seen of this are:
- high returns assumed for cautious assets, without explanation
- projections based entirely on past performance, without considering if this provides an appropriate expectation of the future potential
- not taking tax into account in any withdrawals
- not considering how charges will affect the future potential returns, or failing to account for all product and adviser charges
How can firms improve
Finding 3: Planning for uncertainty
Cashflow modelling is based on assumptions, and in our work we have seen firms explain this poorly to clients.
Cashflow modelling can be a useful tool to help clients plan for their future. If a client understands that returns are based on assumptions about how the market will perform (and their investment value may go up or down) they are less likely to withdraw more than they can afford from their pension or investments.
Firms are required to assess the client’s knowledge and experience of the recommended investment and to check the client’s understanding of risk. If the firm does not explain cashflow modelling clearly its recommendation may not align with the customer’s risk tolerance and capacity for loss. Customers could be misled about the sustainability of their pension.
What we found
Examples we have seen of this are firms:
- mixing real and nominal terms in their cashflow modelling
- only planning for average life expectancy, when 50% of people will live longer than this
- failing to properly stress test outcomes in line with the potential investments
How can firms improve
Finding 4: Consumer understanding
When they get advice, clients may receive a number of communications from firms that refer to future outcomes.
Using multiple growth rates across different communications is likely to confuse clients and lead to misunderstanding if not explained.
What we found
For example,
- risk profiling tools often refer to the potential returns of the selected risk profile or the percentage fall a client may be willing to accept
- key features illustrations will show projections where the pension provider has selected a rate of return which is aligned with the underlying assets
- cashflow models will have their own assumed growth rates, which could be different from the above
How can firms improve
Finding 5: Consider the output
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.
If the firm fails to review the outputs:
- the cashflow model given to the customer may be factually incorrect or misleading
- it may recommend a solution that is not suitable for the customer’s needs or objectives
- there is a higher risk that the financial plan will not work out as intended
- this raises the risk of misunderstanding and poor consumer outcomes
What we found
Examples we have seen of this are that the firm may fail to:
- realise that the model relies on pensions being accessed before the minimum pension age
- identify where the cashflow model relies on illiquid assets, such as the client’s main residence or non-rental property, for lifestyle expenditure
- consider the impact of tax on the client’s proposed withdrawals, with the consequence the client needs to take more from the fund than is projected and could run out of money sooner
How can firms improve
Relevant FCA rules
Relevant rules and guidance include SYSC 6, COBS 9, Principles 2, 3, 6, 7 and 9.
Since 31 July 2023, the Consumer Duty (Principle 12 and PRIN 2A) has set higher and clearer standards of consumer protection across financial services and requires firms to put their customers’ needs first. For more information, see the Finalised Guidance 22/5 (FG22/5).
Firms should be aware of our expectations for cashflow modelling in related advice scenarios, such as pension transfer advice (COBS 19.1 and COBS 19 Annex 4A). For more information on cashflow modelling for pension transfer advice, see Finalised Guidance 21/3 (FG21/3, paragraphs 5.18 to 5.23), including good and poor practice.