The flawed logic of investment pathways

The delay in implementation due to COVID-19 gives the FCA a perfect opportunity to reassess the investment pathway rules, says Martin Jones, Technical Team Leader at AJ Bell.

In July 2019, the FCA published Policy Statement PS19/21, in which it set out its new rules for non-advised drawdown customers.

These rules introduced ‘investment pathways’, a framework to help non-advised customers make better investment decisions in drawdown. On a drawdown-to-drawdown transfer or when designating to drawdown, the customer will be offered the choice of keeping their current investments, picking new ones or choosing one of four investment pathways.

1. I have no plans to touch my money in the next five years.
2. I plan to use my money to set up a guaranteed income (annuity) within the next five years.
3. I plan to start taking my money as a long-term income within the next five years.
4. I plan to take out all my money within the next five years.

Depending on which option the customer selects, they will be offered a pathway investment fund correlating with that outcome.

These rules are in part the FCA’s response to the pension freedoms introduced in 2015. It was concerned that too many customers going into drawdown were sitting in cash and not engaging with their investments, and it wanted customers to have easy access to investment solutions appropriate to their needs in drawdown.

While this mainly affects non-advised customers, financial advisers and their customers are not fully exempt. Advisers who are advising clients on their drawdown investments will have to explain why their recommended investment is better than the pathway investment fund the client could have picked.

Furthermore, if the adviser did not give the client a personal recommendation on the transaction to move into drawdown within the last twelve months, the client must be taken through the investment pathway process.

While these rules are certainly well-intentioned, the logic in the solution is questionable. Earlier this year, the FCA announced that implementation would be delayed until February 2021, and this offers an ideal opportunity for the FCA to rethink.

First, there is a risk that the pathway investment solutions may not offer enough diversity and will not take into account a customer’s risk profile. If the FCA were to review the investment pathway rules, these are issues that need to be addressed.

Just as importantly, however, the FCA needs to acknowledge the difference between insured pensions and SIPPs or platform pensions (and the customers that use them).

With an insured pension, customers are less likely to be engaged with their investments, having made no real investment choices when they come to take drawdown. At this point, they often believe they are moving into a brand new product.

That’s not the case with SIPP customers who, long before the time comes to access their pension, are likely to have a portfolio of investments they have been managing for years. They are more likely to view drawdown as a feature of the SIPP rather than a new product. So, two sets of customers with very different investment journeys.

None of this is to say that a default investment solution is a bad idea. But it is a prescriptive one – outlining the exact course that providers have to follow even if it makes no sense for their customer base or how their processes work.

If the issue is with customers in insured pensions taking their 25% tax-free cash and forgetting to invest the remaining 75%, then perhaps a solution could be as simple as the FCA challenging those insurers on the grounds of managing risk and avoiding poor customer outcomes.

There may be other solutions out there, but pushing customers into a single investment based on one ambiguous question and with no account for risk appetite does not feel like the right one.

This article was previously published by Professional Paraplanner