As part of its thematic review of retirement advice, the Financial Conduct Authority has published guidance on improving the quality of cash flow modelling for clients.
As the regulator points out, cash flow modelling is a key step in providing suitable advice. It can also be at the heart of successful adviser-client relationships.
Helping clients to visualise their goals, connect with their future selves and understand how different scenarios and choices can affect their outcomes is a powerful way to demonstrate value.
However, the FCA has identified concerns about how firms are currently preparing and using cash flow modelling, with potentially serious implications for client outcomes.
With the regulatory focus on this topic likely to continue, what are the key areas for improvement, and how can firms avoid the pitfalls?
Get the data right
The first issue picked up by the regulator is that some firms are relying on information provided by clients without verifying its accuracy.
A great cash flow plan cannot happen without great data, so advisers need to ensure the information clients are giving to them is up to date and consistent with their stated circumstances and goals.
To improve the accuracy of the data on which they are basing their planning, firms can make use of client-facing technology, which makes it easier both to collect data and to challenge it where needed.
This approach means clients can review their finances and update information as often as required, rather than only in the annual review period, improving the timeliness of data.
Advisers can investigate any changes and, if necessary, query them within the system, with the whole process documented for both compliance and regulator.
Use return assumptions you can justify
A second area of focus is on the rates of return firms are using to underpin their cash flow modelling.
The FCA identifies examples in which firms have failed to factor in charges and tax, or used unjustifiably high return assumptions for cautious assets. It also warns against overreliance on past performance.
To ensure the assumptions in a cash flow plan are valid, the underlying asset risk model should be forward-looking in nature.
It is also important to ensure return projections are in real terms, given the potential impact of inflation, particularly for clients near and in retirement.
Communicate the uncertainty
The third concern relates to the way cash flow plans are explained to clients.
Modelling is based on assumptions. If clients do not understand this and believe what they are being shown is certain, the regulator says they are more likely to make harmful decisions such as withdrawing more than they can afford.
Again, the use of real returns in assumptions is important.
The FCA notes that some firms are mixing real and nominal terms, giving clients a misleading picture.
To support understanding of uncertainty, cash flow tools that enable advisers to present a range of potential outcomes are also valuable, allowing clients to prepare for the worst, as well as to plan for the median outcome and to be pleasantly surprised if returns are at the top end of the range.
Be consistent
The FCA’s fourth finding is that customer understanding is not always supported by the communications clients receive about their cash flow plans.
The regulator highlights examples of firms using different growth rates across different communications, perhaps with one set of return assumptions tied to the risk profile, another to the product provider’s key features illustration and a third underpinning the cash flow plan.
By sticking to one definition of risk and using consistent return and volatility projections across tools and touchpoints, firms can ensure all the communications a client receives can be read in conjunction with each other and compared as needed, without creating confusion.
Review the information
Finally, the FCA reminds advice firms of the need to verify the outputs of their cash flow modelling before they send it to clients, to ensure the information is appropriate and based on suitable assumptions.
In this area the regulator has picked up some simple factual errors – for example, a model relying on pensions being accessed before the minimum pension age – that would have been captured in a quick review.
Cash flow modelling technology that generates robust reporting can support this review process.
Ben Goss is chief executive of Dynamic Planner
