REGULATORY EXPERTISE
FCA asks firms to review their use of cash-flow modelling
Whilst the Thematic Review into Retirement Income publication in March 2024 has been at the forefront of much discussion in recent months , it is important not to overlook an important FCA article that flanked the publication . This article was on the use of cashflow modelling ( CFM ) to demonstrate suitability of retirement-related advice .
Alexander McGregor
Head of Policy Simplybiz
Kris Armstrong
Compliance Policy Manager , Simplybiz
CFM has come to prominence recently as the FCA has raised concerns of how firms were monitoring income sustainability . Whilst the FCA stopped short of stating all firms should adopt CFM , it did reference CFM ’ s ‘ significant role ’ in educating a customer around the strategy being recommended and assessing capacity for loss . As with most financial planning tools , the potential usefulness is dependent upon what inputs and assumptions are used ; if used incorrectly , they can create misunderstanding and lead to unsuitable advice . CFM can be a key step in providing suitable advice , helping to establish a client ’ s true monetary capacity for loss in retirement .
Accuracy of information
A key component to successful use of CFM is the accuracy of information , incorporating all of a client ’ s assets . Many advisers will have clients who have – either knowingly or innocently – excluded assets . CFM , when co-completed with the client – which may prevent certain assets going missing – can be a powerful addition to a retirement income file , providing retiring clients with the assurance that they have enough savings to sustain their desired lifestyle and achieve their retirement goals . Firms should also be aware of the FCA ’ s expectations around CFM use in other related areas of advice . CFMs should ensure tax bands and limits are based on reasonable assumptions and projected investment returns are justifiable , consider all relevant tax charges and include stress-testing scenarios . Conducting thorough fact-finding and suitability assessments helps CFM to meet the individual retirement needs , objectives and risk tolerance of each client . All CFM should show figures in real , not nominal , terms . It should be clear to clients how much future income amounts are worth in today ’ s money terms , i . e . after inflation has been considered . Using real terms should also help adjust tax bands and other tax limits more easily . A recommendation would be for firms to adopt a policy for the use of CFM documenting all assumptions , justifications and
stress-testing scenarios to be used across the firm . This not only provides a clear record of the retirement advice provided , but also can drive consistency of use in multi-adviser firms , essential for compliance and for facilitating audits .
Embracing technology
The FCA has encouraged firms to embrace technology to deliver improvement in the advice process . Dovetailing nicely into the findings of the Thematic Review , CFM software provides the opportunity for firms to address the areas for improvement , such as income withdrawal strategy / methodology , providing there is consistency of assumptions used in the steps prior to cash-flow . Most tools incorporate risk-profiling results from the earlier stages of the advice process which pull into the cashflow seamlessly , with the software being able to adapt to several drawdown strategies . Crucially , all current and future income and expenditure requirements can be modelled , along with other individual scenarios . Firms should fully understand the cash-flow projections they are producing for clients and whether the output they have generated is a representation of the client ’ s true retirement future , considering all the assumptions made in constructing the CFM , and sense-check any outputs . Alongside considering their own understanding of the projections , when presenting cash-flow outcomes the firm should make the client aware that any figures presented will not 100 % be borne out in practice . If the risks aren ’ t properly explained , a client may perceive a degree of certainty in the outcomes that does not exist .
A key component to successful use of CFM is the accuracy of information
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