4 min read 1 Oct 20
Against a backdrop of regulatory reviews and numerous market jolts from coronavirus, the remainder of 2020 could be the perfect time to brush up your processes and approach to assessing capacity for loss with clients.
The FCA’s Assessing Suitability Review 1 centred on attitude to risk and accumulation but the second stage of the review, Assessing Suitability Review 2, is now firmly pointed towards retirement advice, which suggests it will focus in on capacity for loss this time around. The review has been pushed back to 2021 as a result of Covid-19, which allows advisers extra time to ensure that their processes and procedures are fully up to speed.
And speaking of the pandemic, the ongoing impact of Covid-19 may well have sparked significant changes to portfolio construction and sources of income for clients in retirement, which may in turn prompt another reason to reassess and take a fresh look at clients’ capacity for loss. And although it may be autumn already, this is arguably time to consider giving your approach a bit of a spring clean while you’re at it.
A good place to start is by thinking about how capacity for loss interacts with your Centralised Retirement Proposition (CRP) or your approach with retirement clients. Capacity for loss tools were highlighted as one for the top three tools for the advisers surveyed to support their CRP. In terms of best practice, exploring a client’s capacity for loss should typically start during the fact find and then through income and expenditure analysis, alongside cashflow modelling. These should be core elements of a centralised retirement proposition.
Your CRP may also include different ways of managing income such as a bucket approach to portfolios or a focus on total return. Our recent research carried by NextWealth highlighted that 42% of advisers use the total return approach with the bucket approach following up with 34%. Think about if and how these aspects of your overall approach may relate to capacity for loss. For example, using an annuity or state pension to cover aspects of clients’ regular expenses or income needs may mean they have a greater capacity for loss when it comes to their other drawdown assets. During more in depth interviews with the advisers who took part in our research one adviser said:
“We establish risk, capacity for loss and the required level of income. We then consider annuity drawdown and a combination of the two, we also consider temporary annuities. For all retained investments, we have portfolios made up of funds, which produce either interest or dividend and all are balanced to our risk profiler.”
The key to all this is being able to clearly articulate your approach around capacity for loss to clients, particularly given the FCA’s hints that this is the level of articulation, detail and consistency it wants to see as part of its suitability review.
Capacity for loss and attitude to risk are often assessed alongside one another, with many risk questionnaires including built-in questions around capacity for loss. But the regulator has made it clear that it expects advisers to consider these separately. It’s particularly important to remember that attitude to risk is generally subjective depending on the client. By comparison, capacity for loss is objective and is clearly measurable by assessing facts and figures instead of a client’s personal feelings and opinions. So instead of relying solely on an attitude to risk tool, pull out the specific areas that relate to capacity for loss and explore them by going into more detail and asking further questions of your clients.
In other ways, capacity for loss and attitude to risk can be complementary in the sense that the former can help constrain the latter if necessary. Capacity for loss can serve as an important reality check if a client’s attitude to risk means the potential consequences of loss of capital could materially impact their living standards.
Some of the cashflow tools out there do an excellent job of helping advisers carry out in depth analysis and scenario planning but not all clients will necessarily be up for the time it takes to review and gather all this information. Assessing capacity for loss separately before going on to take them through cashflow modelling will allow you to gather some of the required information ahead of time, which may make the cashflow process feel less intensive and time consuming from the client’s perspective. Cashflow modelling is undoubtedly an important part of the journey with retirement clients and therefore you don’t want to lose them along the way.
Many clients will naturally worry about running out of money in retirement. Helping them understand their capacity for loss, whether it’s running through scenarios or as a way to adjust their attitude to risk, can reassure clients and ultimately give them confidence in their financial plan.
If you are interested in finding out more about capacity for loss and retirement planning, have a look at our exclusive CRP benchmarking research 2020. And we also explored how sequence risk can impact cashflow modelling and a client’s capacity for loss.
The information contained in this page is for professional Financial Adviser use only. If you are a private investor, please visit the Private Investor section or contact your Financial Adviser for more information.