Proposed new rules in the UK on how pension pots should be projected to retirement could have “perverse” consequences and will probably produce unrealistic and confusing results, consultancy LCP has warned.
The rules in question were set out in a February consultation by the Financial Reporting Council (FRC) about the statutory illustrations members of defined contribution (DC) pensions are entitled to receive; the consultation closes next week.
Until now pension providers have had considerable freedom to make their own assumptions about future investment growth, but with the advent of pension dashboards there have been growing calls to standardise these assumptions so that savers who see all their pensions on a single dashboard see projections that have been carried out on a consistent basis.
The intention is for Estimated Retirement Income (ERI) to be provided on the pensions dashboards following the methods and assumptions specified in the FRC’s rules. The FRC has proposed that pension schemes and providers should be required to project current pension pot values to retirement by estimating the growth to retirement of investment funds in a pension pot based on the past volatility of investment returns.
According to LCP, this would mean that where a fund had experienced more volatile returns in recent years it would be deemed to be high risk/high return and therefore would be projected to retirement at a higher assumed growth rate than a fund which had been less volatile in recent years.
The consultancy is not in favour of such an approach, and believes that a methodology based on accumulation rates by broad asset class would be more understandable by members and easier for pension schemes and providers to carry out.
It pointed out that in recent years returns on bond funds 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.
David Everett, partner at LCP, said the consultancy welcomed the drive to standardise assumptions about the growth of pension funds, especially in the context of the introduction of pensions dashboards, but that the proposed method of standardisation could have perverse consequences, with assets generally thought of as higher risk being projected at unrealistically low growth rates, while lower risk assets could be assigned unrealistically high returns.
“The proposed approach is likely to produce unrealistic and confusing results and we call on the FRC to opt for the much simpler and more intuitive approach which we have set out,” he said.
The new rules are currently due to be implemented with effect from October 2023.