Proposed new rules on how pension pots should be projected to retirement could lead to ‘perverse’ results, according to consultants LCP.
In order to facilitate the government's requirements for providing estimated retirement incomes, the Financial Reporting Council has proposed that pension schemes and providers should be required to project current pension pot values to retirement using a single, standardised, method.
The proposals would involve providers looking at the investment funds that make up the current pension pot and estimating growth to retirement based on the past volatility of investment returns for each investment fund.
Where a fund had experienced more volatile returns in recent years it would be deemed to be a high risk, high return model and therefore would be projected to retire at a higher assumed growth rate than a fund which had been less volatile in recent years.
Responding to the consultation, LCP argued that in recent years, returns on bond funds – traditionally thought of as a lower-risk/lower-return asset class – have been relatively volatile, while there have been periods in the recent past when returns on equity funds – traditionally thought of as higher-risk/higher-return – have been more stable.
“This could have the ‘perverse’ consequence that pension funds largely invested in equities may be projected to have relatively low growth rates in future, while ‘de-risked’ funds largely in bonds would be projected to have relatively high growth rates,” it explained.
Until now the rules have given pension providers considerable freedom to make their own assumptions about future investment growth.
But with the introduction of pensions dashboards, there have been growing calls to standardise these assumptions so that savers who see all their pensions on a single dashboard see projections which have been carried out on a consistent basis.
Within these proposals, money purchase schemes will also be required to include the projected pot size used to calculate the estimated retirement income, if this is held.
This means that a user logging on to a dashboard would be able to see their projected ERI for all schemes and also a final projected pot value for their money purchase schemes, where schemes hold it.
Under existing guidelines, the government said it wants dashboards not just to display the values of people's pensions, but to project that pot to their retirement date and convert it into an estimated retirement income.
It is proposed that pension schemes sending data to dashboards will be required to supply an estimated retirement income alongside other data elements including the income type, basis, calculation date, payable date and an indication of whether the income includes safeguarded benefits.
But to produce these illustrations, pension providers need to consider how the current defined contribution pot is likely to grow between now and when the member reaches pension age.
LCP is calling on the FRC to re-think its approach and instead simply to allow schemes to project based on standardised assumptions for future growth for each main asset class.
The firm explained that if equities were expected to grow more than bonds, then this method would allow schemes to project on that basis, whereas the FRC approach could give the opposite – and more unrealistic – result.
LCP partner David Everett said: “We welcome the drive to standardise assumptions about the growth of pension funds, especially in the context of the introduction of pensions dashboards.
“But the proposed method of standardisation could have perverse consequences, with assets generally thought of as higher risk being projected at unrealistically low growth rates, whilst lower risk assets could be assigned unrealistically high returns.”
Everett said the proposed approach is likely to produce “unrealistic and confusing results” and urged FRC to opt for a simpler and more intuitive approach.
In its consultation paper, the FRC said that while leaving the requirements unchanged would minimise the work required of providers, the resultant estimated retirement income projections would not provide the individual saver with consistency in projections from different providers.
FRC said this would present significant communication challenges in explaining why the projections are not consistent.
“It might also not be possible for the individual to see the differences in the assumptions that produce the various illustrations as these are not part of the proposed data standards,” it wrote.
“Allowing inconsistency also carries reputational risk for pension and dashboard providers, as well as government and regulators. It is likely that inconsistencies would be publicised and undermine public confidence in pensions dashboards and in pension saving more widely.”
The consultation, which is due to close on May 31, asks a number of questions to anyone with an interest in statutory money purchase illustrations, including those responsible for providing these such as trustees, insurers, wealth managers and administrators.
The new rules are due to be implemented with effect from October 2023. LPC said this could mean many pension savers will start to receive statements which could have markedly different projections for their retirement pot than those shown on previous statements which they have received.
sonia.rach@ft.com
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