The first two factors appear in the Pension Transfer Report (previously the TVAS), so it is understandable that advisers might assume that these are comparable – but they are not. They measure entirely different things and are based on entirely different assumptions. These differences need to be understood and explained to clients.

Cash flow models are increasingly being used by firms when advising on pension transfers, and the assumptions that firms make are widely variable, in particular, the growth rate. This often results in cash flow models that give an impression of the client’s future financial situation that is not only more optimistic than realistic, but also confusingly different to the indications from the key elements of the Pension Transfer Report, namely the TVC and critical yield figures.

The FCA considered the use of cash flow models when finalising the new transfer advice rules that took effect in 2018 and decided against requiring their use. In fact, the FCA has concerns about the use of cash flow models of which more later.

However, the rules do not preclude the use of cash flow models, or other projections, provided certain conditions are met. Identifying those conditions is not easy as they are contained in several different places within the FCA Handbook. The key requirements are:

• such analyses must not be given more prominence than an analysis prepared in accordance with COBS 19 Annex 4A;
• projected outcomes at the 50th percentile must be no less conservative than if the analysis had been prepared in accordance with COBS 19 Annex 4A and COBS 19 Annex 4C;
• any indication of future performance must comply with COBS 4.6.7R, the key points of which include:
  • it is not based on and does not refer to simulated past performance;
  • it is based on reasonable assumptions supported by objective data;
  • the effect of commissions, fees or other charges is disclosed;
  • it contains a prominent warning that such forecasts are not a reliable indicator of future performance.
• the projection must use rates of return which reflect the investment potential of the assets in which the retail client’s funds would be invested under the proposed arrangement;
• use more cautious assumptions where appropriate;
• when making assumptions about the rate of return under COBS 19 Annex 4A, a firm should consider consistency with other assumptions (such as inflation and exchange rates);
• assumptions must take account of all charges that may be incurred by the retail client as a result of a pension transfer or pension conversion and subsequent access to funds following such a transaction (except for non-contingent charges or charges paid by a third party e.g. the employer;
• charges that should be included in the analysis include:
  • product and fund charges;
  • platform charges;
  • adviser charges in relation to the personal recommendation and
• subsequently during the pre-retirement period as well as at benefit
• crystallisation and beyond, where likely to be relevant;
  • and any other charges that may be incurred if amounts are
• subsequently withdrawn;
• different assumptions that produce different illustrative financial outcomes should be clearly explained to the client.

Meeting the requirements

So, the rules do not preclude the use of cash flow models, but they must be used in accordance with a pretty demanding set of rules as summarised above and must also satisfy the clear, fair and not misleading rule. Firms must use growth assumptions that are no less conservative than the mandated assumptions and, where other assumptions are used in addition, these must be realistic and supported by objective data. Charges must be accounted for and all relevant projections should be explained clearly to the client.

The objective of the rules is to ensure that clients are given a fair and accurate indication of how their finances might look in future so that they can make an informed decision as to whether to transfer or not. Facing the client with different outcomes from different projections, especially without adequate explanation, hinders an informed decision and could result in a future complaint. Ideally, firms should ensure that they use consistent assumptions. The FCA has stated:

“It is our preference that the role played by the proposed receiving scheme is communicated to the client in the advice as consistently as possible with the KFI which will be provided to the client if a transfer was to proceed.”

The KFI must use mandated growth assumptions. For pension products, the MAXIMUM intermediate rate is currently 5% (ignoring inflation reduction) … but, as required by the rules, a lower rate must be used if more appropriate to the funds in question. The higher and lower rates are then simply 3% points above and below the relevant intermediate rate. The provider of the KFI should do all the ‘objective data’ work to assess the appropriate intermediate rate.

So, the simplest way to ensure the cash flow growth assumption meets all the rules is to look at the key features illustration (KFI). The intermediate growth rate used there (before inflation) can be taken as an appropriate gross growth assumption for any cash flow model that is to be prepared.

To meet the requirement to take account of charges, a deduction must be made to reflect the overall charges that will apply. The net result is an appropriate growth assumption to use within the cash flow model. At its simplest, it would look like this: