Forget CP11/03 or the Board for Actuarial Standards TM1, let’s take a step back, so we can see the wood for the trees, and ask a disarmingly simple question: what are illustrations for? Most would probably answer (1) to show the effect of charges and (2) to show how the fund might grow – after all, that’s what it says on them. The second answer is distinctly dangerous.
I realise that no one knows what the future holds and so we “assume” various things in order to plan. Well, perhaps the FSA should stop requiring pension providers to make an “ass” out of “u” and “me”, as the old joke goes.
There are 4 ways you can “assume” your clients could be misled.
Adopt the Frightened Rabbit Position
Illustrations assume a constant growth rate, usually 7%, which is totally unvarying. Not even Bank of England base rate is that unerring! Illustrations should not be setting the expectation that funds only go up. Faced with reality, this could turn clients in frightened rabbits, crippled by fear of short-term volatility, timidly avoiding risks. In the early to mid years, with an age to go until retirement, this could be most damaging.
Attempt a Mach 2 Landing
Illustrations assume the same growth rate all the way through to retirement date. Implicitly, they are assuming no change in the investment mix, no reduction in risk, no move into cash, not even for the PCLS. What they are assuming, if a 7% growth rate is used, is that by the wonders of compound interest the fund will double in the ten years running up to retirement! That’s a fairly heroic assumption, with no indication of the risk of not hitting it.
A Street Fight with Rules
I’m talking about the 2% above and below the central projection. Despite the words of warning – which few read in spite of your instructions – this looks for all the world like a best and worst case scenario. This further warps clients’ impressions of risk, volatility and probability of outcomes. They should be removed entirely. It’s a brawl out there in the markets: they haven’t read the rules and they’re willing to kick you r “ass-umption”!
220 yards Par 3, Hole-in-One
Or, in other words, your client’s exact retirement age known at the outset – like assuming a hole-in-one. Think about just how many variables we’re dealing with – contributions, investments, returns, bull/bear markets, health, longevity, changes in circumstances and aspirations and so on – and consider how the uncertainty goes exponential adding the variable of time. Unless you are pretty close to retirement (and being able to afford it), the notion of a retirement date is probably a fiction. An auto-enrolled 22-year-old, say, or a 40-year-old starting to think seriously about retirement planning should simply be aiming to land it on the green.
Illustrations can be worse than just useless. High-tech tools can potentially handle the job much better, especially if they help convey volatility, risk, probability and the general lack of precision and certainty about planning. It’s time for the FSA to catch up and help the development of realistic, helpful, modern planning tools.