Drawdown governance service – Q4 2021 update to income sustainability scores

16 March 2022
The income sustainability scores for Q4 2021 have now gone live. Here’s an update on what’s changed.

Market review

Global markets since the last DGS update in November have been driven by a few key factors. Continued rising inflation was seen early in the quarter and uncertainty around interest rate rises remained. This combined with impacts from the Russian Ukraine conflict meant markets saw a volatile few months.

The end of Q4 saw headline CPI in the UK rise by around 5% year on year and around 7.5% in the US. Unpredictability about how central banks would react to restrict rising inflation were priced in by the market. Rate rises were ultimately seen in the UK, with an increase from 0.25% to 0.5% and several increases are expected to happen in the US over this year.

Equity markets continued its post-pandemic rebound from Q3 initially, although concerns around rate rises were seen soon after. An increase in rates reduce in the value of future earnings and this was translated as global equity markets fell. In recent months, global equity markets took a further tumble as reports of the Russian invasion came to light and Europe began its financial sanctions in response.

The inflationary environment has detracted demand for bonds where investors prefer the real income from other assets. Poor performance in bonds held was partly seen by the increase in short and long-term yields. Longer term bonds were hit harder as they’re more sensitive to rate rises.

The year closed with another strong quarter for commodities as the world transitioned out of covid lockdowns and in recent months, supply constraints in the energy sector added to an increase in prices. The exposure to commodities and property has cushioned the fall in equity and bond performance.

Royal London Asset Management’s (RLAM) Multi Asset team have taken some profits seen from commodities and equities over the year and reduced overweight positions in both asset classes. Increases to cash and fixed income assets were also seen in the latest tactical change, reducing their overall underweight position.

RLAM’s investment experts continue to monitor the situation in Ukraine and provide oversight on adjustments to the mix of investments to manage the impact of short-term drops. Recent volatility highlights the importance of tools like the drawdown governance service in supporting client conversations about the long-term sustainability of their income plans and investment choices. It may also highlight the need to re-evaluate client risk appetite and capacity for loss.

Drawdown governance service (DGS) model update

This quarter’s model calibration shows similar or lower scores for most customers with lower sustainability. A further fall in scores will be seen by most customers due to a fall in fund values since the last update.

How are the DGS ratings calculated?

Here’s a reminder of how the income sustainability scores are calculated:

  1. Nominated sustainability score – what’s the customer’s score relative to their nominated ‘target’?
  2. Investment performance – have the customer’s investments outperformed inflation?
  3. Annuity rates – how have market annuity rates changed?
  4. Income plan – has the customer taken more or less income than initially discussed with you?

These factors work together every quarter alongside the Moody Analytic’s assumptions to give you and your clients an idea of whether their income sustainability is still on track or needs some attention.

Setting a reasonable income relative to your client’s investments is one of the key aspects of investing through drawdown. Our financial planning tool is useful in helping model different income scenarios and helping drive discussions when planning an income through retirement.

The underlying assumptions for the financial planning tool have also been updated this quarter.

What does this mean for DGS and income sustainability scores?

This quarter’s calibration shows similar or lower income sustainability scores for most clients.

Annuity rates have been edging higher through the year although are still very low. The buying power for income for life (taking an income then buying an annuity) clients hasn’t changed much which means income for life and income to age (taking an income to a selected age) should see similar movements in scores this quarter.

Our houseview

Our current view is that a 3.5% withdrawal rate is highly sustainable.

Our ‘houseview’ represents our current opinion on what would be a sustainable level of income for someone aged 65 just starting out in drawdown. Just starting out in drawdown is important here as the houseview doesn’t capture the impact of recent market turmoil on the value of pension savings and assumes that the individual is looking to use these savings to start drawdown over 25 years, investing in GRIP 3 with a yearly charge of 1%.  We haven’t adjusted our view this quarter and continue to believe that 3.5% income over 25 years is highly sustainable.

This may seem low, but the value of the DGS is its ability to provide visualisation on the impact of not just current market conditions, but also fund performance and actual client income levels on sustainability scores. Ideally, this means you and your clients can responsibly adjust income levels to reflect the wider economic environment and ensure they maximise the likelihood of sustaining income throughout retirement or until annuity purchase.

  Nominal Income %
15 100.0% 100.0% 100.0% 100% 100% 100% 98% 93% 82%
20 100.0% 100.0% 100.0% 100% 96% 87% 71% 46% 26%
25 100.0% 100.0% 98% 91% 77% 55% 31% 15% 6%
30 100.0% 99% 91% 76% 52% 30% 13% 4% 1%
35 100.0% 94% 82% 58% 34% 16% 6% 2% 1%

 All values calculated using a 1% AMC and using GOVERNED RETIREMENT INCOME PORTFOLIO 3

Key: 85%+ Highly sustainable  75 - 84% Quite sustainable  50 - 74% Barely sustainable  0-49% Not sustainable

Further information 

If you have any questions or would like more information speak to your usual Royal London contact. If your clients have any questions they should contact Servicing Team to discuss.

This website is intended for financial advisers only and shouldn't be relied upon by any other person. If you are not an adviser please visit royallondon.com.

The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.