Cashflow modelling software company Prestwood has defended its product after the Financial Conduct Authority (FCA) questioned consumer’s ability to understand the outcomes of stochastic (or probabilistic) modelling.
Julie Lord (pictured), director of Prestwood and chief executive of Magenta Financial Planning, acknowledged the FCA’s concerns expressed in a consultation paper on defined benefit (DB) pension transfers published last week.
‘Although entirely transparent, I don’t believe that a stochastic analysis adds any clarity for the consumer.
‘Telling the client there is a 96% probability that they can achieve a specific level of income in retirement is no substitute for ongoing planning and advice incorporating a lifelong cashflow model which takes into account all of the client’s lifestyle goals and objectives,’ said Lord.
However, Lord said used in conjunction with illustrations created by Prestwood’s deterministic modelling, based on known circumstances as opposed to possible scenarios, the client could get a clear and useful picture of their future finances.
‘The stochastic model has its place in helping to present a range of investment results for a pension fund which is why Prestwood’s Truth® has a built-in stochastic calculator - but then we need a more deterministic cashflow model to take account of all client circumstances,' she said.
The FCA paper questioned clients’ ability to understand the outcome of stochastic modelling which cashflow tools use when being presented with information about a possible pension transfer.
‘It is our preference that the role played by the proposed receiving scheme is communicated to the client in the advice as consistently as possible with the Key Features Illustration which will be provided to the client if a transfer was to proceed,' it said.
‘This does not prevent firms from using stochastic software for holistic financial planning but it does require… the advice can be justified to the client by reference to a deterministic analysis which is consistent with a KFI, where relevant.’
The FCA paper asked for evidence clients could understand the outcomes of stochastic modelling.
‘We are interested to receive firms’ views on reconciling stochastic cashflow modelling and appropriate pension transfer analysis (APTAs) more broadly with other mandated projections in the transfer advice process.
‘In particular, we welcome robust evidence on consumers’ ability to understand the outcomes of stochastic modelling,’ it stated.
Lord said Prestwood was able to produce useful illustrations for the client but the stochastic models were really just for the benefit of the financial adviser.