CP22/15: Assumptions and methodology analysis
In their recent consultation CP22/15, the FCA has proposed changes in methodology to determine redress for non-compliant pension transfer advice, as detailed in this note.
Pre-retirement interest rate discounting
The consultation has clarified how the personal pension charges deduction should be applied to the pre-retirement interest rate – that is the deduction should be applied on a geometric (rather than an arithmetic) basis.
Post-retirement inflation volatility
The inflation rate is adjusted by an amount that is derived using a Black-Scholes model. The justification is that in the presence of a cap in some scenarios future inflation will set below the cap.
Married at retirement
The current methodology sets the likelihood that a member is married at retirement at 85% – independent of their current marital status. The new proposed approach is more precise in that it will take into account current marital status and the member’s term to retirement.
Growth in dividends and dividend yield
The new methodology proposes dividend growth at a rate of 1% per annum and that the FTSE All Share dividend yield (used to determine the pre-retirement interest rate) is averaged on a monthly basis over the past 12 months.
Pre-retirement inflation model
The current FG17/9 adopts RPI as a basis but CP22/15 moves to CPI. The impact of this is that the derived inflation rate will be lower which impacts the pre-retirement discount rate.
New CPI methodology
The methodology requires the use of market inflation rates – these are based on RPI government bonds or “gilt linkers” so an adjustment needs to be made to derive CPI. The current FG17/9 approach is to prescribe a table which provides adjustments for term to retirement and retirement age. CP22/15 is suggesting a more “dynamic” method to determine the adjustment required to derive CPI rates.
Mortality table
Current use of PxA08 tables published by the Institute & Faculty of Actuaries (IFoA) Continuous Mortality is to be replaced with PxA16 tables. Mortality improvement applies in both cases.
We compare the results of current methodology FG17/9 to the new proposed methodology CP22/15. In the table below we consider a deferred member who left a defined benefit scheme on 31/03/2017 with a pension entitlement of £10,000 per annum. That entitlement is subject to revaluation and escalation with caps to the increase pension of 5% and 2.5% per annum respectively. We take retirement age as 65 with the spouse (the assumption is that the member is married at calculation date) entitled to 50% of the member’s pension in death in retirement. Personal pension charges are set at 0.75%. The table below shows some results when we consider a member 5 and 10 years from retirement where revaluation-escalation is on a CPI-CPI and RPI-RPI basis.
The table above shows the difference in results is not material – less than 0.25% in all cases but please note that other situations e.g. term to retirement, retirement age, marital status etc will give rise to different results. It is instructive to analyse the factors that give rise to the above difference and the chart below illustrates that for the “5Yr CPI-CPI” result in the table above – where the Present Value at Calculation Date is £264,080.39 and the difference is £26.98 is broken down as follows:
Subscribers to our Congruent CalculationsTM platform are now able to calculate redress using both FG17/9 and CP22/15 for comparison purposes.
