For Financial Adviser use only
A short guide to Capacity for Loss
& Pre-Retirement Planning
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Featuring
Billy Burrows
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MetLife
A quick summary of the FSA Guidance
on Capacity for Loss
The FSA’s own definition in their Guidance Consultation January 2011, states that, “by ‘capacity
for loss’, we refer to the customer’s ability to absorb falls in the value of their investment. If any
loss of capital would have a materially detrimental effect on their standard of living, this should be
taken into account in assessing the risk that they are able to take.”
‘Capacity for Loss’ is a distinct concept, but related to Attitude to Risk, and should therefore
be considered and documented separately. Firms should ensure they have a robust process for
assessing the risk a customer is willing and able to take.
Firms should ensure:
• tools, where used, are fit for purpose and any limitations recognised and mitigated;
• any questions and answers that are used to establish the risk a customer is willing
and able to take, and descriptions used to check this, are fair, clear and not misleading;
• they have a robust and flexible process for ensuring investment selections are suitable
given all aspects of a customer’s investment objectives and financial situation (including
the risk they are willing and able to take) as well as their knowledge and experience;
• they understand the nature and risks of products or assets selected for customers; and
• they engage customers in a suitability assessment process (including risk-profiling)
which acts in the best interests of those customers.
“Our particular focus is on Capacity for Loss when
undertaking retirement planning. There is acceptance
that whilst a person’s attitude to risk may not change,
due to life circumstances, their Capacity for Loss does.
Given this, we believe effective retirement planning,
whether you’re looking for pre, at or in retirement clients,
needs to incorporate Capacity for Loss.”
Peter Carter, Product Marketing Director, MetLife
A short guide to Capacity for Loss & Pre-Retirement Planning
Assessing your clients’ Capacity
for Loss in the 10 year countdown
to retirement
Whilst there is no definitive list set out by the FSA to help determine a client’s Capacity
for Loss, here are some sample questions you may find useful to better understand a
client’s financial circumstances and assess their Capacity for Loss.
What are your income and outgoings now… and what will they be
in retirement?
L ook at different scenarios with clients to identify their Capacity for Loss. MetLife
research conducted in August 2012 has shown that one of the biggest concerns for
those who are in the ten year countdown to retirement is redundancy or a drop in
income. And, only a third of women at this age are working full time. So it’s important
to understand how long a client could manage without an income, what impact this
would have on funding their retirement and what they would do if the State pension
age went up further.
hat assets and liabilities do you currently have… and are likely to have
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at retirement?
gain it is important to explore different scenarios with clients – property values,
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inflation, annuity rates and investment volatility can all impact on a client’s cash flow
in retirement. This is particularly pertinent for those who are divorced, as our research
indicates they have half the net asset value of other households. So, the key question
here is, “How much of your invested money could you stand to lose without having a
significant impact on your standard of living in retirement?”
Do you have dependants in the run up to and into retirement?
T his was a big eye opener for us. Our research showed that pre-retirees are more likely
to provide financial support to others than receive it. A third of those aged 50 to 60
still had children or parents living with them and 63% had given an average of £3,135
in the past six months to dependants. With so many pre-retirees providing financial
support to others, it will certainly impact their ability to absorb any losses.
“Most advisers will understand their client’s circumstances
but few actually challenge them about their Capacity
for Loss. The key to understanding financial objectives
is to determine future income requirements, how much
flexibility is needed and their risk profile.”
Billy Burrows, retirement income expert
and Director of Better Retirement Group
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MetLife
What are the key factors affecting
clients’ Capacity for Loss?
We’ve undertaken extensive research to understand the major factors that are affecting clients’
Capacity for Loss, and have identified three Critical Loss Factors which you should consider when
advising your clients.
Critical Loss Factor
Critical Loss Factor
Critical Loss Factor
Life Changes in the run
up to retirement
The impact of Annuity
Rate Volatility
The Impact of Investment
Volatility
Unexpected life changes can
impact upon a client’s ability
to absorb investment losses.
Based on consumer research
conducted in August 2012,
we understand the particular
life changes which clients
may face include:
With falling annuity rates and
gender no longer being taken
into account when calculating
life expectancy, clients may
see an impact on their
retirement income, and so
affect their Capacity for Loss.
Investment volatility is of
particular worry to clients
who are close to retirement
as they have little or no time
to regain any investment
losses due to a drop in
the market.
•Redundancy
Did you know?
• A divorce
There has been a drop in
annuity rates for men and
women of 46% and 42%
respectively over the past
15 years.*
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• Supporting adult children
or ageing parents
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And if clients are in
drawdown investment
volatility will impact directly
upon their current and
future income.
I didn’t expect at my age
to have both children living
at home with me again.
All those extra mouths
to feed and utilities have
put a strain on my budget
and my ability to save.
*Source: MetLife UGen Research 2012
A short guide to Capacity for Loss & Pre-Retirement Planning
Pre-retirement planning
and tackling Capacity for Loss
Q&A with Billy Burrows
Q
A
What are the key headlines for pre-retirement planning
with clients?
Many clients are between a rock and a hard place; low interest rates, volatile equity markets and many of the traditional options do not serve investors well in these difficult times. In the run up to retirement, clients
face a number of unknowns, including:
•
•
•
•
•
Q
A
Don’t know when they are going to fully retire
Outlook for equity markets and interest rates
How inflation will erode future spending power
How long they will live
The state of their health in the future
million
Brits are financially
supporting adult
children aged 21
and over.*
apacity for Loss is an important consideration for all clients in the
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run up to retirement; what are the key drivers at present?
T he three important factors to take into account: the client’s overall
financial position, their financial objectives and their risk profile.
Many advisers will understand their clients’ circumstances but few actually
challenge them about their Capacity for Loss.
The key to understanding financial objectives is to determine future
income requirements and agree how much flexibility is needed.
Finally, risk profiling is more than a simple 1-5 scale of risk; it involves a
more detailed discussion about all the relevant factors, including Capacity
for Loss.
Q
A
3.3
How does it work alongside risk assessment - isn’t it quite
confusing for clients?
T he important thing is to get a client to look at what would happen if
their retirement plans all went wrong and they were to lose a significant
amount of their capital, and ask how they would cope.
Far from finding this confusing, clients find it very helpful to consider the
worst case scenario, as it concentrates their mind.
Clients find it
useful to consider
the worst case
scenario.
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5
MetLife
Pre-retirement planning
and tackling Capacity for Loss
Q&A with Billy Burrows (continued)
Q
A
What are the key questions to tackle?
I have always said that there are ‘three golden rules’ for advising
in the run up to retirement:
•
• • Does the client have other sources of income or capital
to fall back on if their chosen strategy does not work?
Do they understand all the risks involved?
Have they explored all the relevant options?
If these rules are followed the advice given will be sound, but if these
rules are broken and things go wrong, the advice may be questioned.
Q
A
Q
A
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million
people in the UK
are financially
supporting elderly
loved ones.*
But isn’t there a danger in the current market, that it makes
clients even more cautious and worried about doing anything?
I talk about the so-called risk paradox - clients may think they are
reducing risk by investing in low yielding assets, but they do not escape
the risk that their pension will not keep up with future inflation.
Put simply, taking some risk, especially controlled risk, may turn out to be
the less risky option in the long run. Sounds a bit of a contradiction, but
clients get the message.
Controlled risk
may turn out to
be the less risky
option in the
long run.
So with clients who clearly have low/no Capacity for Loss,
what are the solutions for them?
There are a range of choices including traditional options such as
lifestyle funds and annuities, but increasingly clients and their advisers are
seeing the benefits of more modern and sophisticated approaches, such
as unit-linked guarantees. As one client put it to me, “I don’t want to
miss out on a new idea if it is going to benefit me.”
Summary at a glance
Clients are currently finding themselves in a difficult position. To plan effectively it’s essential
to have a detailed discussion about all relevant factors - and that includes understanding their
Capacity for Loss. Help clients to see what would happen if their plans all went wrong.
And for clients with low or no Capacity for Loss, it’s important to look at all investment
options - both traditional and more modern approaches.
*Source: MetLife UGen Research 2012
A short guide to Capacity for Loss & Pre-Retirement Planning
At retirement clients with
low or no Capacity for Loss
For clients on the cusp of retirement who have low or no Capacity For Loss, there are
several issues to look at.
• Are they ready to fully retire?
• Do they want to take an income now or would they prefer to defer their income?
• Do they realise that retirement can last for 20 to 30 years, so they could experience tremendous life changes and market volatility during this time?
It’s also essential to look at current annuity rates and speak to clients about the potential missed
opportunity of market upswings, should they opt for an annuity.
If clients are thinking about drawdown, be sure to look at Government imposed GAD rates
which limit what they would be able to take each year. Furthermore, if clients already have
low or no Capacity for Loss, any further market drops could result in significant drops in
their retirement income.
Retirees in distressed drawdown
As markets have suffered year after year, clients who are in drawdown may have seen their
pension pot eroding, causing a dramatic decrease in their income.
Clients with a low Capacity for Loss will have quite an urgent need to repair their eroded
income as soon as possible, giving them more certainty for the future.
The initial reaction may be to look at an annuity, but it’s worth pointing out that with the
continued drop in annuity rates, this may not deliver the income they need. Annuities are also
not exposed to the market, and while this could give a degree of security, it would also mean
losing out on potential market upswings in the future.
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the Financial Services Authority are available from us on request. Registered address: 20 on Hatch, Lower Hatch Street, Dublin 2, Ireland.
Registration number 415123. UK branch address: One Canada Square, Canary Wharf, London E14 5AA. Branch registration number
BR008866. www.metlife.co.uk
M13 00 032 l FEB 2013 l 1390.2 JAN 2013