The retirement income market is being choked by regulatory complexity, challenges to the life insurance business model and rapid sector consolidation, a new report from the Pensions Institute concludes.
The report argues the life office sector is dividing between those maintaining a risk-based model and those adopting a ‘capital-lite’ approach similar to asset managers. It warns that Solvency II has already held back life office innovation and cautions that a further tightening of regulation may stifle the bulk annuity market, while the individual annuity market is becoming increasingly uncompetitive and lacking in innovation.
The paper says regulation of life companies and the introduction of pensions freedoms have reduced consumer choice, with fewer drawdown products, hybrids or newer products withdrawn and annuities marginalised since 2015.
The shrinking annuity market has reduced the number of players offering annuity policies in the retail market. No longer is this business a core competency, but is rapidly becoming a specialist or niche market.
The report reiterates Pensions Institute concerns that Government policy in the retirement income market deviates from that of its peers in other countries and is working against policies, such as auto-enrolment.
Since the pensions reforms, few products that bridge the gap between flexibility and guaranteed income have been launched, while most hybrid products have been withdrawn by providers, as they did not attract sufficient business due to the additional cost of the guarantees, the report finds. Consumers, dissuaded from annuity purchase must rely on income drawdown, traditionally a stopgap product for wealthier individuals or those who refused to buy an annuity under the old regime. However, drawdown remains unproven as an effective product for the mass market and unadvised sales are being reviewed by the FCA, it says.
It concludes that while consumers essentially want with-profit products, but won’t pay for the guarantees, this situation could change in the future if gilt markets and therefore annuity rates return to historically higher levels. However the move away from life products to an asset management model means there will be fewer providers playing in the risk-based market and so it will be increasingly specialist and niche.
The report also argues consolidation of the master trust sector is accelerating, though some smaller providers may survive if they can meet the increasing regulatory requirements.
Report author Padraig Floyd says: “Policy and regulatory reforms have broken the near-monopoly of life companies in the DC market for accumulation and decumulation, facilitating the entrance and growth of powerful competitors in the master trust market. The impact of Solvency II brings into question the continued use of the life model for delivery of DC products and the asset management model makes much more commercial sense.
“The expectation is that the direct-to-customer (D2C) will be the main distribution channel in the auto-enrolment market for smaller employers. Larger employers may consider a switch to D2C in future, once the market has stabilised, in order to save costs. In the UK, Nest, along with a few other master trusts, is likely to remain the main channel for distribution to small employers, although D2C is likely to play a greater role where the asset manager sells investment products to investors that are sold outside the pensions wrapper and through other tax savings wrappers such as Isas and Lisas.”
Pensions Institute director David Blake says: “The retirement journey will turn out to be a rough one for many consumers either because the products that hedge the key risks faced in retirement – especially longevity and inflation risks – are not available or because consumers do not see or are not being advised to see their value. There is no coherence to the government’s approach to pension policy in contrast to what is happening in other OECD countries. Regulations, although there to protect consumers, are having the effect of impeding both innovation and the risk management practices of insurers.
“Platform technology which should be there to help the retirement journey run smoothly is not yet fit for purpose, despite the huge sums spent on it, and life companies, partly in response to the previous four factors, are both consolidating and moving away from traditional pension business for retail customers, leaving the real prospect that in a few years’ time there will be no private sector providers of longevity risk cover, with the state having to bail out those individuals who outlive their pension assets. The consequences for future intergenerational solidarity can only be imagined.”
Phoenix Group chief executive Clive Bannister says: “The range of retirement products available has shrunk, whilst freedom and choice has made the retirement income environment more complex for consumers. However, the majority do not seek advice and this is expected to result in sub- optimal decisions which will ultimately be detrimental to consumers.
“This pace of change is unlikely to abate, with the continued pressure from government and regulators, as well as the yet unknown impact of Brexit. What is clear is that the life sector will continue to evolve to react to these challenges, but for that evolution to be successful, clarity of understanding of market conditions, regulatory risk and government policy together with a clear vision for the future is essential.”
Retirement Advantage pensions technical director Andrew Tully says: “We share the concerns of the Pensions Institute and Cass Business School over the lack of informed choice being made by over 50s about their retirement finances and the risk this poses of retirees running out of money in retirement.
“There is evidence of a strong correlation between receiving advice and shopping around for the best retirement income product, so the fact that so many customers stick with their existing provider, whether purchasing an annuity or drawdown, is extremely worrying. Our analysis of industry data for the first two years of pension freedoms shows that those who fail to shop around for an annuity will collectively miss out on £765m of income over the course of retirement. Meanwhile we calculated that each individual using drawdown without shopping around could lose £12,000, equivalent to three years income.
“However, research we’ve conducted in the two years since pension freedoms were introduced shows that the majority of over 50s are not planning to go to a professional financial adviser for information on their retirement finance options. Internet research is consistently the most commonly chosen option by those approaching retirement. In 2015 this was followed by professional financial advice, but since August 2016 has been overtaken by the Government’s Pension Wise service. Turning to their current pension provider has repeatedly been the fourth most commonly chosen option.
“Interestingly, our research suggests that those approaching retirement would welcome tougher rules around shopping around. In August 2016, 68 per cent of over 50s agreed that people approaching retirement should have to shop around for retirement finance products rather than simply buying a product offered by their current pension company, with only 9 per cent disagreeing.”