Pensions illustrations regulation risks FCA Consumer Duty compliance obligations

21 May 2024

COBS rules

I recently asked one of my colleagues to provide a summary of the key COBS rules which dictate what goes into a pensions key features illustration. My colleague delivered a list of sixteen major rules which must be abided by when producing pensions illustrations for our clients in 2024. In reality, there are even more sixteen - which is a considerable number of rules which determine exactly what we must put in these illustrations.

These rules mandate how our customers present projections to consumers and how those projections are calculated. Many are frankly a turn-off for people reading (or rather not reading) these vital documents.

Right now, key features illustrations are likely to discourage people from saving more before retirement. Equally, they are not helping those in decumulation to carefully manage retirement income in line with investment growth, never mind combat the ever-present drains of charges and inflation.

I've decided to outline the Top 6 COBS rules which, at worst, are likely to completely alienate and disengage the few consumers that do read their pension statements; or, at best, give them a worst-case scenario view of what their savings could buy at retirement.

1. Projection restrictions

COBS mandates that projections for future growth must be no higher than 2%, 5% and 8% for the low, mid and high growth rates in tax-exempt wrappers. In addition, it stipulates that there must be a 3% difference between each of the growth rates used.

This doesn't always accurately reflect the returns that fund managers expect to achieve, which are sometimes higher than this, but cannot be illustrated.

2. Projecting with a standardised deterministic model

It is well understood within the industry that deterministic projections fail to take account of random and unexpected movements in markets triggered by major events. In the last 16 years alone, we have seen; the Great Recession, the COVID-19 Pandemic and the Russia-Ukraine war.

By contrast, stochastic models incorporate probability and randomness into their models, accounting for certain levels of unpredictability which increasingly seem to be the norm today. Yet the FCA places several caveats on the use of projections calculated using stochastic modelling which together make their addition into key features illustrations very onerous for providers. Stochastic projections may not be able to predict everything, but they are often more accurate and thus beneficial to consumers.

However, due to the above constraints by the FCA, most providers do not produce them.

3. COBS-prescribed inflation adjusted percentages

COBS rules mandate that key features illustrations projections must factor in future inflation and that the rate used must be 2% per year. This is aligned with the Bank of England's long-term inflation target, but as recent years have demonstrated, inflation can get much higher than this; 2% is not always appropriate. It would therefore seem sensible to allow consumers to model the effects of different levels of inflation on their projected retirement savings.

In addition, the 2% inflation rate for COBS illustrations is different to the rate we have to use for Statutory Money Purchase Illustrations (SMPIs), which is set at 2.5% by the Financial Reporting Council, which is responsible for the SMPI assumptions. This represents another area where we have to explain the difference when, from a consumer's point of perspective, they should just be the same.

4. Projected figures

Final projection figures must be rounded down to the first three significant numbers so that £1,389,945 is shown as £1,380,000 for example. Whilst the FCA's rationale for doing this is to ensure that consumers use the illustration as a guide to what might happen in the future, rather than set an expectation of an exact figure, it does mean that large fund values can be significantly understated.

5. Annuity value at retirement must be displayed

Even though less than 10% of those drawing on their pension for the first time in 2023 purchased an annuity, the FCA still mandates that annuity values must be provided in all pension illustrations.

The rates used to calculate the annuity must also be based on historical mortality data. The data currently in use is based on information collected from UK insurance companies from 2015 to 2018. Not only is this data very out of date, but it also ignores the impact of the COVID-19 Pandemic on mortality data, which has been significant over the last four years.

6. Differing regulatory regimes

Although pension illustrations are mostly governed by the COBS rules, charges can also be disclosed in line with MiFID II rules which were brought in by the EU in 2018 and adopted into UK law as part of Brexit. Whilst most illustrations will use TISA's best practice guide to disclose charges in a way that is compliant with MiFID II, the material differences between the two regimes make understanding and comparing illustrations more difficult.

Consumer Duty & COBS rules

The highly prescriptive nature of the COBS rules for determining projection values and mandating some of what must be disclosed in a key features illustration, has arguably worked well in a world where everything was delivered annually on paper but these are increasingly neither read nor acted on.

However, this passive, non-interactive approach to consumer communications now runs in direct opposition to what the FCA demands of regulated firms in the Consumer Understanding outcome of the Consumer Duty:

"We want consumers to understand the information they are given and make timely and informed decisions". PRIN 2A.5 of the FCA handbook sets out the FCA's expectations but these can be summarised as:

Communications must be clear and not misleading whilst supporting a consumer's understanding by having the information needed, use language that is likely to be understood and equips the consumer to make effective, timely and properly informed decisions.
The communication channel needs to support the decision-making process and enable the consumer to review the information and their options.
Communications should be tailored to consider the consumer's characteristics (including vulnerability), the product complexity, the communication channel and the role of the firm producing the communication.
Communications need to be tested to ensure they are supporting good outcomes with any deficiencies corrected.

Moving to principle-based illustrations regulation

I am a firm believer that the Consumer Duty outcomes are a positive addition for consumers and offer an opportunity to revisit the traditional methods of educating and engaging with them. Against this, the prescriptive regulations which govern the look and feel of key features illustrations and other regulatory documentation now seem out of step.

The Consumer Understanding outcome presents a real opportunity to create a more engaging, consumer-focused and personalised communication approach that better meets the needs of the consumer but currently we are being straightjacketed by a separate piece of regulation.

It is time, therefore, that a more principles-based approach is adopted for documents such as KFIs – giving firms the freedom to highlight aspects which are relevant to individuals.If a person in their early 60s has already expressed an interest in purchasing an annuity at retirement, then continue providing that annuity calculation (or better still an interactive tool with which to generate their own personalised annuity quote).

But, for the nearly 90% that have not expressed interest, providers should be able to place this quote further down the document and instead offer prominence to something more suitable to that individual, such as an income drawdown affordability calculator showing likely income levels given contribution history, projections and other relevant parameters.

Controlled guidance rather than prescription must surely be the right approach in future as we move to a world where the customer is truly in the driving seat when planning for retirement.

Customers must be given user-friendly tools, in a medium and approach that works for them to provide easily understandable information on which they can make better-informed decisions. As an additional consequence for many more would-be retirees, doing this should drive more of them to realise that they need financial advice to optimise their plans for retirement, or highlight the value their advice is giving them. This change of approach will inevitably improve financial education, as well engagement and ownership levels whilst maintaining accurate and insightful information for the consumer.

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