The recent introduction of Investment Pathways leads to risks for both customers and providers alike.
The FCA has for a long time now had concerns about poor outcomes for customers at retirement. Following the introduction of Pensions Freedoms in 2015 they have conducted several market reviews into the retirement market culminating in the Retirement Outcome Review in 2018.
One of the findings was that there were many customers who were choosing to move into income drawdown without advice. Often the main driver for this was to get their hands on the tax-free cash. The FCA also found that up to one third of these customers did not know, or at the time care about, where their remaining funds were invested. In many cases this led to them being invested wholly in cash leading to issues in keeping up with inflation.
To remedy this the FCA now require any provider allowing customers to take tax free cash and move the rest into Income Drawdown without advice to put customers through a structured investment decision process forcing the customer to make an active decision on where their remaining funds will be invested. Customers must now be asked to choose between Investment Pathways, self selecting any investment from all the choices on offer to Income Drawdown customers or, if the situation allows, leaving their money in the investment that they were in prior to the move to Income Drawdown.
Investment Pathways is the new kid on the block here. Following on from the Retirement Outcome Review, the FCA now require that the customer be offered four possible aims for the next five years that the customer can choose from:
- Option 1: I have no plans to touch my money in the next 5 years;
- Option 2: I plan to use my money to set up a guaranteed income (annuity) within the next 5 years;
- Option 3: I plan to start taking my money as a long-term income within the next 5 years;
- Option 4: I plan to take out all my money within the next 5 years.
Once the customer has chosen one of these options, the provider must offer them an investment solution that is appropriate for the option chosen. This is referred to as a Pathway Investment. Only one Pathway Investment should be offered for each option.
In deciding on an appropriate Pathway Investment, the provider is required to take account of the needs, characteristics, and objectives of their particular target market. This will lead to a generic investment solution based on a particular set of characteristics. The provider, therefore, is required to describe the solution in enough detail that the customer can decide if this fits with their own needs and objectives. One of the principal areas that is called out specifically by the FCA is the requirement to describe in plain language the riskiness of the Pathway Investment solution so that the customer can make an informed decision that this is in line with their own risk appetite. The provider is specifically not allowed to ask the customer what their risk appetite is as this would lead to a personal recommendation.
This leads to two requirements in terms of risk analysis:
- A need for the provider to be very clear, in language that a customer will understand, about the risk profile of the particular Pathway Investment solution indicative and the risk profile of the type of customers that this is suitable for.
- A need for the customer to have an idea of what their own attitude to risk is so that they can decide whether this is in line with the risk level of the Pathway Investment solution being offered by the provider.
The first of these puts pressure on the provider to identify the level of risk the solution contains and be clear in easily understandable language as to what level of attitude to risk it is pitched at.
The second is even more difficult as the provider cannot provide advice or ascertain the risk attitude of the individual. It is up to the customer to understand their risk profile and whether it matches the Pathway Investment solution being offered. The provider can, however, provide the customer with information that may help the customer to understand what their risk attitude is. One way of doing this is through risk profiling tools. However, if these are provided it is extremely important that any results are caveated and that the customer is asked to understand the limitations of the risk profiling tool and that the customer should consider if the profile described fits with their own views of themselves.
The balancing act between offering support to ensure that the risk profile of the solution fits the customer and not providing anything that could be seen as advice is an exceptionally fine one.
To ensure that this is all conducted in a clear, fair, and not misleading way the FCA is requiring the Independent Governance Committee (“IGC”) to review the development and ongoing use of the Pathway Investment solutions including, most importantly, the communications surrounding them. Acting on behalf of the customer they will put extra pressure on the provider to be very clear on the riskiness of their Pathway Investment solutions and provide as much support as they can to the customer in this area.
In addition, the FCA has committed to conduct a thematic review on what providers and IGCs have done, most probably early next year. It is highly likely that one of the areas they will focus on is the clarity of communications including how they are describing the riskiness of the Pathway Investment solutions and how they are helping customers to identify if this is suitable for them.
Understanding risk attitudes will be key in ensuring that customers do not make poor choices here.
Iain Horn
Business Consultant
A2Risk
