By Alistair MacDougall, Technical Manager, ATEB Consulting

As a leading compliance consultancy and provider of Suitability, the widely used report writing software, ATEB maintains a keen interest in tools advisers use when advising clients. Our interest is not casual.

Way back in the mists of time (March 2011), when the FCA was still a twinkle in HM Treasury’s eye, the FSA issued final guidance around assessing a client’s risk profile. The Regulator had found that poor client outcomes occurred where firms:

  1. Used tools that were not fit for purpose
  2. Did not understand how a tool works or its limitations
  3. Failed to mitigate a tool’s limitations within the suitability assessment

That concern found its way into the rule book and is dotted around the suitability rules in COBS 9, requiring firms to take reasonable steps to ensure that ‘all tools, such as risk assessment profiling tools or tools to assess a customer’s knowledge and experience, employed in the suitability assessment process are fit for purpose and appropriately designed for use with their customers, with any limitations identified and actively mitigated through the suitability assessment process’.

Over the last decade or so, cash flow modelling has increasingly become a standard part of an adviser’s toolbox. So much so that the FCA considered, but discounted, whether the use of cash flow models should be mandatory when finalising the 2018 pension transfer rules.

The FCA decided against mandating the use of cash flow models because they had concerns about how they were being used. The two areas of concern were:

  1. Are growth and other assumptions realistic and compliant?
  2. How the output is used and how well clients understand it

That ‘fit for purpose’ requirement undoubtedly extends to cash flow modelling, so it was with a compliance professional’s eye that we recently looked at the new Dynamic Planner Cash flow, in particular considering the fit for purpose, growth assumptions and output aspects.

Fit for purpose

Fitness for purpose comes in two flavours. First, some tools are simply flawed, often in our experience arising from the designers misunderstanding relevant rule requirements. We saw nothing in Dynamic Planner Cash flow that fell into this category.

On the contrary, it has some design attributes that specifically contribute to fitness for purpose – see growth comments below. The user interface appears intuitive. Changes in circumstances are easily catered for. A client might retire two years later? Drag the timeline accordingly and the result is recalculated instantly.

The second problem that can and does arise is how a tool is used.

The designers cannot be held responsible for problems arising from users applying the tool in a context for which it was not designed or in a way that was not intended. Such issues usually arise from the issue found back in 2011, namely advisers not understanding how a tool works or its limitations.

To combat that risk, Dynamic Planner Cash flow is accompanied by several detailed documents aimed at explaining how the tool works, so that advisers can be confident of understanding what the model can and cannot do, and explain projections and probabilities to clients accurately and effectively.

Some of the detail is quite technical, especially around the Monte Carlo calculations, which aim to provide a view of the potential outcome in a number of different scenarios. We think that care will be necessary when explaining the probabilities that come out from the Monte Carlo projections to clients as having a full grasp of probability is (probably!) not widespread beyond the realms of statisticians. However, if advisers do not feel they fully understand any aspect, Dynamic Planner are happy to elaborate.

The October 2020 rules state that any cash flow model used in connection with pension transfer advice must:

  1. Be produced in real terms in line with the CPI inflation rate
  2. (If net income is being modelled) ensure that tax bands and limits applied are based on reasonable assumptions
  3. Take into account all relevant tax charges that may apply in both the ceding arrangement and the proposed arrangement
  4. Include stress-testing scenarios to enable the retail client to assess more than one potential outcome

Dynamic Planner Cash flow planning certainly satisfies the first and last of these requirements. What it does not do is account for anything other than standard UK tax rates. That is to say, currently the higher rates of tax that apply in Scotland are not catered for so advisers would need to explain that to any client subject to those rates.

Growth assumptions

Realistic growth assumptions are good practice across the board, but are actually subject to specific rules and guidance where defined benefit transfer advice is concerned – and we mostly see cash flow modelling being done in connection with transfer advice.

The FCA has stated: “It is our preference that the role played by the proposed receiving scheme is communicated to the client in the advice as consistently as possible with the KFI, which will be provided to the client if a transfer was to proceed.”

The KFI [Key Features Illustration] must use mandated growth assumptions. For pension products, the maximum intermediate rate is currently 5% (ignoring inflation reduction) – but, as also required by the rules, a lower rate must be used if more appropriate to the funds in question.

The higher and lower rates are then simply 3% above and below the relevant intermediate rate. The provider of the KFI should do all the ‘objective data’ work to assess the appropriate intermediate rate.

The ‘objective data’ referred to comes into play if an adviser wishes to use a rate other than that shown in the KFI. This is permitted, but only if the assumed growth rate is supported by objective data and that is not a trivial task. Looking at a few years of past performance would not be sufficient.

Dynamic Planner Cash flow does not permit users to enter their own growth rates, thus avoiding unrealistic and non-compliant projections. Instead, growth assumptions appropriate to the client’s Dynamic Planner risk profile score are set by the Dynamic Planner Investment Committee. Full details of the assumption setting process can be found in the background documentation.

Output

Resolving the FCA’s output concern is less straightforward. Firms sometimes use cash flow modelling in the background to support the recommendation made, perhaps extracting a few key points to the suitability report, but not presenting the output in detail to the client. And that is a perfectly valid approach, although we would always recommend that a source reference is included so that the client knows where they can obtain the full information.

If the output is to be presented to the client, it is important that the output is clear and understandable.

The sample Dynamic Planner Cash flow reports we have seen are clear and well structured. But advisers retain an obligation to ensure that they can explain the output and what it means. Dynamic Planner Cash flow has a small number of charts that present the fundamental information that a cash flow model is intended to show. We have seen other software where the output is a vast collection of highly coloured and very busy charts. In our view, it is important that the client is not faced with more charts than is really going to help them make an informed decision. Less is definitely more, in this context.

We gave a series of presentations on behalf of Professional Paraplanner last year. The topic was FCA concerns around cash flow modelling. To demonstrate how confusing some outputs can be, we included a number of slides showing sample outputs we had seen in suitability reports.

We invited the audience to come up and explain what they thought the slides were showing. No takers! To prove the point, the last slide was a screen grab of a heart rate monitor. Nobody noticed. We rest our case!

How can new Dynamic Planner Cash flow help your firm? Find out more

About ATEB Consulting – www.atebconsulting.co.uk

ATEB is one of the few compliance consultancies that can undertake FCA Conduct of Business Skilled Persons (Section 166) Reviews. We are one of the earliest compliance consultancies, founded in 1996 to plug a gap in the market. Since then, we have provided pragmatic and hands-on support to IFAs, mortgage brokers and general insurance intermediaries.
We have long standing and loyal clients; many have been with us since the start in 1996. While we can introduce you to third party professionals, we do not receive any form of inducement for doing so and hence we provide a completely unbiased and independent service, focusing solely on your needs. ATEB has been awarded the ISO 9001 internationally recognised Quality Management System (QMS) accreditation by the British Assessment Bureau Registration Number 211178