Using cash flow modelling to illustrate suitability of retirement-related advice

The timing of the review also gave the FCA an opportunity to explore how firms were implementing the consumer duty and responding to changing consumer needs due to the rising cost of living.

The FCA sent a 'Dear CEO' letter, including a link to the published review, summarising their key findings and outlining expectations for the future. The letter also set out the next steps the FCA expected firms to undertake:

1. Address the review’s findings 

• Firms should consider the findings and take appropriate steps to meet the FCA requirements on retirement income advice, including the duty, and document how they have done so. 
• They should also refer to the questions in the data survey to identify what improvements could be made to their management information to monitor customer outcomes and respond to regulatory information requests. 
• The report highlights examples of good and poor practice. Firms may find these useful to identify how they can support their customers to make informed decisions, avoid causing foreseeable harm and act to deliver good outcomes for retail customers. 

2. Provision of the retirement income advice assessment tool (RIAAT) 

• The FCA also published the RIAAT and accompanying instructions, developed for the purpose of the review to assess the suitability of advice files. 
• This tool will help firms providing retirement income advice understand the FCA’s methodology. 

3. Refer to the FCA’s article on cash flow modelling 

• In addition to the review’s findings, the FCA has also published an article that sets out how firms can improve the way they use cash flow modelling. 
• It outlines points to consider when undertaking modelling to help firms deliver suitable advice and aid consumer understanding. 

While the FCA’s article on cash flow modelling focused specifically on retirement-related advice, firms should consider the impact on other areas where they use cash flow modelling. There were some key findings and suggestions on what firms can do to improve their client outcomes. 

Cash flow modelling can project a variety of outcomes, depending on the inputs and assumptions used.

When used effectively, these outcomes can help clients understand how different economic circumstances could affect their retirement income, as well as the potential drawbacks and risks of the recommended approach. This helps clients make effective decisions and take appropriate action. 

But if used incorrectly, it can create misunderstanding and unsuitable advice. Foreseeable harm can be caused if firms:

• do not consider how clients will interpret the output;
• project forward using returns that are unjustified and don’t result in realistic outcomes; or
• do not consider the inputs and outputs objectively.

Each of these has a profound impact on client understanding and could have an impact on the suitability of any recommendation based on the model used.

Firms relying on information without considering accuracy

A firm is entitled to rely on information provided by clients unless it knows the information is clearly out of date, inaccurate or incomplete. 

The FCA expects firms to consider if the information clients give them is consistent with their stated goals or expectations for retirement.

This information is key to providing suitable advice.

They would expect firms to challenge clients on the figures provided; for example, where income and expenditure indicate savings are available, but the client has no savings recorded. 

Firms should ensure:

• they have a reasonable basis for the estimated expenditure in the cash flow modelling, both at present and in future, considering the client’s needs for the basic cost of living, desired lifestyle expenditure, discretionary expenditure and savings;
• how the client’s personal circumstances and lifestyle are likely to change throughout retirement and how this might affect future expenditure; 
• they are using up-to-date salary information to calculate current net income and identify surplus/deficits in current household budgets;
• the salary information takes proper account of the method for paying workplace pension contributions, eg: net pay, salary sacrifice and relief at source;
• they have included all sources of income up to and throughout retirement, such as employment earnings, benefits including child benefits, property rental income, share dividend income, reliable bonuses and other sources of regular income and pensions, including a justifiable estimate of state pension;
• they have used up-to-date market values of all investible assets in the projection;
• they can justify any estimated figures used in the projection; and
• they have considered whether the advice is being given on a single life or joint life basis.

Using justifiable rates of return

The returns used within cash flow modelling are one of the most important parts of the model. The FCA expect firms to have a reasonable and justifiable basis for all assumptions they use in the model.

A client’s investment objective may rely on their investments achieving a certain rate of return. So, if the firm’s modelling is based on incorrect assumptions, there is a higher risk of poor consumer outcomes. 

Firms can improve their modelling by: 

• using rates of return that are aligned with the investments being recommended; 
• ensuring that rates of return are consistent across similar assets in different wrappers; and 
• using the correct tax rates consistent with the clients’ circumstances.  

Any rates of return must be justifiable – it is unlikely that future rates of return will mirror the pattern of past rates. When setting future rates of return for cash flow modelling, firms should: