When people invest in a pension or other financial products they are given illustrative projections as to how their money could grow over time.
For pensions specifically, clients get three which represent high, low, and intermediate estimates based on the economic environment and outlook.
But interest rates have been dragging along the bottom since the global financial crisis. This decade of low return will have affected the long-term growth potential of pensions and investments – but do the illustrations reflect that?
Realistic assessment
Steven Cameron, pensions director at Aegon, told International Adviser that the intermediate rate is capped by the Financial Conduct Authority, and is currently at 5%.
The high and low estimates can go 3% above and below the intermediate projection.
“Importantly, firms can’t simply use 5% as the intermediate rate,” Cameron explained. “Instead, they must set this, and review it regularly, for each fund based on the underlying assets and the firm’s realistic assessment of how each asset class might perform in future.
“So, for example, any cash element will have an expected return far below 5%. This means that, in times when the expectation is for returns to be lower, projection rates will also be lower.”
In the case of pensions, such projections will also need to take into accounts that they may be around for very long periods of time – even up to 40 years – and they should reflect that.
Case study
Singapore’s Life Insurance Association (LIA) has asked the industry to decrease the illustrative return caps used in Singapore-dollar denominated policies from 1 July 2021.
Insurers are expected to illustrate at least two scenarios: an upper and a lower investment return to provide a “reasonable potential range of the level of benefits”, the LIA said.
The higher rate will be capped at 4.25% per annum and the lower at 3%, with the LIA stating that the lower estimate must be “at least 1.25% pa below the upper illustration rate”.
Also, they should not be “higher than the insurer’s view of the investment returns achievable over the lifetime of the policies”, it added.
Previously, such estimates were capped at 4.75% pa and 3.25%, respectively.
Khor Hock Seng, president of the LIA Singapore, said: “The association made a decision to make a downward revision on caps for investment returns assumed for policy illustrations primarily in consideration of the sustained low interest rate environment.
“Our objective in doing so is to provide consumers a more realistic range of projected investment returns so individuals can make better informed financial decisions.”
Time to go lower?
Following Singapore’s example, is there a case for the UK to follow suit?
Tom Selby, senior analyst at AJ Bell, told IA: “Whilst projection rates should be reviewed regularly so that they are aligned with prevailing economic conditions, it is important to remember that these projections apply to pensions which may have a 30+ year lifespan and economic conditions are likely to change significantly over that sort of timeframe.
“They can only therefore be a very rough guide as to what someone may get back from their pension. In the UK we already use quite wide bands for projections for different asset classes that give people a range of outcomes based on a low, mid-, and high point.
“For most people planning for the very long term this will be sufficient and tinkering with them too often is unlikely to have a material impact on their decision to invest.”
One argument, however, is that after 10+ years of low interest rates, people may end up having less than they expected to get based on their original illustrations.
Steve Webb, partner at LCP, added: “It is vitally important that the projections which individuals receive are realistic, understandable and consistent across different investments.
“It should, however, be for regulators to impose common standards across the industry rather than rely on individual schemes and providers to go it alone.
“In a world of pensions dashboards where people will be able to see all their pensions in one place, any pension projections must be on a consistent and realistic basis, regardless of the type of pension or underlying investment.”
Regulatory matters
Still, the decision remains in the regulator’s hands.
Aegon’s Cameron said: “The FCA could decide to reduce the 5% cap, but is likely to do so only if there is a long-term expectation that 5% as an intermediate return for any asset class over any time period is too optimistic.
“As long as firms are setting realistic expectations at fund level, there is arguably no need for this.”
IA contacted the watchdog to ask whether it intends to change the intermediate projection cap considering the interest rate environment of the last 10 years, and whether making such a decision could incentivise people to save more as they would receive more realistic estimates reflecting the current climate.
The FCA did not reply in time for publication.
