DC workplace pensions will soon have to offer default retirement solutions that provide an income to members, under measures set out in the Pension Schemes Bill, currently making its way through Parliament.
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It is clear that the policy drive behind this is to ensure these tax-advantaged savings are used to deliver income throughout retirement, and to help improve outcomes for members — many of whom struggle with the complex financial choices they face at retirement in the wake of pension freedom rules.
These default options are likely to be mandated within three years. At a recent roundtable event to discuss this initiative, providers and leading advisers met to discuss what these new solutions might look like, and how they might work in practice.
Stephen Coates, head of proposition at Mercer Workplace Savings, outlined the challenges for the industry with these default retirement options, particularly the “thorny issue” of the requirement to offer an income element.
“Suffice to say, it is complicated. We’re looking to build a solution that meets the requirements of the Pension Schemes Bill. The first requirement will be to provide an income, ideally for life. But there is some debate as to what this longevity protection means, but we’re working on the basis that it means your money mustn’t run out.”
Coates said it remains to be seen whether such default options will be a “hygiene factor” — a solution providers offer as a last resort for members who fail to engage at all with decision-making around retirement — or whether defaults will be the go-to option, and drive innovation and differentiation in this sector.
Advisers at the event were hopeful these new requirements might spearhead more innovation in the retirement space, with many critical of the progress that has been made to date.
Barnett Waddingham partner Andy Parker pointed out that pension freedom rules have been in place for around a decade and it is taking “a disappointing amount of time for solutions to come to market.”
“Providers seem to have latched onto the idea of ‘flex and fix’ and this is certainly flavour of the month right now,” he said. “There’s a bit of a herd mentality at present, with seven or so ‘unique’ offerings out there. Everyone seems to be claiming the concept is brand new and they’re the only one to adopt it.”
Muse Advisory associate Paul Armitage, who leads its DC advisory team, agreed that “flex and fix seems to be everywhere”.
He pointed out that some providers in the US are taking a different approach. “US providers acknowledge that consumer engagement is incredibly hard and think automation is the answer to a lot of this. But in the US they are looking at partial annuitisation from the start.”
Armitage said it was striking that UK providers aren’t pioneering similar approaches, particularly for those with larger pension plans. “It is surprising that the architecture of these solutions is not more differentiated here,” he added.
But other advisers said they expect to see more innovation coming through. “Obviously there’s not full clarity yet on what the final rules will be,” said WTW director Mark French. “Nobody wants to invest significant sums developing something for it to fall foul of the final rules.”
He also said that there was a degree of variation within this ‘flex and fix’ model. “There are different solutions, in terms of the liquidity of these different ‘pots’ and when the deferred annuitisation kicks in, and what choices members have at that point.” He said these solutions could also dovetail with future developments in the CDC market.
Hymans Robertson head of DC provider relations Shabna Islam said: “I’d like to see providers developing solutions that cater to their own membership, rather than a one-size-fits all option that operates across the industry. I think more tailored options would be great.
“But I do think regulation is going to have a big influence here. Providers may wait until they see what the final regulations look like before developing and launching their own solutions.”
Coates said: “To draw a comparison, we could see a situation where all providers offer a ‘bolognaise sauce’ option, but everyone has their own secret recipe.” He added that while there will be a range of retirement options for members, “when you sit down and think about a default solution, you realise ‘flex and fix’ will be appropriate for many people.
“There might be differences relating to the underlying products, but do you need to differentiate substantially on the architecture of this default?” he asked.
CDC revolution
One area where advisers think there will be scope for more significant variation is collective defined contribution — particularly if retirement-only CDC becomes an option.
Advisers said providers seem to be taking divergent approaches with regards to CDC, although most agreed we are a long way from commercial solutions being launched into the workplace market.
However, many of the advisers thought this could be an innovative income option — particularly for providers whose profile involves many members with smaller DC pots, who may be less engaged and more at risk of outliving their savings.
Parker said: “This is one area where there’s less of a herd mentality, but it’s hard to gauge what will happen here as we are still at the early stages. We talk to one big provider and they say it’s not for us, then the next provider says this is the only way to offer a default retirement income solution, then the next provider says it’s not for us again. It’s hard to tell who is right.”
Targeted support
Another area of discussion was how default retirement income solutions might work with the new targeted support proposals. Targeted support is designed to offer a third way between full-fat financial advice and guidance, allowing providers to offer products and solutions to consumer cohorts sharing certain key characteristics.
Many at the event felt that targeted support could nudge people towards better retirement options, particularly those who currently don’t engage with what can be complex decisions.
French said: “This could nudge people into making better choices. Perhaps outside of a default investment solution you may be able to direct people towards a range of retirement solutions, perhaps targeted towards more cautious, balanced or adventurous options.”
Coates said he could see a default income solution being, to some extent, the targeted support option in the retirement market.
This led to a discussion as to whether there needs to be greater focus on improving engagement and encouraging more people to take advice, rather than delivering product solutions. Many thought this could be a better way to improve member retirement outcomes.
Isio DC pensions consultant Thomas Chalkley said: “What might set a product apart is the support that’s wrapped around it.” He said offering more effective support to members could “change the dial on how we evaluate and rate providers, particularly if this is integrated back into the accumulation journey.”
One of the questions asked was whether providers might take account of an individual’s wider financial situation, for example if they were a homeowner or renter, their postcode or health facts, when signposting them to different retirement pathways or default solutions.
XPS head of DC investment Mark Searle said he did not expect these wider data points to be taken into account initially.
Mercer’s head of engagement Tom Higham said: “I think looking at those wider issues moves us from targeted support into personalised advice quite quickly. With targeted support, the industry will adopt some relatively safe starting positions to begin with.
“A lot of this will be around more targeted communications at key times to certain demographics, where we can signpost particular products or solutions. This has been happening already, but we will be able to take it a little further with targeted support.”
Coates gave an example of how this might work in practice: identifying members of a workplace scheme who are not taking advantage of a matching scheme, and sending communications that highlight the benefits of increasing contribution rates. Currently employers and providers may have been hesitant about sending more personalised communications suggesting people pay more into pensions, due to concerns about crossing the guidance/ advice boundary.
Parker said he’d like to see a more radical approach. “We have to find new ways to engage with people, so maybe we’ve got to focus more on how to drive people towards advice options. Perhaps you could pay people to seek advice, rather than them paying for this service. Or say that they can’t have money from their pension until they’ve had an advice session. We need to think differently and try new ways of doing this, rather than building more tools that people often don’t use.”
Coates agreed that advice remained the ‘gold standard’, and providers like Mercer were looking at more bespoke solutions, particularly given their more affluent customer base.
Default definitions
There was also discussion about what the term ‘default’ might actually mean in the decumulation space. When it comes to accumulation, default investment strategies can suit larger cohorts who don’t have to engage at all with their pensions.
Higham said: “When it comes to retirement, the default is more likely to be a backstop that automates some of the decision-making, and takes it out of the member’s hands. You remove some of the risk of poor decision making if they are not willing to go down the advice route.”
Coates pointed out that this is different from people making no decision at all. “There aren’t people who’ve stopped working, need income, and don’t touch funds in their pension. That’s not the fundamental problem here. People are making decisions, but they might be the wrong decisions in some cases: cashing in pension funds too early, paying unnecessary tax on withdrawals, and keeping money they don’t need for day-to-day spending in bank accounts with zero long-term growth.
“People are saying give me my money, but they are not making any decisions beyond that. This is the key issue I think default retirement solutions need to grapple with.”
For this reason, Coates, and many others on the panel, said a default solution is likely to be a ‘last resort’ option.
Those on the panel agreed that a default retirement solution needs to be primarily focused on delivering income, but there was a degree of concern about how providers can move people automatically into an annuity or other income product that is essentially non-reversible.
Finding a product that can provide income in the short term while maintaining a degree of flexibility will be a key challenge of this initiative and it remains to be seen how CDC fits into this mix. .
Those on the panel agreed that this whole area remains fraught with complexity. Most want greater innovation in the retirement space, not only when it comes to default retirement options but wider access to more affordable advice services.
Advisers said policy initiatives in this area are unlikely to be a silver bullet, but they remain hopeful that current proposals being developed will help more people to make better choices at retirement.
