What is more, further changes may be in store, according to industry sources, who note that the Financial Services Authority (FSA) has disclosed plans to consult with the industry this year on possible additional changes, ahead of the Retail Distribution Review, taking effect in 2013.
“Advisers’ lives have been made a little harder,” observes Steven Cameron, head of business regulation at Aegon, who wrote about the need to change investment product illustrations in a blog last year.
Adds Richard Leeson, sales and marketing director at Axa Isle of Man: "The fundamental difference is that the projection rules behind the illustrations used to explain investment returns to clients are no longer arbitrary.
“Now they [projection estimates] are having to reflect more closely the kinds of returns that the underlying assets will be expected to produce – this is why we are now calling them ‘asset-based’ projections.”
Industry standard since mid-1990s
The standard investment projections in use almost universally by UK life and pension companies were first introduced in the mid-1990s by the FSA, which, until recently, expressed no real concerns over them.
According to Cameron, they were never intended to be anything more than a rough guide as to how a particular investment might perform.
Nevertheless, providers have used these standard projections to help advisers, and in turn, their customers, to get a ballpark idea of a general range of likely returns from a range of packaged investment products, such as pensions and investment bonds.
5, 7 and 9
Under the original projection rules set down in the FSA’s Conduct of Business Sourcebook, companies handling investment products were – and still are – required to project on three different rates of return: 5%, 7% and 9% – or 4%, 6% and 8% for products with heavier tax liabilities.
Recently, though, the FSA began to notice that these rates were overly optimistic for some newer types of investment funds, such as cash funds. And in October 2009, it issued a note to compliance officers in which it reminded them of the need to move away from standard projections in some circumstances.
In this “dear CO letter”, the FSA formally withdrew permission for companies to “use the standard rates with a caveat that these may overstate the potential for certain products or funds”, and instead, told them they must “revise the standard rates downwards where a product is unlikely to achieve returns in line with these rates”.
At the same time, companies were told they must also ensure that the same rates were used to explain the charges to their clients, and that the FSA would be surveying firms to ensure that they were in compliance.
As a result, product marketeers, such as life and pension companies, say they are having to come up with new ways of determining projected rates of return that more closely represent what their clients might receive as a result of their specific choice of investment fund or funds.
“The FSA correctly points out that this isn’t a new rule,” Cameron says. “But it’s one that until recently hadn’t been explicitly enforced.”
So it was that in September 2010, Aegon moved to what it calls “fund specific projection rates” based on its own long-term expectations of returns on the underlying mix of assets held by its funds.
Those funds primarily invested in equities are still show 7% projections, while cash funds are being projected at 4% “and others lie in-between”, Cameron says.
The main reason advisers are struggling a bit, he adds, is that “different providers are now using different projection rates even for funds that have very similar underlying investments”, and there is no standard convention on how these rates are to be determined.
Some providers have yet to make any adjustment at all, he adds.
“None of this makes the adviser’s task any easier.”
Different charges add to confusion
Axa IoM’s Leeson says the confusion is exacerbated by the variety of charging structures among product providers, as these are included in the illustrations used – and by the fact, as Cameron noted, that some product providers are still relying on the standard 5%/7%/9% projections.
“That different providers can choose different rates of growth for the same assets is causing confusion for some advisers,” he explains.
“Illustrations really need to be looked at as an expression of charges, rather than providing an expectation of likely returns.”
Axa: revised illustration format
Axa IoM’s newly-revised illustration system went live on 20 December. In a letter to clients explaining the changes, the company said they had been made in line with industry norms, and to “ensure that we incorporate asset- based projection rates for our customers”.
The Axa products affected by the changes are its Evolution, Estate Planning Bond and Regular Investment Account.
According to Axa, the system it uses for its illustrations now is an average derived from the mix of funds chosen, the underlying asset mix of each fund, and long-term assumptions about investment potential of different types of assets.
The number thus derived is then rounded to the nearest 0.5% and used as the central rate for illustration purposes, with the higher and lower rates 2% above and below this.
While financial advisers may find the new approach to calculating and illustrating projected returns daunting, it is also placing a new burden on product providers, Leeson notes.
“Until advisers feel comfortable with these new approaches to illustrations, there will inevitably be a need for providers to clearly communicate the reasons for them, and their effects on projections.”