FCA Handbook - COBS 19 Annex 7 Interactive pension simulation rules

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COBS 19 Annex 7 Interactive pension simulation rules

Type of rate of return

An interactive pension simulation must be based on:

(1) a standardised deterministic simulation;
(2) a stochastic simulation; or
(3) a combination of (1) and (2).

Standardised deterministic simulation: presenting the rate(s) of return

(1) Where an interactive pension simulation includes a standardised deterministic simulation, the firm must present the retail client with:
1. (a) a single initial rate of return, with the option for that retail client to view and interact with additional higher and lower rates; or
2. (b) the higher, intermediate and lower rates together.
(2) When presenting 3 rates together for the purposes of (1), a firm must ensure the higher and lower rates of return are presented with equal prominence.

Standardised deterministic simulation: calculating the rate(s) of return

A standardised deterministic simulation must:

(1) accurately and fairly reflect the long-term investment potential of each of the product’s underlying investment options; and
(2) ensure the higher and lower rates of return required in COBS 19 Annex 7.2R maintain an equal percentage differential relative to the initial rate or, where all 3 rates are presented together, relative to the intermediate rate.

(1) An example of the requirement in COBS 19 Annex 7.3R(2) is that a higher rate should be 3 percentage points higher than the intermediate rate and the lower rate should be 3 percentage points lower than the intermediate rate.
(2) The higher and lower rates should reflect a reasonable range of possible outcomes around the rate of return in the initial simulation.

(1) The effect of COBS 19 Annex 7.3R(1) is that the standardised deterministic simulation must be based on the expected long-term performance, typically 10 to 15 years, of the underlying investment options. As a result, firms should not be unduly influenced by short-term market conditions.
(2) Where the period of the simulation is for a period before the 10-to-15-year horizon, firms should use the expected long-term performance to work out the estimated valuation for that selected period.
(3) When determining rates of return, firms should base their assumptions on objective, evidence-based data and be able to demonstrate how any decision was made, including the evidence relied upon.

Firms should assess, on a regular basis, whether the rates of return used in the interactive pension simulation comply with the rules in COBS 19 Annex 7 and remain appropriate for inclusion.

Providing a stochastic simulation

A stochastic simulation must be:

(1) based on a reasonable number of simulations and assumptions that are reasonable and supported by objective data; and
(2) a balanced and fair reflection of expected performance based on the anticipated long-term investment performance.

For the purposes of COBS 19 Annex 7.7R:

(1) In relation to the number of simulations and assumptions used, firms should be able to demonstrate:
1. (a) in a way that the retail client is able to understand, that there was a reasonable basis for the anticipated investment performance the retail client was given; and
2. (b) how the firm had adequate regard to whether the outputs generated by the model:
  1. (i) were stable, representative and reliable, including verifying that the outputs were not affected by random variations; and
  2. (ii) provide a reasonable basis for producing simulations that fairly reflect expected performance based on the long-term investment potential.
(2) A firm may comply with COBS 19 Annex 7.7R(2) by presenting the 50th percentile, or a range centred on the 50th percentile, with the ability, in both cases, for the retail client to interact with different percentiles.

Additional requirements for calculating simulations

An interactive pension simulation must be:

(1) presented in real terms; and
(2) rounded down to the nearest pound.

An interactive pension simulation must be based on the most up-to-date value of the retail client’s in-force personal pension scheme or stakeholder pension scheme available to the firm. In any event, the value must be no more than 12 months old.

(1) When generating an interactive pension simulation, a firm must present the rates of return to a retail client in real terms, using the rates calculated in accordance with COBS 19 Annex 7.
(2) In addition to (1), a firm may present rates of return in both real terms and nominal terms where:
1. (a) it reasonably considers this would support retail client understanding;
2. (b) the nominal rates of return are accompanied by information about the inflation assumption used; and
3. (c) the rates presented in real terms are given greater prominence than the rates in nominal terms.

Assumptions to follow when calculating simulations: simulation date for when client will access their pension

(1) An interactive pension simulation must be calculated assuming access at the same dates used in COBS 13 Annex 2 Rule 2 2.1R for projections, unless either:
1. (a) the retail client is already accessing their pension benefits; or
2. (b) (2) applies.
(2) Following an initial simulation provided in accordance with COBS 19.13.5R(1), an interactive pension simulation may be calculated to a date chosen by the retail client at which they will access their pension.

Assumptions to follow when calculating simulations: contributions

An interactive pension simulation must be calculated on the same basis as the rule in COBS 13 Annex 2 Rule 2 2.2R, using the retail client’s current contribution level for the initial simulation, and subsequently (if relevant) using any different contribution level selected by the retail client.

Assumptions to follow when calculating simulations: inflation

(1) An interactive pension simulation must be calculated using inflation assumptions that reasonably reflect the impact of inflation over the long term and take into account relevant measures of inflation generally accepted in the United Kingdom which might reasonably apply.
(2) In relation to a standardised deterministic simulation, when incorporating inflation, a firm must ensure that:
1. (a) there is a meaningful difference between the intermediate and other rates of return; and
2. (b) the same inflation differential is used for the lower and higher rates of return required in COBS 19 Annex 7.2R(1).

(1) Firms are not required to enable a retail client to interact with the inflation assumption used in an interactive pension simulation.
(2) For the purposes of COBS 19 Annex 7.14R(1), firms should consider the most appropriate inflation rate relative to the different rates of return to avoid the risk of overstating a simulation presented in real terms.
(3) Firms should consider what measures of inflation may be relevant for the purposes of COBS 19 Annex 7.14R and determine what measure would be appropriate to use. Firms should be using a measure of inflation that is appropriate for the longer term. For example, firms could use relevant long‑term benchmarks such as the Bank of England inflation targets where appropriate.

Fees and charges

(1) A firm must ensure that any interactive pension simulation takes account of and calculates:
1. (a) all charges in relation to the personal pension scheme or the stakeholder pension scheme in the way required under COBS 13 Annex 2 Rule 2 2.6R and (where applicable) COBS 13 Annex 4 1.1R(4); and
2. (b) any additional charges of which the firm is aware, including adviser charges.
(2) Where a firm does not know the charges that would apply in relation to a particular decumulation option, the charges must be calculated based on a reasonable estimate of the charges for the relevant decumulation option.

Additional requirements: decumulation options – pension in accumulation

(1) Where the interactive pension simulation relates to a pension in accumulation, a firm must, as a minimum, provide the retail client with the ability to select, and interact with, at least:
1. (a) one lifetime income option; and
2. (b) one flexible income option.
(2) For the purposes of (1):
1. (a) a ‘lifetime income option’ means a form of regular income that is guaranteed to be paid for life, such as a lifetime annuity; and
2. (b) a ‘flexible income option’ means a form of regular income which is not guaranteed to last a lifetime, such as drawdown or uncrystallised funds pension lump sums.
(3) A firm must ensure that any lifetime income option and flexible income option it includes is consistent with the firm’s obligations under PRIN 2A.
(4) A firm must present either:
1. (a) a single decumulation option with the ability to interact with any other option(s); or
2. (b) more than one decumulation option,
3. for an initial simulation.

When a firm is determining which decumulation option to present for the purposes of COBS 19 Annex 7.17R(4)(a), it should take into account, as relevant, the following in relation to the retail clients to whom the digital pensions calculator will be made available:

(1) whether the decumulation option should be consistent with a relevant ready-made suggestion where the digital pensions calculator will be provided to retail clients who receive a targeted support service;
(2) whether, based on information already held, an option would be impossible for a retail client to take out; and
(3) any option that is included in the pension scheme contract, such as a guaranteed annuity rate option.

Firms should consider how to present one or more flexible income options in a way that enables a retail client to understand:

(1) that a pension commencement lump sum can be accessed at different times, including by being spread across the period over which pensions benefits are accessed; and
(2) the implications that different approaches to accessing a pension commencement lump sum may have for the level, timing and sustainability of retirement income.

A firm must present any decumulation option in a fair and reasonable way that supports the retail clients’ ability to:

(1) compare the different decumulation options; and
(2) understand the key differences between the decumulation options, including how long the retail client’s funds may last.

(1) For the purposes of COBS 19 Annex 7.20R for a flexible income option, a firm should consider how best to enable a retail client to understand the implications of different withdrawal rates. This may include:
1. (a) modelling a flexible income option over a period based on average life expectancy;
2. (b) enabling a retail client to select different withdrawal rates in order to understand how long their funds may last, including going beyond average life expectancy; or
3. (c) matching the level of the lifetime income option when presenting a flexible income option.
(2) A firm should consider the information a retail client may need in order to understand the implications of different decumulation options, such as the certainty of a fixed income – for example, an annuity – compared with the longevity risk that higher drawdown rates may result in funds being exhausted during the retail client’s lifetime.

Additional requirements: decumulation options – pension in decumulation

(1) When presenting an interactive pension simulation for a pension in decumulation, a firm must offer a retail client the choice of viewing and interacting with any decumulation option in COBS 19 Annex 7.17R that is available and relevant for that retail client.
(2) For the purposes of (1), the options in COBS 19 Annex 7.17R(1) should be included for the retail client to view and interact with where the options are offered by the firm or would otherwise be available to the retail client from another person, unless – based on information available to the firm – it is impossible for the retail client to pursue that option.

Additional requirements: decumulation options – guidance

(1) When presenting a decumulation option, firms should include a clear statement to retail clients that there are a range of different decumulation options and the retail client may wish to consider alternative decumulation options.
(2) Firms can include additional decumulation options to the minimum required in COBS 19 Annex 7.17R(1) where they can demonstrate that this is appropriate for their retail clients, including that it is consistent with rules elsewhere in the FCA Handbook. For example, firms can present decumulation options in combination where that interaction may support retail clients’ understanding, such as where a lifetime income option begins after a period of flexible income.
(3) Firms should enable retail clients to interact with pension commencement lump sums and any other lump sums by varying the amount of lump sum that may be withdrawn. This should include a range from zero up to the maximum lump sum permitted. Where a lump sum is presented alongside a pension annuity (or other decumulation option), the retail client should be able to see the option of taking out a pension annuity alone by setting the lump sum amount to zero.
(4) A firm should use an appropriate rate of return for any decumulation option to ensure the simulation of that option accurately reflects its potential return. For example, the rate of return that may be appropriate for a personal pension scheme in accumulation that is investing in an annuity lifestyling fund may not also be appropriate to use for a drawdown option due to a difference in the risk profiles of those arrangements.

(1) Where practicable, firms should consider using net income when presenting the different decumulation options as this can help retail clients understand the tax implications.
(2) Firms can make reasonable assumptions and/or enable retail clients to input information to inform the net income assessment.

Following the initial interactive pension simulation, firms should offer retail clients the choice of viewing a simulation for one or more decumulation options each time the retail client interacts with any of the assumptions.

Firms should consider what annuity options would be appropriate to enable the firm to present consistent decumulation options. For example, where the firm provides an inflation-linked drawdown option, it should consider whether the annuity option should also be inflation-linked.

Additional requirements: decumulation options – annuities

(1) For the purposes of COBS 19 Annex 7.17R(1)(a), where a firm includes an annuity, it must offer the retail client the ability to interact with any pension annuity type that guarantees a regular income for life and:
1. (a) is consistent with the needs, objectives and characteristics of a typical retail client of the firm; and
2. (b) would be available to the retail client (whether offered by the firm or another firm).
(2) Any pension annuity option must be calculated in accordance with COBS 13 Annex 2 Rule 3 3.1R and COBS 13 Annex 2 Rule 3 3.2R, except:
1. (a) for an in-force product with an assumed annuitisation date specified in the contract of 6 months or less, a pension annuity option may be prepared and presented on any reasonable basis; and
2. (b) a firm may calculate the higher and lower rates of return on a different basis to that specified in COBS 13 Annex 2 Rule 3.1 and COBS 13 Annex 2 Rule 3 3.2R, where the firm can demonstrate that this approach:
  1. (i) would produce rates that more closely align to the future economic scenarios associated with the intermediate annuity rate;
  2. (ii) provides an accurate reflection of expected performance at higher and lower rates of return; and
  3. (iii) is consistent with PRIN 2A, including that it will deliver good outcomes.
(3) A firm must explain, when presenting a pension annuity, that there are different types of pension annuities available, whether from the firm or another provider, that may be better suited to the retail client.

(1) A firm may provide a retail client with the option to view different types of pension annuities. Where a firm does so, it should, when determining what different types of pension annuities to include, consider which pension annuities will best support the retail client’s understanding of, and engagement with, the range of pension annuities that the retail client could obtain.
(2) When communicating annuity rates, firms should consider how they communicate to retail clients that the annuity rate:
1. (a) is uncertain and may change over time; and
2. (b) will depend on additional factors, such as the retail client’s health information.
(3) Firms should be able to demonstrate how they have considered and, where appropriate, included options for the retail client to interact with different annuity rates (high, intermediate and low) and the different types of pension annuity.
(4) The effect of (2) is that firms will need to use the formula in COBS 13 Annex 2 Rule 3 when including an annuity as a lifetime income option. Firms will need to monitor and update the annuity assumptions in line with the approach required to comply with COBS 13 Annex 2.

The effect of COBS 19 Annex 7.27R is that:

(1) for retail clients where the simulation is for a product that is more than 6 months from the assumed annuitisation date, a firm should use the approach in COBS 13 Annex 2 Rule 3 3.1R to COBS 13 Annex 2 Rule 3 3.2R;
(2) in the case of a future annuity with less than 1 year to the assumed annuitisation date, firms should not include in the interactive pension simulation an annuity rate higher than the current immediate market rate. In practice, that will mean firms need to check the formulaic intermediate annuity rate against the firm’s current annuity rate (or a market rate if not applicable) and use the lower of the two (COBS 13 Annex 2 Rule 3 3.1R(7)); and
(3) the requirement on how to calculate an annuity applies in relation to any simulation, whether for a pension product in accumulation or for one in decumulation.

Additional requirements: multiple internal pension arrangements

(1) An ‘internal pension’ is a personal pension scheme or stakeholder pension scheme that is provided by the firm providing the digital pensions calculator or by an associate of that firm.
(2) Where the output of the digital pensions calculator being communicated to the retail client relates to more than one internal pension, a firm must use reasonable endeavours, including to obtain any relevant information from an associate, to calculate a simulation separately for each internal pension in accordance with COBS 19 Annex 7.
(3) Where a firm is unable to calculate a simulation separately for one or more internal pensions in accordance with (2), the firm may calculate a simulation for those internal pensions using a rate of return that has been calculated based on any one of the internal pensions in accordance with the requirements in COBS 19 Annex 7 (and COBS 19.13) but only where this would not lead to a simulation that is misleading.

(1) Firms should use reasonable endeavours, including to obtain any relevant information, to calculate a simulation for each internal pension separately, taking into account:
1. (a) the availability and quality of underlying data; and
2. (b) operational feasibility.
(2) Where a firm relies on COBS 19 Annex 7.30R(3), it will need to hold sufficient information and calculate the rates of return and charges in line with the minimum requirements of COBS 19.13 and COBS 19 Annex 7 for at least one of the internal pensions that the retail client holds to generate an interactive pension simulation.
(3) In considering what would lead a simulation to be misleading, a firm should have regard to whether the simulation would support the retail client’s understanding. If the firm determines the simulation would be misleading, it will not be able to provide that simulation. In that situation, the firm should explain to the retail client that it does not have access to the information to do this.

When determining its approach under COBS 19 Annex 7.30R, a firm should have regard to the accuracy and reliability of the resulting outputs and how to support retail clients’ understanding of the projections.

A firm must communicate to the retail client, alongside the interactive pension simulation, the approach in COBS 19 Annex 7.30R(3) that it has used, including any material assumptions upon which it has relied, together with the limitations of the approach.

A firm must not, in relation to any internal pension where the firm has relied on COBS 19 Annex 7.30R(3), include in, or with, the interactive pension simulation any means (including the sending of an application form) by which the retail client can buy or sell an investment.

Additional optionality in digital pensions calculators: fund strategies/level of risk

(1) The rules in COBS 19 Annex 7 on rates of return require firms to provide an initial interactive pension simulation that is based on the investment potential of the underlying assets and that should reflect the pension fund and/or fund strategy of the retail client’s in-force product.
(2) Firms may provide additional options following the initial interactive pension simulation to enable the retail client to understand the impact of changing their current fund strategy.
(3) Firms that offer the additional options in (2) should ensure, in order to meet the requirements in COBS 19.13, that such options are communicated in a way that supports retail clients’ understanding, including, at least, by informing retail clients that:
1. (a) investment outcomes are uncertain; and
2. (b) if the retail client is interacting with different fund strategies, the rates no longer reflect the investment potential of their existing pension product.

Additional optionality in digital pensions calculators: holistic tools

(1) For the purposes of COBS 19 Annex 7.36R to COBS 19 Annex 7.44R, a ‘holistic tool’ is a digital pensions calculator that:
1. (a) provides an interactive pension simulation for one or more in-force internal pensions; and
2. (b) enables a retail client to add in additional retirement income streams, such as other pensions, including external pensions, additional occupational pension schemes and the state pension as well as other investments (the ‘generic components’).
(2) For holistic tools, COBS 19.13.5R does not apply to the generic components in (1)(b).

(1) For the purposes of this rule, an ‘external pension’ is:
1. (a) a personal pension scheme or stakeholder pension scheme that is not an internal pension (as defined in COBS 19 Annex 7.30R(1)); and
2. (b) a defined contribution occupational pension scheme.
(2) A firm that provides a holistic tool must:
1. (a) calculate a simulation for:
  1. (i) any external pension or any other tax-exempt investment product (other than a defined benefit occupational pension scheme) in accordance with COBS 19 Annex 7.39R; and
  2. (ii) other generic components, including any defined benefit occupational pension scheme and the state pension, on a reasonable basis; and
2. (b) enable the retail client to interact in the same way for any pensions (other than a defined benefit occupational pension scheme or the state pension) included in the holistic tool.

(1) The purpose of COBS 19 Annex 7.37R is that a simulation which includes any generic component that is an external pension or tax-exempt investment product will be based on the same rate of return as an internal pension calculated in accordance with COBS 19 Annex 7.
(2) For any other generic components, firms can apply the approach in COBS 13 Annex 2 Rule 2 2.3R, which provides for a differential in the rates applied to tax-exempt business and those applied to all other products.

Where a firm enables a retail client to include an external pension or other tax-exempt investment product in a holistic tool, the firm must:

(1) where there is a single internal pension, use the rate of return calculated for that internal pension for any external pension or other tax-exempt investment product;
(2) where multiple internal pensions are presented in a holistic tool:
1. (a) where a firm applies a single rate of return for the internal pensions, use that rate of return for any external pension or other tax-exempt investment product; or
2. (b) where the firm uses different rates of return for any internal pensions, apply to any external pension or other tax-exempt investment product one of the rates of return used for an internal pension.

In determining the rate to be used under COBS 19 Annex 7.39R, a firm must:

(1) use an approach that is fair and objective; and
(2) not adopt assumptions, methodologies or presentational approaches that would inappropriately make pensions held with that firm appear more attractive than pensions held with other providers.

Where COBS 19 Annex 7.39R applies, a firm must communicate to the retail client that:

(1) it has applied the rate for internal pensions to any external pension or, as relevant, any other tax-exempt investment product due to not having the underlying information to calculate the rates of return for that external pension or investment product; and
(2) on the basis of (1), the information provided for an external pension or, as relevant, any other tax-exempt investment product is not a reliable projected simulation for that pension product.

While the rules in COBS 19.13 do not apply to the generic components (other than COBS 19 Annex 7.37R) in a holistic tool, firms should consider their obligations under PRIN 2A, including communicating to retail clients that:

(1) the generic components being displayed do not convey or communicate a reliable projected outcome of the retail client’s investments because the firm does not have access to the underlying data for those products; and
(2) the retail client should not compare the in-force product simulation component with the generic components, such as the additional pension(s) or investment(s) that have been added in.

Where a firm provides a holistic tool, the firm must not, in relation to the generic components of the simulation, include in, or with, the interactive pension simulation any means (including the sending of an application form) by which the retail client can buy or sell an investment (including any product that is subject to a simulation calculated in accordance with COBS 19 Annex 7.37R).

The effect of COBS 19 Annex 7.43R (and COBS 19 Annex 7.34R) is that firms should not provide the means within the digital pensions calculator that would enable a retail client to directly initiate a transaction for any pension or, as relevant, other investment, where the simulation for that pension or investment is not calculated separately based on the approach in COBS 19.13 and COBS 19 Annex 7. Firms may provide products and/or services through other channels where this is consistent with FCA rules.

The guidance in COBS 19 Annex 7.35G(2) stating that firms may enable retail clients to understand the impact of changing their current fund strategy also applies to holistic tools and firms may enable this function in relation to both internal and external pensions.