The Defined Benefit Advice Assessment Tool: Reading between the lines
Last month the FCA made clear how they assess the suitability of a DB transfer, by making their Defined Benefit Advice Assessment Tool, now widely known by a catchy little acronym of DBAAT, freely available to anyone who wants to have a look at it.
Why is this something that interests us here at Timeline?
Well, we’ve always banged the drum about the brave new world of retirement income planning post Pension Freedoms, and the dangers of sequence of returns risk on a retirement portfolio. We also talk a lot about the two widely researched and competing ideas of ‘Safety-first’ vs ‘Probability-driven’ planning. Indeed, our CEO, Abraham Okusanya, has often warned of the dangers of relying on deterministic cash flow modelling to validate the lifespan of retirement plans - and we will revisit this later.
Now, central to the Probability-driven advice approach is the science of sustainable withdrawal rate methodology and underpinning this is the need to treat the retirement income conundrum with the respect it deserves by recognising the stochastic nature of the challenge - which is ultimately what led to the creation of Timeline.
…and, what’s this got to do with the DBAAT?
Well, although the terminology wasn’t in use at the time, we can now articulate that pension legislation here in the UK before Pension Freedoms meant retirement income advice operated under a Safety-first type of structure, evidenced by things such as the Minimum Income Requirement (MIR) and Government Actuary Department (GAD) limits for income drawdown. However, once the shackles of the old legislation were shaken off, anything resembling a Safety-first approach was abandoned in favour of a far more laissezfaire environment with any form of guaranteed income, including Final Salary benefits, being ignored in favour of flexibility and capital.
Now bearing in mind that Pension Freedoms was the invention of HM Treasury and that the FCA were caught out by the 2014 budget just like everybody else, they are now starting to clarify their expectations. If you read between the lines in the DBAAT user guide, it implies that, if advisers do not want to follow a Safety-first approach, for whatever reason, they need to adopt the Probability-driven alternative for all of a clients’ non-discretionary retirement expenditure. We can say this with confidence because contained within Sec 2.22 of the DBAAT user guide are references to a sustainable withdrawal rate and the stress testing of a clients’ retirement portfolio.
This is where we come back to Abraham’s dislike of deterministic cash flow modelling, because although Sec 2.22 does not specifically state that deterministic modelling is not acceptable, deterministic modelling cannot deliver a truly sustainable withdrawal rate. This is because a key component of a SWR is the level of certainty/probability used to evidence the sustainability of that level of withdrawal. You can also read between the lines that the reference to stress testing suggests it should be done to a level of robustness across a wide range of market conditions, not just a handful of scenarios with random market collapses thrown in to the mix.
So, we believe that, reading between the lines, advisory firms operating a non-evidence based advice approach supported by deterministic modelling will have to embrace the more robust and research rich, stochastically based Probability-driven approach. Enter Timeline – a powerful piece of technology created to support this methodology.
The only question now is whether this will be reflected in the upcoming Suitability II review… And whether they will apply to the wider retirement income advice area, not just money emanating from a DB scheme. The more we think about that, the more we have to conclude that it probably will.