Assessing customer risk profiles at retirement requires a dedicated tool

Assessing customer risk profiles at retirement requires a dedicated tool

A customer’s risk profile changes over their lifetime and for good reason. The risks that are reasonable for a young saver to take are unlikely to match those of a retiree looking for a stable income. For advisory firms, this means assessing customer risk profiling requires more than a one-size-fits-all solution.

Before pension freedoms, 90% of retirees bought an annuity, but that figure has now dropped to just 10%,[1] as more people opt for continued investment together with drawdown of their pension savings.  This means assessing customer risk profiles has become an even more crucial part of financial advice. 

The growth in defined contribution schemes, auto enrolment and pension freedoms have opened up a new range of choices for those at or approaching retirement – and assessing customers risk profiles requires tools to match the wider and more complex options available.

The risk profile has two components: an assessment of capacity for loss (CFL) – a factual review of a customer’s financial circumstances – and an assessment of attitude to risk (ATR) which helps determine the customer’s appetite for taking different levels of risk in their investment fund.

These should be seen as distinct processes – and both require attention and fine tuning for the new pensions landscape.

The regulator has its eye on customer risk profiling

The Financial Conduct Authority (FCA) recognises the importance of this issue and in March 2024 published a thematic review into retirement income advice.[2]

 Surprisingly, its survey of almost 1,000 advisers found many were not assessing retirement risk profiles appropriately: ‘it was apparent that not all firms were taking account of the differing needs of their customers in decumulation, as opposed to accumulation’ (TR24/1,paragraph 1.23).

Firstly, fewer than a third of firms (30%) used separate processes for assessing CFL and ATR. CFL not only involves a financial fact find, it needs to determine whether a customer is able to cope with a fall in the value of their investment fund, in terms of spending less or waiting longer to meet some goals.  ATR is a psychological attribute and typically a questionnaire is used to assess how each customer feels about financial risk and what level of risk is acceptable to them.

The FCA takes the view that CFL and ATR should be assessed separately. Despite this, 70% of firms appear to conflate these quite distinct concepts.  Furthermore, at retirement, a customer’s CFL could well be quite different from that of a young saver, who, if their pension pot takes a knock, may have years or decades for it to recover.

The second issue that emerged in the FCA’s work was a failure among firms to adjust their assessment of attitude to risk depending upon whether they were in the accumulation or decumulation phase.

Out of 970 advisory firms, just 221 (23%) had a different process for assessing attitude to risk in decumulation from that used in accumulation.[3] It is surprising that most advisers do not make a distinction in ATR between accumulation and decumulation, given that these customers are quite obviously at a different stage in their life cycle.

The FCA’s thematic review is timely, coming as advisers must ensure they are meeting the requirements of the new Consumer Duty rules. But the question of whether ATR needs to be assessed differently in the decumulation phase is not new. A2Risk has offered a distinct ATR questionnaire for customers in decumulation since 2011 and has worked with leading pension groups to implement it on their platforms.

Tuning the ATR assessment  for decumulation

Continued investment in growth assets might be sensible for some retirees and particularly for those with sufficient resources to cope with a fall in asset values. For most, however, the overwhelming priority will be to secure a relatively predictable income and to protect the capital upon which that income depends.

Our work in this field has shown that the assessment questionnaires for accumulation and decumulation phases need to differ in a number of subtle ways. The differences involve only a few questions and often the change in wording is quite modest. Nevertheless, this can lead to a quite different assessment for the customer. It may, for example, be appropriate to ask a customer in accumulation whether they  are willing to take more risk in the hope of higher returns.  The relevant question when it comes to decumulation requires the customer to consider whether they value a stable income rather than take more risk and have a higher average but more volatile income.

Similarly, in accumulation it makes sense to ask whether a customer sees risk as something to be feared or the opportunity for upside. In decumulation, it is more appropriate to measure their sensitivity to loss.

Further, some questions suitable for accumulation-phase customers would be confusing for those in the decumulation phase. Trade-offs involving higher or lower saving rates are one example.

Despite the requirement to assess each customer’s situation, the FCA determined that all firms in their Centralised Retirement Proposition review used ‘language and questions [which] were not specifically framed for customers in decumulation… This means customers could be inaccurately profiled and take on risk not in line with their circumstances’(TR24/1, paragraph 2.23).

The evolution of UK pensions is still ongoing and decumulation is the next big challenge faced by the industry. It has been estimated that over the next decade the assets in defined contribution schemes will more than double to £1.2 trillion, while the assets held by the over 55s (those close to or already in decumulation and in need of guidance or advice) will almost triple to £527 billion.[4]

The FCA expects a well-designed process to assess the risk profile of at-retirement customers. This is not what it typically found in its Centralised Retirement Proposition review (TR24/1). Firms should consider whether a one-size-fits all approach to risk profiling is likely to produce the outcomes that the regulator is seeking.[5]

[1] Thematic review of Retirement Income Advice | FCA

[2] Thematic review of Retirement Income Advice | FCA

[3] Thematic review of Retirement Income Advice | FCA p.20

[4] PPI launch November 2023 | The Pensions Regulator and broadridge-uk-workplace-dc-to-more-than-double-in-size-by-2031.pdf

[5] Another concerning observation from the FCA – from its Retirement Income Market Data 2022/23 analysis – was that fewer than half of people (47%) bother to seek advice or guidance before buying an annuity;

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