By Steph Willcox, Head Actuary, Dynamic Planner
The FCA is concerned about how firms prepare and use cash flow modelling. It has reviewed firms’ usage and provided guidance on how to improve the quality of cash flow modelling for clients.
Dynamic Planner welcomes the review and is pleased to see the FCA-desired approach to cash flow modelling tightly mirrors our own. Dynamic Planner’s cash flow is a quick and efficient way to bring a client’s finances to life. It enables a client to connect with their future self and it helps advisers deliver suitable advice, to help their clients achieve their goals.
Dynamic Planner’s stochastic Monte Carlo forecaster projects thousands of runs monthly, to reflect the way your clients spend their money, and ensure that sequencing of returns risk is successfully captured for higher risk investments.
Following March’s publication of a FCA review, here we can share how Dynamic Planner’s cash flow solution provides your firm with a compliant and insightful cash flow plan for all your clients.
FCA finding 1: Firms relying on information without considering accuracy
The FCA recognises that a great cash flow plan cannot happen without great data, but it is concerned that advisers are using out-of-date information, or accepting client updates without questioning what has been provided.
Within Dynamic Planner’s ‘one system’ approach, we have a ‘Client Access’ module which enables you to invite your client to complete questionnaires, as well as collect important information from them. This includes incomes, expenditures, details of pensions, savings and investments, and their future goals.
Using ‘Client Access’, your clients can review their finances as often as required, to ensure that a client’s current cash flow model is relevant and accurate. You can investigate any changes in information provided by a client before updating the client’s record. As a result, you are not forced to simply accept changes provided by clients. You’re free to challenge anything which seems unusual or incorrect.
Model changing income and expenditure
You can have good conversations with your clients about their goals, and place monetary values and timeframes on them to help illustrate what the future life looks like for a client.
Clients may have no idea what their retirement spending could look like, so the use of ‘life phases’ within Dynamic Planner Cash flow enables you to have structured conversations about changes in income and expenditure at different stages in life.
Linking start and end dates to life phases allows you to have a seamless conversation about the timing of these events, by intuitively dragging them up and down a timeline of your client’s life. You can also make use of Dynamic Planner’s valuation integrations with different platforms and providers to ensure you hold accurate figures for all pensions, savings and investments.
FCA finding 2: Using justifiable rates of return
The FCA has specified that ‘the returns used within cash flow modelling are one of the most important parts of the model’, and that ‘firms [should] have a reasonable and justifiable basis for all assumptions they use’. It adds that simply repeating specific patterns of past returns is not appropriate.
At Dynamic Planner, our asset risk model is entirely forward-looking, providing expectations of real return and volatility for 72 underlying asset classes. These are combined to create expectations of real return and volatility for our 10 risk profiles. As our returns are real in nature, this allows for variable rates of inflation over time and powerfully reflects reality.
Our asset risk model and its assumptions are independently reviewed each quarter by Dynamic Planner’s Investment Committee, which includes external and internal experts, covering fields of academia, research and regulation, as well as the investment industry both inside and outside the UK.
Assumptions reviewed every quarter
The Investment Committee updates and approves all assumptions used within Dynamic Planner. The underlying returns and volatilities are then updated each quarter in Dynamic Planner. New assumptions take effect immediately, so you can be confident subsequent cash flow forecasts are using the latest assumptions. This documented process ensures all assumptions have been rigorously tested before being applied to any client forecasts.
All forecasting within Dynamic Planner uses our stochastic Monte Carlo forecaster, which uses monthly projections across thousands of runs to generate a range of results for a client. We then present this range of results from the 5th percentile to the 95th, to ensure that clients are aware of the results they might achieve.
By forecasting assets by their risk level, we naturally allow similar assets to be projected in a similar way, regardless of the wrapper they sit within, and can allow for all applicable charges to be included in projections too. We also include calculations on income tax and national insurance, where applicable.
FCA finding 3: Planning for uncertainty
The FCA has found that cash flow planning can be misleading for clients where it is poorly explained to clients. Examples of this include mixing real and nominal terms or planning for average life expectancy.
Throughout Dynamic Planner, we only use real figures. Every forecasted number is shown in real terms so that clients can understand the purchasing power of their investments at every point in time. Cash flow also uses real returns, allowing for variable rates of inflation within the projections.
A projection that performs well may reflect a high level of return and a low level of inflation. Similarly, a poorly performing projection may reflect a good level of return, but a high level of inflation.
Advisers are free to set the end date of their cash flow plan, and this does not need to be based on life expectancy. As life expectancy is so varied, we do not show this within cash flow. This encourages advisers to consider what length of cash flow plan is appropriate for each client individually. The FCA also stressed that highlighting the lower percentile outcomes in stochastic modelling is important.
At all times, Dynamic Planner presents three forecasted outcomes:
- ‘Be prepared for this’ – the 5th percentile result
- ‘Plan for this’ – the 50th percentile (median) result
- ‘Be pleasantly surprised by this’ – the 95th percentile result
As well as having the option of displaying each of these three outcomes on charts, our 5th percentile returns can clearly be seen in analysis and a wealth chart Dynamic Planner produces for you to share with your client in report, as well as under a simple headline, ‘When will my money run out?’ This gives a client a clear indication of the asset values they should be prepared for, in case of poor future returns.
In Dynamic Planner, you can also ‘show paths’ to illustrate for a client how their investment journey may fluctuate over time. Twenty Monte Carlo projections will be displayed, to highlight the monthly gains and losses that may be experienced. This can support a capacity for loss conversation.
You can quickly increase expenditure in retirement and ask Dynamic Planner to disinvest from assets to meet this spending requirement. This gives you the ability to show a client how higher spending will deplete assets sooner. This can be even more effective if you make use of the three different expenditure levels available, ‘Must do’, ‘Like to’ and ‘Dream of’, to quickly show the effects.
FCA finding 4: Consumer understanding
A clear part of Consumer Duty is ensuring that your clients understand what they are looking at, particularly if they have reports that they are taking away, outside of a meeting with their adviser. The FCA is keen to ensure that all communications received from an adviser are consistent, or explainable if they are not.
Dynamic Planner uses consistent projections throughout, and one definition of risk, ensuring that all communications produced can be read in conjunction with one another without causing confusion.
Dynamic Planner’s cash flow report has also been researched and tested with advisers and members of the general public who have received advice. It is intended to contain all information discussed with their adviser and can be read independently of the meeting. It also includes: assumptions used in the modelling; a complete description of uncertainty and Dynamic Planner’s modelling; and all information provided by the client.
It can be presented in different colours and text sizes, and is entirely customisable by the adviser, to tailor to the individual client.
FCA finding 5: Consider the output
Rather than send cash flow modelling outputs directly to clients, the FCA wants to ensure that advisers are reviewing information they are about to provide, to check it’s appropriate, and it is based on suitable assumptions.
The FCA particularly highlights that cash flow models could include withdrawing from assets before they are available [like a pension before the minimum pension age, or from illiquid assets that a client has no desire to sell] or that expenditure items might not be detailed enough to cover specific life events.
The FCA also encourages advisers to check how long funds will last under the ‘base’ and additional cash flow modelling scenarios.
Dynamic Planner’s cash flow report clearly shows all outputs from the ‘base’ scenario, including a focussed section on how long the client’s portfolio will last. This is compared to how long the portfolio will last under all alternative scenarios included in the report.
All scenarios created can be clearly included in the report, as well as on screen. The report includes a clear display of the differences between the ‘base’ scenario and the additional scenario, in terms of inputs as well as outputs.
The system’s flexible expenditure input enables expenditures to be entered in any format: one-off; recurring; or with a wide range of frequencies. They can also be entered as a ‘Planned goal / event’, enabling it to be assigned an intuitive icon and be flagged on all charting to help bring the client’s financial picture to life.
Summary
Dynamic Planner Cash flow can be used with your clients to help bring their finances to life, and to ensure that they understand the risks they are taking, throughout their lifetime and beyond. At Dynamic Planner, we believe in our cash flow module, and in light of the 20 March 2024 publication of the FCA review, we are proud to continue to help advisers meet their requirements of quality cash flow modelling.
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