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Storm clouds on the horizon

The FSA report ” Financing the Future: Mind the Gap” considers the implications of an ageing population and looks at areas of potential risk to the general public and to providers of financial services products. It is a wide-ranging report that includes the UK&#39s changing demographics but also gives notice of the FSA supervision work on selling activities.

Most financial advisers would say they already know that there is an increasingly ageing population, whose life expectancy is greater and who, as a result of lower fertility generally, will be supported in retirement by fewer workers.

Financial advisers are also aware of the transference of responsibility for pension provision from state to private and the growing “in-retirement” market. However, they will probably not be prepared for what the report says about decumulation.

Decumulation is the process by which wealth accumulated during an individual&#39s lifetime through savings and investment products can be used to meet consumers&#39 needs in retirement, such as providing an income stream (for example, an annuity) or to meet the costs of long-term care (for example, long-term care insurance products).

The FSA highlights the risks of people in their 60s and 70s not understanding their choices in retirement as a result of lack of information and generic advice and because of the complexity of the options available. This includes annuities, income withdrawal plans and equity release schemes.

The FSA plan to consult by September 2002 on proposed changes to training requirements of financial advisers in the complex area of decumulation products and the needs of the old and very old, with changes to training to come in by 2004. The FSA will also review exams for products like specialist annuities, income withdrawal and long-term care.

The FSA is also concerned about whether commission bias exists between income withdrawal plans and conventional annuities and between income withdrawal plans and other options that give access to capital or income, such as borrowing or selling shares, where no commission is paid.

The FSA will also review the guidance on critical yields given to investors when they enter into income withdrawal plans and also later in the contract as at some point the investor will have to buy an annuity. As well as calculating the critical yield there the is matter of attaining it through performance, which could involve changing asset allocation.

The FSA will review the advice financial advisers give to investors and seek changes to review letters to encourage investors to seek advice.

Although the equity release market is small it has the potential for considerable growth. The FSA thinks consumers may not fully understand the complexities and risks associated with these products, for example the possibility of negative equity or the size of rolled-up mortgage interest on the lifetime mortgage.

Other concerns are the impact on the estate that the consumer can end up leaving to his or her beneficiaries, the effect on inheritance tax and whether a lifetime mortgage or home reversion is the best option and the implications for eligibility for means-tested benefits such as Pension Credit.

The FSA has a six-point plan of action and proposals for the financial services industry:

•To encourage retirement planning and provide consumers with the tools to plan – particularly younger consumers.

•Raise consumer understanding of the risks associated with increasing exposure to investment risk and inadequate savings levels.

•Equip older consumers with the right questions to ask and relevant information to increase their understanding of decumulation products.

•Ensure that firms take full account of the implications for themselves arising from the growth in the market for retirement products, for example the way in which annuity providers manage the burden of increased life expectancy and how they price for this business.

•Ensure firms respond appropriately to the risks to consumers when developing and marketing new and innovative products, particularly annuities and equity release. The FSA will carry out themed supervision work to examine the adequacy of information disclosed to consumers.

•Encourage financial advisers to take account of the changing needs of consumers, particularly the different wealth and debt profiles across different age groups.

This report will have far-reaching consequences for providers and advisers.

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