Expert: James Tothill, Aviva Investors
Facilitator: Colette Dunn, Milliman
As we all know there’s a lot of interest on pensions freedom in the industry and this group wasn’t any different. This remains a big part of all businesses around the table and amongst many things it was pointed out the increase seen over the last six months in DB-DT transfer.
So it’s very important to discuss how advisers talk to their clients about Risk and Suitability. Before you can talk solutions you need to discuss with every client their attitude to risk?
So, when someone comes to an adviser to talk about their decumulation phase, what sort of conversations do advisers have with that client around risk? How do they convey the risks? How do they get that client to think about the risk? How do they asses what their attitude towards risk is?
What is the definition of risk – is it their capacity for loss or are we talking volatility?
Many around the table agreed that the truth is that clients don’t have any idea of what the adviser is going on about. The chances are that they don’t understand so it is imperative that advisers take the time to train/ educate the client. But do advisers actually know it themselves? Or do many just put the data into a psychometric table and just go by the result which is usually a 5….
Is not attitude to risk, capacity for loss, etc.… about understanding what the client expectations are and if we can get there, you need to look at each client and their needs.
So when mentioning psychometric testing, the question was raised as if everyone makes their clients fill in a form? Most people replied yes but many questioned if that wasn’t just a step they take for the regulator sake.
One point raised is that it’s important to find the right client for you, some advisers will be prepared to talk to clients in the middle of the night if the market is down and the client is panicking; other advisers won’t.
Most people in public service on defined benefit schemes took no investment risk, it was part of their contract, they didn’t see it as a vehicle for investment it was their employer that defined the risk. So the worry is that many advisers are now sniffing a big transfer value and pursuing that; and we all know that the pound sign is what motivates clients and their actions. So when looking at all these big transfers you need to ask them what it is that is suddenly putting them off a sustainable income? Then you need to ask them about their risk!!
There was a disagreement in the room as many believed that is not the adviser looking for this kind of business. They are being inundated with requests for transfers and many are refusing to do them all together – it is not their policy to do DB-DC transfers. It was concluded that this is the conversation that everyone in the industry is having at the moment and there doesn’t seem to be a right/wrong answer. The truth is that everyone has a preference and transfers should be analysed on an individual basis.
There is not one right way. It is just finding a way that is acceptable within your business and that keeps you true to what your client wants/needs.
Whatever your risk assessment is, it is important to have a formal process. All advisers’ views are going to influence what their client does. If advisers are cautious, all their clients are low risk. However if the adviser is less cautious his clients tend to be classed as higher risk. Whatever the adviser thinks filters down. It is not very objective that is why it is so important to have a system.
The model could be an assessment risk of 10. The problem comes when you then have to judge exactly which fund to put them in. One firm has a modeller out that puts 0.001 out and you are supposed to move the model around and change their funds. This was viewed as being slightly absurd. Another model could be more generic where you understand whether your client will have sleepless nights if things go down or not, etc... But whichever way you choose it should be something external as the adviser and his/her views are too much of an influencer and a single organisation should use a single system, whichever that may be. (There’s no right way. It is about whatever works for you to judge the customer’s preferences.)
What’s the process to choose a solution that is acceptable for your business? What solutions are out there? How do you apply different strategies to different people?
E.g. If you have someone who is 50 years old and they are thinking they are going to do a drawdown at 55, how do you prepare their portfolio at 50, what process do advisers have in place?
They are always going to run out of money but the first decision is when? Before they pass away versus leaving something behind for their family?
Before going into products the group looks at the demographics driving the retirement market. After the war there was a decrease in the number of people reaching 65. But in the next 12 years there will be a 40% increase in people reaching 65. This growth is massive for these businesses.
The annuity market is very stable, about 1,000m in the last 10 quarters. It hasn’t fallen as far as people think.
Are annuities dead?
- Retirement market artificially inflates Q3 12 to Q1 13 due to introduction of gender-based annuity pricing
- Underlying demographics reducing retirement market between 2012 and 2017
- Annuity market today would only be c. £1.5-2bn per quarter even without freedom and choice
- Retirement market should grow steadily from now for approx. 15 years
- Equity markets are a key driver of drawdown
- Interest rates are a key driver of relative annuities attractiveness
Aviva/Moody’s analytics research conclusions: a blend of drawdown and an annuity will produce the best results for most people.
Drawdown with heavier equity weighting (80%) produces the highest lifetime income and the highest death benefit
Drawdown with heavy fixed interest weighting (60%+) has high chance of running out before death
Variable annuities will produce lower lifetime income than a conventional annuity
The case for fixed-term annuities is weak versus SIPP with fixed term deposits
Income drawdown hit by volatility in the early years significantly increased income suitability
Many suggest that following William Bengen’s “Four percent rule" (based on historical data of worst case scenario for a 30 year period) or what Morningstar recalculated for the UK as a 3.72% rate for withdrawal has become relevant to the UK since pension freedoms. But in many cases people ended with too much money left to pass on.
So since then many have come over and designed new ways to do it e.g. based on historical data and over a 40 year period. This could be one way to manage your drawdown, other ways might be to apply the same thinking but on funds. It has to be a solution that is implementable by the advisers.
What would advisers consider useful from a provider? E.g. such as research, analysis. Would they lose their independence if they were to commission it? How can providers help to develop their thinking into a new model in a way that is useful to the adviser and in a way that helps their business? For example, if a provider came with a solution that rebalances the drawdown portfolio every year and you don’t have to do anything with it, is that useful or a bit of an overkill from a provider?
How do you put portfolios together for drawdown?
So far the group discussed risk a bit but haven’t talked yet about cash flow modelling and being able to see what people need in different stages of later life. You have different bits of income falling at different stages. So how do you fill those gaps and analyse their budget properly so that you know what has to go out of the door and what is left for them to enjoy their retirement. You can balance those two in different ways. Do you use annuities for the guaranteed bit or do you have a very big drawdown and stress test it? Deciding how you are going to give people their money in years to come is a big job.
It’s good to see new products coming into market that are trying to address the concept of balancing annuities and drawdown.
Advisers are also very expensive and when people go into retirement with a small pot of money, they are not going to spend a chunk of it on seeing an adviser every year. It would be good to see more products that can be self-managed.
For high net worth clients it is easier as they are willing to pay for advisers to help them do what they need to do. However providers should bring forward products that advisers can use to help the lower end of the market.
Risk models are not about what the solution is, the risk model is more about understanding your client and trying to find out what a reasonable solution would be for them. There is no exact science and we need to live with an Ombudsman who may turn on you if anything goes wrong.
It was mentioned that some advisers are lazy and they would try getting away with doing the minimum amount of work. Many just ask what your outgoings are and that is all they ask instead of properly budgeting and understanding what the client needs really are.
The mind-set of advisers has to change - you need to have a front end process to assess the client not the solution.
It was mentioned that natural yield is a big thing - how do you manage that as a business? How far have dividends fallen historically? Actually not massively - about 15% in the worst of times.
Longevity assessment is part of the conversation with the clients. How long are you going to live? Do advisers use any tools? In most cases this information needs to be taken with a pinch of salt as medical advances need to be taken into consideration. At the end of the day this is a conversation with the client and they are the ones that need to decide what they want to do.
- Sequencing risk
It is about balancing all those risks. You can apply different risk assessments for different pots of money – different “buckets”.
Is the industry sleep-walking into a massive crisis? One bad practise can bring down others who are doing good things - is it too late? The industry should have been advising properly on transfers for the last 20 years but were too scared of the review coming. Even if we think it might be late we need to learn to do it right. Only hindsight is going to show what was perceived as wrong.
There’s a big difference between risk-volatility metric. Imagine the life of a turkey in the US, their life all year is very calm (low volatility state) but we know that at Thanksgiving he will have his head chopped off. So a “bucket” approach makes a lot of sense.
When drawdown first came out a lot of it was promoted to very high net worth clients as asset cascade.
Another thing it would be good for providers to do, would be to help advisers decided what to do with new money. No investment manager would suggest putting a million pounds into the market right now, they’ll suggest you stagger it, but that is what people are doing for their clients. So could providers not do something where they use the expertise of the investment manager to determine, when advisers bring new money to them, how they put it into the market? Advisers are told by compliance departments that timing the market is not a good idea but clearly no adviser would put their own money in so why can we not learn to do this for your clients?
When talking about bucket investing – these are some of the products that advisers are looking at in regard to volatility control:
- Find their guaranteed income and add to it to so you can be more relaxed about what happens to the rest of their funds.
- Investment manager as they don’t choose their own portfolio
- Dynamic Planner
- iFunds – quite small, only 4 people there but great algorithm
- ETF more popular now
- True Funds
A few have seen a huge increase in the use of Risk Target solutions.