Investments  

FCA right to question stochastic modelling

FCA right to question stochastic modelling

The FCA is right to question consumers’ understanding of stochastic modelling, financial planning software provider Prestwood has said.

Prestwood Software said used alone, stochastic modelling confused consumers and was not “the new sexy”.

Julie Lord, Prestwood director and Magenta financial planning chief executive, added that to be effective stochastic modelling needed to incorporate ongoing planning and advice.

Stochastic modelling is a form of financial modelling that includes one or more random variables. It estimates how probable outcomes are within a forecast to predict conditions for different situations.

Lord added: “Although entirely transparent, I don’t believe that a stochastic analysis adds any clarity for the consumer. 

“Telling the client there is a 96 per cent probability that they can achieve a specific level of income in retirement is no substitute for ongoing planning and advice incorporating a lifelong cash flow model which takes into account all of the client’s lifestyle goals and objectives. 

“The stochastic model has its place in helping to present a range of investment results for a pension fund, but then we need a more deterministic cash flow model to take account of all client circumstances.  

In an consultation paper in June the FCA raised questions about customers’ ability to understand the information.

The FCA said: “We know that a number of advisers use stochastic financial planning software for future cashflow modelling and to demonstrate the uncertainties of investment and mortality.

“We have considered whether an appropriate analysis could be undertaken on a stochastic basis and easily communicated to the client.

“We welcome robust evidence on consumers’ ability to understand the outcomes of stochastic modelling.”

Ms Lord said that Prestwood’s software financial planning tools provided a holistic view and allowed planners to show the benefits of defined benefit transfers to their clients, but also to highlight the risks.