The FSA review of investment projections faces a fundamental problem – no one knows what will happen in the future, least of all, it would seem, actuaries, as their faulty predictions have amply illustrated. And to try to remove all risk from investment is impossible.
The current system of prescribed illustrations for investment returns has, arguably, done more to eliminate misselling than any other measure undertaken by the FSA and it would be a big mistake to abandon regulation of projections altogether, as the FSA itself acknowledges.
Dodgy salespeople can no longer make exaggerated claims for the likely out-turn on a long-term life or pensions savings plan and this is definitely a big improvement.
But clearly the FSA is worried that if it sets the prescribed projections for investment returns, it could itself be accused of misleading investors, if those projections turn out to be wildly optimistic.
It is obviously anxious not to precipitate another investment disaster by raising investors' expectations to unrealistic levels. Again, as the FSA freely admits, the regulator has no more a monopoly of wisdom on what the future will bring than the actuaries or anyone else.
Back in the late 1980s, investment returns averaging 12 per cent a year were a reality but look what happened. Perhaps today's approved projection of 5 per cent will also turn out to be an overestimate. It certainly would have been in the 1930s.
One of the main objectives of the review, says the FSA, is to ensure that projections provide information that is clearly understood by consumers and improves their decision-making.
The difficulty here is that the average buyer of a long-term savings or pension product has no idea of whether a return of 5 per cent a year over the coming 15 to 25 years is realistic or not, indeed, over such a long term neither does the actuaries or the regulator or anyone else, as has been proved by events.
The other main objectives are to ensure that whatever projections are used, they are simple and clear and that salespeople and providers do not provide “speculatively high projections”. The current system already does this, which is the biggest single argument for no change.
But this is at odds with the FSA's other stated objective which is to give firms, “greater responsibility for working out the assumptions used to illustrate potential returns on their products”.
Reading between the lines, this means the FSA wants to divest itself of the responsibility for setting potential investment returns in case it gets it wrong and itself becomes the victim of compensation claims.
David Severn makes the valid point that the present broad-brush approach “does not take sufficient account of the timeframe for which the consumer wishes to invest”.
If the FSA wants to hand back some responsibility for projections to the product provider, then perhaps projections should be restricted to predictions of the potential return for the next five years – a much more realistic timeframe.
This could include a requirement for the product provider, salesperson or the financial adviser to go back to the client after five years, with a further five-year projection – rather like life companies are now required to inform endowment holders of the likely progress of their savings policies.
One of the major problems with all financial products is that there is no “after service” from either the product provider or the adviser.
A requirement to “reproject” every five years would help the consumer to maintain contact with the product provider and create an interest in the progress of their savings.
Change for change's sake is not a good idea and the current system has worked reasonably well. Modifying the timescale over which projections can be made but still prescribing the figures, would be a helpful compromise.
As Severn says, “the current system has both strengths and weaknesses and we must be careful not to throw away the baby with the bathwater”.