Pension projection rules could generate ‘unrealistic’ results

Proposed new rules on how pension pots should be projected to retirement could lead to ‘perverse and unrealistic’ results, according to consultancy firm LCP.

LCP made their comments in a response to a consultation by the Financial Reporting Council (FRC).

The FRC has been consulting on statutory illustrations which members of DC pension schemes receive. 

To produce these illustrations pension providers need to consider how the current DC pot is likely to grow between now and when the member reaches pension age.  Current rules give pension providers the freedom to make their own assumptions about future investment growth. 

With the advent of Pensions Dashboards, there have been growing calls to standardise these assumptions so that savers who see all their pensions on a single dashboard see projections which have been carried out on a consistent basis. 

To facilitate this, the FRC has proposed that pension schemes and providers should be required to project current pension pot values to retirement using a single, standardised, method. This would involve looking at the investment funds that make up the current pension pot and estimating growth to retirement based on the past volatility of investment returns for each investment fund. 

Where a fund had experienced more volatile returns in recent years it would be deemed to be high risk / high return and therefore would be projected to retirement at a higher assumed growth rate than a fund which had been less volatile in recent years.

LCP believe their team have found a major problem with this proposed method.

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The consultancy firm said that in recent years returns on bond funds (traditionally thought of as a lower-risk/lower-return) have been relatively volatile, whilst there have been periods in the recent past when returns on equity funds (traditionally thought of as higher-risk/higher-return) have been more stable. 

LCP said the new rules could have the ‘perverse’ consequence that pension funds largely invested in equities may be projected to have relatively low growth rates in future, whilst ‘de-risked’ funds largely in bonds would be projected to have relatively high growth rates.

LCP are calling on the FRC to re-think this approach and instead allow schemes to project based on standardised assumptions for future growth for each main asset class.  If equities were expected to grow more than bonds, then this method would allow schemes to project on that basis, whereas the FRC approach could give the opposite, and more unrealistic, result.

David Everett, partner at LCP said: “We welcome the drive to standardise assumptions about the growth of pension funds, especially in the context of the introduction of Pensions Dashboards.  But the proposed method of standardisation could have perverse consequences, with assets generally thought of as higher risk being projected at unrealistically low growth rates, whilst lower risk assets could be assigned unrealistically high returns.  

“The proposed approach is likely to produce unrealistic and confusing results and we call on the FRC to opt for the much simpler and more intuitive approach which we have set out.”

The new rules are due to be implemented from October 2023.

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Pension projection rules could generate ‘unrealistic’ results