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Feedback Statement and Impact Assessment - AS TM1: Statutory Money Purchase Illustrations (February 2025)
The FRC does not accept any liability to any party for any loss, damage or costs howsoever arising, whether directly or indirectly, whether in contract, tort or otherwise from any action or decision taken (or not taken) as a result of any person relying on or otherwise using this document or arising from any omission from it. The Financial Reporting Council Limited 2025 The Financial Reporting Council Limited is a company limited by guarantee. Registered in England number 2486368. Registered Office: 8th Floor, 125 London Wall, London EC2Y 5AS
Executive Summary
1The Financial Reporting Council (FRC) consulted in November 2024 on not making any amendments to Actuarial Standard Technical Memorandum 1 ('AS TM1') v5.1 based on a review of market conditions as at 30 September 2024.
2The FRC received eight written responses to our consultation, which were mainly from pension consultancies. This executive summary draws out the key areas in which feedback was provided.
Proposal not to amend the assumptions in AS TM1 v5.1
3Most respondents agreed with the proposal to make no amendments to the assumptions in AS TM1 v5.1 as a result of our annual review.
4A small number of respondents suggested to either:
- increase the upper accumulation rate assumption to allow for significantly higher return expectations for some asset types; or
- increase the number of volatility groups, to allow a smaller difference in the accumulation rate assumptions between volatility groups.
5As the majority of feedback was supportive of the proposal not to amend the assumptions in AS TM1 v5.1 at this annual review, the FRC has finalised this proposal and AS TM1 v5.1 will remain effective from 6 April 2025.
Other areas of feedback
6A number of respondents commented on known limitations of the use of volatility groups to determine accumulation rates for defined contribution investments, for example highlighting that certain funds, including index linked gilts, could be in volatility group 4 but this was not representative of reasonable long-term expected returns for these funds. Some respondents commented on the impact of potential different interpretations of the 'date calculation is performed' as referenced in AS TM1. The FRC addressed these two issues in the feedback statement published in February 2024.
7Although the FRC is not currently reviewing the volatility-based approach in setting the accumulation rate assumptions, which was introduced in AS TM1 v5.0 with effect from 1 October 2023, we intend to engage with the industry later this year to gain a better understanding of the issues raised in the consultation responses, as part of our ongoing effort to take into consideration our stakeholders' views.
Introduction and background
1The FRC is the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. The FRC is responsible for setting Technical Actuarial Standards in the UK.
2Since 6 April 2003 money purchase pension arrangements have been required to provide members with Statutory Money Purchase Illustrations (SMPIs). These illustrations are governed by the Occupational and Personal Pension Schemes (Disclosure of Information) Regulations 2013 as amended. Legislation requires that statutory illustrations be produced in accordance with guidance prepared by a prescribed body approved by the Secretary of State for Work and Pensions and by the Department for Social Development in Northern Ireland.
3The FRC has been the prescribed body since 6 April 2007 and fulfils its obligations through the publication of Actuarial Standard Technical Memorandum 1: Statutory Money Purchase Illustrations (AS TM1). AS TM1 specifies the assumptions and methods to be used in the calculation of statutory illustrations of money purchase pensions, also known as defined contribution pensions.
4Providers' point of sale and ad hoc projections are subject to the assumptions set within the Conduct of Business Sourcebook (CoBS) chapter 13, issued by the FCA.
5Following publication of AS TM1 v5.0 in October 2022, in the accompanying feedback statement, the FRC noted its intention to review the appropriateness of accumulation rate assumptions and volatility group boundaries annually based on 30 September data.
6The FRC issued a consultation paper in November 2024 to propose no amendments to AS TM1 v5.1, based on a review of market conditions as at 30 September 2024. Alongside this, the FRC published a technical analysis underlying this proposal. The consultation closed on 7 December 2024. This paper provides a summary of the feedback received and sets out the FRC's response.
Summary of Responses
Responses to the public consultation
1The FRC received eight written responses, which have been published on the FRC website. The table summarises the number of responses by respondent type and a list of respondents is set out in Appendix 1.
| Category of Respondent | Number |
|---|---|
| Industry bodies | 2 |
| Consultancies / professional services firms | 5 |
| Individuals | 1 |
| Total | 8 |
2Respondents were broadly supportive of not amending the assumptions in AS TM1 v5.1 at this time. Although not the subject of the consultation, the majority of respondents also commented on the method used in AS TM1 to determine the accumulation rate and the reference to the date the 'calculation is performed' in paragraph C.2.8.
3In this section we summarise the points raised in written submissions and provide comment on the FRC's position.
Question 1: Do you agree with the FRC's proposal not to amend the accumulation rates in AS TM1 v5.1 at this annual review? If not, what alternative accumulation rate do you think would be appropriate for this group? Please provide supporting evidence for any alternative view.
4Seven respondents answered this question. Six of these agreed our proposal not to amend the accumulation rates in AS TM1 v5.1.
5One respondent suggested that the highest volatility group should have a higher accumulation rate, noting that for private equity assets the respondent expects a median return of c12% p.a. for the next 20 years based on their own analysis. The respondent did not specify whether this be achieved through adding additional volatility groups or by increasing the accumulation rate for volatility group 4.
FRC response
6In determining the accumulation rate assumptions, the FRC takes into account a number of considerations such as backward-looking data-driven analysis, judgement-based forward-looking analysis, and benchmarking against third-party assumptions.
7One of the considerations 1 is whether, given inherent uncertainty in predicting the future and limitations of the models and data, it is appropriate to introduce a degree of prudence. As set out in paragraph 2.7 of our consultation paper from our 2023 review of AS TM1 assumptions, the FRC considers increasing the accumulation rate assumption above the current 7% could risk providing overly optimistic pension illustrations to users of SMPIs, which could lead to users making inappropriate assumptions about the sufficiency of their pension savings, noting that it may be more difficult for a user to increase contributions in later life to make up for any shortfall.
8Further, our benchmarking exercise on the long-term return assumptions in third party capital asset pricing models ('CAPM's) for the various asset classes shows that, as expected there is a wide range of expected returns used across higher-risk asset classes, such as various types of equity, and whilst 7% p.a. is on the more prudent end, an expected return of 12% p.a. would be an outlier.
9As the majority of responses are supportive of the proposal, the FRC has not made amendments to the accumulation rates assumptions in AS TM1.
Question 2: Do you agree with the FRC's proposal not to amend any of the non-accumulation rate assumptions? If you think they should change, what changes do you consider to be appropriate? Please provide supporting evidence for any alternative view.
10Eight respondents answered this question. Six of these agreed with the proposal not to amend any of the non-accumulation rate assumptions.
11The remaining two respondents recommended introducing additional volatility groups and hence reduce the size of the difference in accumulation rate assumptions between adjacent volatility groups. This was suggested to reduce the change in accumulation rate when a fund moves from one volatility group to another, and to reduce the difference in assumed returns between funds that may have very similar volatilities but fall in different volatility groups.
FRC response
12As the majority of responses are supportive of the proposal, the FRC has not made amendments to any of the non-accumulation rate assumptions in AS TM1.
13The FRC acknowledges the suggestion of increasing the number of volatility groups and the desire to reduce the step change in the assumed accumulation rate when the fund moves from one volatility group to another. It is the FRC's policy to carry out periodic reviews of all the standards it sets to ensure they continue to be fit for purpose, and the FRC will consider this suggestion at the next full review of AS TM1. We also note that the method set out in AS TM1 (as per C.2.12) allows for a movement of 0.5% above/below the volatility group boundary before an investment changes group. This corridor around the boundary of the groups is designed to help reduce idiosyncratic fund movements.
Question 3: Do you agree with the conclusions in the impact assessment? If not, please give reasons for your response.
14Six respondents answered this question. All six of these respondents agreed with the impact assessment.
FRC response
15Given above, the FRC regards the Impact Assessment as set out in the consultation paper remains valid.
General comments
16In addition to responses to questions asked in the consultation, the majority of respondents also made comments on the wider aspects of AS TM1.
17Seven respondents raised concerns over the suitability of using a fund's volatility to assign an accumulation rate assumption (the volatility-based approach):
- resulting accumulation rates sometimes appearing anomalous for the fund type, for example index-linked gilt funds in some cases being placed in the highest volatility group and therefore having a higher accumulation rate than some emerging market equities funds;
- a lack of suitability for infrequently-priced assets, such as illiquid assets, where the volatility group may understate potential expected returns; and
- a lack of consistency with other regimes such as CoBS 13 issued by the FCA.
18A number of these respondents made suggestions for amendments to AS TM1 to address the concerns they raised on the volatility-based approach. These broadly fall into two categories a) to replace the volatility-based approach with an approach which assigns accumulation rate assumptions based on the type of assets held in a fund; or b) to make adjustments to the volatility-based approach to reduce the impact of some of the above issues.
19Five respondents commented on the reference to the date the 'calculation is performed' in paragraph C.2.8 and in the effective date of AS TM1 v5.1, highlighting the potential to take different interpretations of this date, and that it may be inconsistent with the 'illustration date' referred to elsewhere in AS TM1.
20One respondent made a number of suggestions for a review of the effectiveness of AS TM1 in anticipation of projections under AS TM1 being shown on pension dashboards. This included recommendations to consider:
- the degree to which AS TM1 has achieved consistency in how defined contribution (DC) pension benefits are projected; and
- the impact of assuming a level annuity is purchased in retirement, and the potential inconsistency with illustrations on dashboards of defined benefit (DB) pensions (which will largely be inflation-linked).
FRC response
21As noted in paragraph 1.4 of the consultation paper, this consultation relates to the annual review which focuses on the appropriateness of accumulation rate assumptions and volatility group boundaries. The FRC is not currently reviewing the general approach of setting accumulation rate assumptions based on an investment's 5-year volatility of monthly returns, which was introduced in AS TM1 v5.0 with effect from 1 October 2023.
22The FRC acknowledges these concerns and recognises that the complexity involved in the consideration of change in approach adopted in AS TM1 and the relative trade-off between different criteria such as consistency of the projections produced for different providers, reliability of the projections, stability of projections over time, practicality of implementation, and implementation costs of a change in the standard. We will consider these concerns and suggestions as part of the next full review of the methodology underlying AS TM1.
23We set out a summary of our responses below, noting that a fuller response can be found in previous feedback statements.
24The comments outlined in paragraphs 17 and 18 above were raised at the time the FRC consulted on introducing the volatility-based approach in AS TM1 v5.0. The FRC addressed the limitations of the volatility-based approach in the feedback statement to this consultation, published in October 2022, in particular:
- in paragraph 5.44 of the feedback statement we acknowledged that index-linked gilts may have a weaker connection between volatility of monthly returns and expected future returns. But we noted that index-linked gilt holdings are a relatively small proportion of DC fund investments, and this is particularly true for savers further from retirement where the accumulation rate has the most significant impact on the pension illustrations. We therefore considered this limitation to be acceptable and acknowledge this in paragraph 4.11 of our latest Technical Analysis noting our research which will aid our understanding the impact of this issue on SMPIs;
25as set out in paragraph 5.91 of the feedback statement, and in the guidance to AS TM1, the standard allows volatility group 3 to be used for unquoted assets. While this may be lower than the expected returns for some illiquid assets used for pension savings, we believe it continues to be pragmatic and simple approach considering the range of illiquid investments that may be held currently, although we would revisit this assumption in a fuller review of AS TM1 if the proportion of illiquid investments held changes; and
- paragraphs 5.19 to 5.24 of the feedback statement set out the limitations of the proposed alternative of an asset-class based approach for setting accumulation rates.
26The comments outlined in paragraph 19 above were raised in the consultation on the introduction of AS TM1 v5.1 in 2023. As set out the feedback statement to the November 2023 consultation we are comfortable with the approach where providers interpret the 'date calculation is performed' to be the same as the 'illustration date', and noted that it is possible to take a different interpretation whereby the 'date calculation is performed' is different to the 'illustration date'. The FRC considers it inappropriate to amend C.2.8 to refer to 'illustration date' at this stage of the process without further consultation or outreach.
27The FRC intends to engage with the industry later this year to gain a better understanding of the issues raised in the consultation responses, as part of our ongoing effort to take into consideration our stakeholders views.
Impact Assessment
1Based on a review of market conditions as at 30 September 2024, the FRC considers that the assumptions in AS TM1 v5.1 continue to remain appropriate and we have not made any amendments to AS TM1 v5.1. This will avoid the potential costs for providers associated with changes to the assumptions used in calculating SMPIs.
Appendix 1 – List of respondents to consultation
The FRC received 8 written responses to the consultation, which are published on the FRC website. The respondents were as follows:
- The Association of Consulting Actuaries
- Dominic Lindley
- Gallagher
- Hymans Robertson
- Isio
- Mercer
- Pensions and Lifetime Savings Association
- Willis Towers Watson
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Technical analysis paper October 2022: AS TM1 – Accumulation Rate Assumptions paragraph 7.1 ↩