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Don't Stop....Believin'

by Becky Colley on 29·04·2020

Culturally, we have been happy with what a map is and does for quite a long time.  

 

The oldest known maps are preserved on Babylonian clay tablets from about 2300 B.C. and they have served our purposes perfectly well up to the late 1990s.

 

Then along came the young upstart ‘Satellite Navigation’.

 

Sat Nav is ubiquitous.  Can you imagine heading out on a journey to somewhere you have never been before without using a satnav? 

 

Whether it is a map or a sat nav, we can turn to something to help us on a journey into the unknown, and that is what cashflow planning is.

 

The FCA sent out a ‘Dear CEO’ letter at the start of the year, outlining their intention to look more closely at retirement advice.

 

This should be a massive flag for any adviser as most have clients in the ‘approaching retirement’ or ‘newly retired’ group.

 

The implication of the letter is that they are concerned with the way ‘income strategy’ advice is delivered.  This is surely a reference to a lack of structure around income withdrawals, source of withdrawals, management of withdrawals and ultimately sustainability of withdrawals.

 

There is one, potentially easy fix for this – cashflow modelling. 

 

The problem is that cashflows modelling itself isn’t a regulated function.  As a result, you have hardcore ‘planners’ who believe their way is the only right way, and deniers who have never used cashflows so why should they start now.

 

There is, however, a real problem with cashflows in both of these groups.

 

Before getting into what the problems are, let me give you a little history lesson on cashflows in financial advice. 

 

The truth is that cashflows evolved as a brilliant way for advisers to sell more!

 

“Oh look, if you want to retire you need to invest more” or “oh no, look how exposed your family are if you die – you need MORE INSURANCE”

 

Cashflow was first introduced in the late 1960s in the USA.  The early cashflows were ‘budget based’ that is to say they charted actual money in and money out to predict the future.

 

Then in 1972 the Certified Financial Planner qualification mandated cashflows and so as the qualification become more widespread, so too did the use of cashflows. 

 

The next big change then came in the mid-1980s, when cashflows moved from budget based to goals based.  That is to say, start with a destination in mind and work out how to get there.

 

This was the era that cashflows became established in the UK, when Paul Etheridge established the Institute of Financial Planning and brought the CFP to the UK.

 

Whether it is a simple map or a complicated sat nav, a cashflow forecast should really be the cornerstone of almost all advice, and this is the problem.

 

Financial planners will get snooty about ‘proper’ financial planning, and that is fine.  The problem is that a proper cashflow takes time to produce, and ultimately time costs money.  This means that potentially those with the greatest need for cashflow (as they have lower value assets to support them in retirement) are excluded on the grounds of affordability.

 

At the same time, deniers are not helping themselves or their clients as no cashflow means there is nothing to ensure the ship remains on course.

 

Wouldn’t it be great if advisers could build a tiered approach to cashflows; simple, easy to use tools for the clients with lower values of assets (a basic map) and more complicated cashflows for the higher values of clients (a sat nav).

 

At the end of the day, a simple cashflow will be much more beneficial for a client than no cashflow.

 

It is essential, however, that if firms use any form of cashflow they record rules and parameters for their basic assumptions.  Whilst I appreciate not all advisers are involved with DB transfers, they are a great barometer for the regulators outlook with regard to cashflows, I think.

 

On the back of the retirement income review and their Dear CEO letter, the FCA have stated that DB Transfers will be coming under increasing scrutiny, specifically with regards to the starting position for such transfers to be - in their view - that it is unsuitable for the client to transfer benefits. It is impossible to imagine a DB transfer APTA TVC done properly without a cashflow.

 

Currently we see that the assumptions used by firms are widely variable, particularly in terms of growth rates and in the number of projections produced with differing underlying growth rates which can be confusing for clients. The cash flow forecasts often provide different results and conclusions than the TVC or the critical yield figures provided, and the amount of information being provided to an average client is bound to cause some perplexity. 

 

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 which means the same growth rates as assumed in the KFI of the recommended products.

 

There is the possibility that at some point, the notion of a cashflow actually becomes part of the regulated function.  Our experience of the regulator is not that they check whether your answer is right or wrong, but rather that your workings out are sensible. 

 

There are two areas which require thought around how your firm uses cash flow forecasting:

 

–    are the assumptions realistic and match the objectives of the regulator?

–    how the results are presented to the client and how well does the client understand it?

 

The FCA has voiced concerns about the use of cash flow forecasting in the past, especially with regards to the underlying assumptions and how well the client understands the results.

 

This view is easy to understand when a client can be faced with 5, 10, 15 or more different graphs, based on either optimistic or unrealistic assumptions, which are not viewer friendly or easy to understand and when there is no clear explanation from the adviser documented on the file.

 

The first issue can be easily managed by using the growth and charges figures from the KFI.

 

Resolving the second issue is less straightforward. For DB transfers, there should be cashflow scenarios comparing retaining the scheme benefits to the transfer on a holistic position basis i.e. taking into account all client assets and income against a realistic retirement budget based on current and future expenditure levels.

 

How to present the results to clients in an understandable way should be considered, prioritised and documented, including the adviser conversations around the cashflows.

 

With increasing use of mobile technology in front of clients in this arena; documentation is paramount and will become a focus for FCA investigation.

 

I’ve seen one firm use a questionnaire about a client’s understanding of the cashflows which provides the adviser with a written account in the clients’ own words of their discussions. A great demonstration of client understanding which the FCA is likely to approve of.

 

As a minimum, firms should be considering how they are utilising cashflow forecasts in their advice, how it aids the advice process and how they are both presenting this to clients and demonstrating client understanding of these tools. A thorough review of this area of your business will ensure continued compliance with FCA suitability and reduced risk of future complaints.

 

DB transfers aside, cashflow forecasting is an excellent tool to match recommendations to client circumstances and for demonstrating a holistic financial planning approach.  Even a simple cashflow will help garner more loyal clients, which is particularly pertinent in the current climate, and with the FCA making it clear they are concerned about income strategy advice, now is the time to make cashflows a client wide part of your proposition.