The FCA has confirmed it did not undertake a “systematic review” of cashflow modelling before finding that it has been “used in a way that could be misleading” in defined benefit transfers.
In its consultation paper on pension transfer advice last month, the FCA said that while cashflow modelling is not required when conducting an appropriate pension transfer analysis test, it can be a useful aid to illustrate to consumers whether their needs will be met by a transfer and help justify a recommendation.
However, it said it had found some areas it was “used in a way that could be misleading”, for example where inflation wasn’t explained in cases when nominal terms were used, failures to account for market downturns and tax bands or limits not being indexed.
The result, the FCA said, was some advisers could be presenting unrealistic future income projections to clients.
In a Freedom of information request, Money Marketing asked for aggregated results of the work. This could indicate, for example, what overall percentage of firms used misleading cashflows, what the most common errors were, how many firms presented no cashflow before transfer, and whether this impacted the proportion of clients that ended up transferring.
We also asked whether the FCA had researched the impact of forcing a cashflow to be presented to a client wishing to transfer.
In its response, the FCA said that it had not collected the data in a way that it could pull out the wider patterns.
The response reads: “By way of background, as cashflow modelling is not currently required under our rules, our supervision team did not undertake a systematic review of firms’ cashflow modelling outputs when carrying out their work. However, they did see examples of flawed modelling when they were reviewing files focusing on other key risks.
“Therefore, as we have not systematically analysed any data on cashflow modelling received in the course of our work we would have to re-open all the files we have looked at and compile the statistics you have requested, which would exceed [the] cost limit provided for.”
This means that while file checkers have clearly found issues in some cases, the FCA is unable to give an overview of how many firms overall had inappropriate processes for cashflow in place without reviewing the reports on each individual firm again.
The FCA also confirmed that it had “not undertaken any work on a cost-benefit analysis in relation to mandating cashflow modelling.”
In its consultation, the FCA proposed the following reforms to how cashflow modelling should be conducted for DB transfer cases on the basis of the shortcomings it saw:
- Firms must prepare cashflow models in real terms, i.e. in today’s money terms. This will ensure that the models are consistent with other mandated documents such as Key Features Illustrations.
- Firms must ensure that tax bands and tax limits are set using reasonable assumptions if they model net income from year to year. The use of real terms’ modelling should facilitate appropriate indexation.
- The model should explicitly allow for taxes or constraints that are likely to arise on a transfer that would not occur if safeguarded benefits were retained, such as a lifetime allowance charge, any tax applicable on the death of the consumer, or the application of the money purchase annual allowance.
- The modelling must include ‘stress testing’ scenarios to illustrate the impact of less favourable future scenarios so that the consumer can see more than one potential outcome.
The consultation is open until the end of October.