Director of Specialist Business Support
With the introduction of pension freedoms it is clear that many people have turned to drawdown as their retirement income vehicle of choice. Since the first announcement of pension freedoms, annuity sales are around a third of where they were, whilst income drawdown sales are around four times where they were.
Many of these customers will of course be advised. But what about the forthcoming Consumer Duty? How will that affect income drawdown? All regulated firms will need to consider these new rules in detail. As a brief reminder firms should have agreed implementation plans and oversight by 31st October, with most of the final rules coming into play from the end of July next year.
The new rules and guidance applies to all regulated firms. However for the purposes of this article I’ll concentrate on advice firms specifically.
So what does the consumer duty introduce? In short it requires firms to do the following:
Pretty much all advice firms would say that’s already business as usual, but let’s have a look specifically at drawdown clients.
No adviser can say categorically that a drawdown strategy is going to work 100%. Volatility over recent years caused by unpredictable events has shown us that.
So it naturally follows to avoid foreseeable harm the risks of drawdown need to be identified and a plan created to deal with them.
So what are the risks? This is not an exhaustive list but the key ones include:
These are all generally well known so I will not elaborate on these further. Many firm’s will have these included within a centralised retirement proposition (CRP) as risks, and also how these risks are managed.
There will be a requirement for a report to be produced and signed off by a firms board on an annual basis. The report would be an assessment of whether the firm is delivering good outcomes for its customers which are consistent with the Consumer Duty. This assessment should include:
This assessment will be part of the evidence the FCA use to assess a firm’s compliance with the Consumer Duty and they will expect it to be provided on request.
So taking income drawdown as a snapshot, what could the part of the return look like concerning income drawdown customers? Let’s not forget a big part of the Consumer Duty is avoiding foreseeable harm. Looking back over recent years we can see that a constantly shifting investment market with some extreme volatility has occurred as well as significantly rising inflation. Although it is impossible to predict the occurrence of such events, we can identify the potential risks of these and also put a plan in place to deal with them.
It might look something like this, drawing information from the firms CRP and client management information (MI). This is not supposed to be ‘all encompassing’ as many advisers will have additional strategies, plans etc in their CRP. However an analysis of the key risks, the plans for dealing with those risks and then an assessment of what was done to provide good customer outcomes feels like a good place to start. Once the ‘tactics’ have been established, it should be relatively straightforward to analyse what’s happened in practice to include as MI for the report.
Below is an example of the type of information an advice firm might produce based upon the identifiable risks of drawdown. This also doesn’t take account of wider MI which it would be prudent to consider, such as for example how many clients are falling outside of a firms initial and ongoing fee ranges, though this could be picked up separately as part of a wider piece concentrating on more macro issues.
CRP table – dealing with risks of drawdown
Drawdown = DD
Cashflow model = CM
Suitability report = SR
|Key Risks||How risk is assessed at outset||Strategy (ies) for dealing with risk||Flag to identify risk crystallising/potentially crystallising||Strategy (ies) for dealing if risk crystallises (as prepared and planned for and identified under SR)|
|CM to include longevity modelling based upon market data||SR to highlight need for regular reviews using CM||Annual review with CM to show risk of fund exhaustion using current market data||
Consider purchase of annuity
Take money from cash buffer outside of portfolio
|Inflation risk||CM to include multiple projections of future growth and suitably stress tested||
Use of bucket system to target when funds should be drawn on
Use of multi asset fund to help ensure consistency of return
Adjustment made to income based upon stress tested model reflecting current market experience
|Funds underachieving target growth rate for defined period of time||CM at review to identify reduced income level, which may need to be supplemented by available funds outside of DD|
|Sequencing of return risk||CM to include potential for market falls||
SR to include cash buffer held within portfolio to take income from over short term
SR to identify any sources of funds that could be used to draw income from in short term
SR to include recommendation for fund/part of fund to be invested via smoothed fund to reduce fund volatility
SR to include recommendation for natural income to provide all/part client income
Use of bucket strategy to reduce volatility from fund paying income
Evaluation of fund’s sequencing risk profile
Market falls by a predetermined amount
Volatility of portfolio exceeds expected boundary
Conduct client review immediately with updated CM
Take money from cash buffer in portfolio
Take money from cash buffer outside of DD
|Change in circumstances||Any future changes to be notified by client||Client contact or identified at review time or client contact in interim||Revised CM to determine effect of new requirement (for example lump sum taken or increased income requirement)||Determined by new need or objective|
Having established and identified where the key risks lay, the data can then be collated to provide information for the annual report Collection of clients in drawdown MI for the firm’s annual assessment report. Below is an example of some of the information this could contain.
|Number of clients in drawdown||Number of clients where client objectives not met as per SR||Reason(s) for client objectives not being met||How remedied and any change required to CRP?||Number of clients where risk highlighted in CRP/SR crystallised||Number of clients where strategy in CRP/SR was used||Number of client complaints received for drawdown clients||Reason(s) for complaint||How complaint dealt with|
Most advice firms will already have robust processes in place to deal with the risks a client may face, in order to ensure they have good understanding and achieve a good outcome. The challenge going forward will be how to marry these processes with the Consumer Duty, whilst also capturing and presenting the relevant MI under the new rules and guidance.
Given the relatively short timescale to implementation of the new rules and guidance, now is a good time to start thinking through the necessary processes and collation of data.