The future of projection rates is hanging in the balance as the FSA considers whether it is the role of the regulator to set rates and in some cases whether they should be set at all.
After a report on long-term market conditions and projection rates by PricewaterhouseCoopers last June concluded that a more sophisticated approach to setting rates could be helpful in improving consu-mers' appreciation of investment risks, the FSA said it would be reviewing the use of projection rates on investment products.
At the time, the FSA said it would not be changing the projection rates it currently requires firms to use, which remain at 5 per cent, 7 per cent and 9 per cent for untaxed products such as pensions and Isas and 4 per cent, 6 per cent and 8 per cent for taxed products such as collective investment schemes and mortgage endowments.
But Money Marketing has learnt that the discussion paper will not only look at the level that the rates are set but also whether it is the FSA's role to set them and, more important, whether they should be set at all.
Norwich Union senior actuary David Riddington says the FSA is considering whether all products need projection rates. He says: “Projection rates are most useful either when the product has a target benefit, like a mortgage endowment, or in the pension arena when it is necessary to have an idea of what the pension is heading towards. If a policy is taken out purely as a savings product, a consumer will want to pick the best product and the right fund but what the answer is at the end of the day is not really the important thing.”
Riddington says there is an argument to be made – and which the FSA is considering – that bonds do not need projection rates as they are competing in the same area as unit trusts and Oeics which do not have projection rates.
Money Marketing understands that the FSA is interested in keeping projection rates for products with specific targets such as endowment mortgages but could look to drop them for products where the projection rate could be used as a sales tool.
Scottish Widows head of industry relations George Andrew believes the most sensible approach would be for the FSA to set generic projection rates for equities and gilts, leaving companies to specify the composition of their own funds and their individual performance. He says: “This would sound more sensible than having a free-for-all.”
Riddington says the FSA is considering setting assumptions for different asset types which could be taken as a base, with companies accounting for the mix of their own funds.
Swallow Financial Planning partner Mark Ruse says this is a good idea in principle but questions how it would be put into practice. He says: “Relying on insurance companies is probably quite dangerous as they have their own agenda and if it is left entirely up to insurance companies to set projection rates, it would be impossible to compare products on a like-for-like basis.”
At the moment, the projection rates set by the FSA are the same across the market, with differences between companies caused by charges. Riddington agrees with Ruse, saying that if different growth rates came into being, a new model would have to be developed to enable consumers to compare charges.
Raising Standards director Martin Shaw points to the US system, where a generic projection rate is in place but if a company is aware that its mix of funds is such that it is unable to attain the rate, it puts in something lower.
He says that projection rates are useful for mortgage-related products and pensions but can only provide an indication of what is to happen for bonds.
Shaw says: “One thing is clear – throwing complex information at the customer is a waste of time and money. If simple information is provided to the consumer, with more complex supporting information given to the adviser, this would strike a happy medium.”
He is adamant that what-ever changes the FSA introduces must not add unnecessary cost to the industry.
Riddington is pushing for substantial road-testing of any changes before introducing them as a requirement. He says: “The problem could be that changes are introduced and providers spend a lot of money changing things but then policyholders do not understand things better anyway. If a lot of money is spent on these changes, we have to be sure they are improving on what we have already.”
One suggestion that Money Marketing understands has been made to the FSA by the Institute of Actuaries, which is carrying out research looking at new formats for projection rates, including stochastic projections, is the possibility of using odds for rates.
Riddington says: “The institute has found that people find it difficult to understand percentages and so somewhat flippantly suggested that it might be better to provide projection rates in terms of odds.”
This is unlikely to be taken up by the regulator but the discussion paper, due in the next month, will be posing all these questions and it will be up to the industry and IFAs in particular to make their views known.