Millions of savers have been brought into the pension system thanks to a successful auto-enrolment strategy that has relied on the power of inertia. But while workplace defaults have proved to be a very effective mechanism for building pension savings during the accumulation stage — consensus is growing around the idea that this disengaged approach is increasingly less appropriate as savers near retirement.
At a roundtable event hosted by Corporate Adviser last month, consultants and providers debated how to address this and other conundrums facing retiring DC savers, and what the industry should be doing to help improve outcomes for members in retirement.
One central area of debate was whether more innovation and personalisation was needed around defaults, with more bespoke glide paths targeting different retirement needs. Aegon director, consultant and adviser relationships, Martin Trenchard said: “The default approach works really well for the occupational phase but nobody wants a default retirement.”
Pension freedoms have given people far more choice, he said, but this has led to inevitable complexity. “I was struck by recent comments from Richard Thaler, a Nobel Prize winner in economic sciences, who said that when people are asked to solve their own retirement savings issue, it is like being asked to build their own car.”
Retirement conundrum
He described savers as having to negotiate a “maze of complexity” when it comes to assessing different retirement options — and not surprisingly many simply end up sticking with the default pathway offered by their pension scheme.
At present, many will be in ‘lifestyle’ funds where there is a de-risking of assets as individuals approach a pre-set retirement age. But those at the debate pointed out there was a huge variation in how providers approached this, with some de-risking over five years and others taking a 10 year or longer glidepath.
Willis Towers Watson director, retirement support Anne Jones said that these glidepaths will also be targeting very different outcomes: some may be assuming savers will stay in drawdown post retirement, others target an annuity purchase or cash. This will affect the mix of assets as well as the derisking glidepath.
Differences in these approaches were certainly highlighted last Autumn when turmoil in gilt markets saw schemes with high bond exposures suffer particularly significant losses. In many cases this meant that those closer to retirement suffered heavier falls than younger savers, in supposedly higher risk assets.
Those on the panel said the key was ensuring that individuals were in a glide path that matched their retirement needs, but this requires far better engagement with members to ensure they are in an appropriate product.
Could providers use existing data on members — with information on salary, savings levels, and age — to ‘predict’ likely retirement choices and offer a more tailored glide path? It was noted that the default offered by workplace pension provider Irish Life already offer similar bespeaking in the Republic of Ireland, although the pensions landscape is subtly different there.
Jones said that the challenge with this approach is knowing what other pensions or other assets members have. “Providers have no real oversight. They may have a £5,000 pot, and the assumption would be that they are likely to cash that in. But then they may have substantial funds elsewhere, or lots of pots and they will consolidate to keep invested in drawdown.”
Personalised route
Offering a more tailored approach without this oversight could potentially be misleading she said, although Jones added that the dashboard — when it eventually arrives — should give a better understanding that could help facilitate a more bespoke approach.
Punter Southall Aspire managing director of employee benefits consulting Gavin Zaprzala-Banks argued that engagement remains the top priority. “We talk about education a lot but engagement is the key battle we need to win.
“The reality is there are 10 to 12 million savers who are totally disconnected from this pension they are building. They are not asked any questions, or for any input. They are defaulted into a retirement fund at a contribution level with a retirement age that they haven’t selected. Asking questions about what people are planning to do with this pot of money and what their plans are would be a step in the right direction.”
One option could be to effectively require members to make a decision, say five years from retirement, which would determine which glide path they went into. However advisers said many people would find this decision difficult. “If you ask people five years out whether they are planning on taking flexible benefits or an annuity you are probably not going to get much response,” said Gallagher benefits consulting director Jason Cannon. “There’s got to be a way that we engage people to make a conscious decision, but it is about getting the language right.”
When to engage
Advisers were divided on the issue of when to start the engagement process. Cannon said he was “conflicted” about the value of this engagement at a very early stage, pointing out that inertia was helping people on the accumulation journey, and with the current cost-of-living crisis there was the danger that more engaged savers simply choose to opt out of AE and use the money elsewhere, which could prove counter-productive in the long run. People aren’t saving enough for retirement, he said and this could make the problem worse.
Communications revamp
Changing the way the pensions industry communicate with members would help, said advisers. Cannon pointed out that people don’t understand the terminology around annuities, drawdown or flexible retirement options, and added that communications from providers need to reflect the reality of retirement today.
Cannon said: “The cliff edge between work and retirement has gone. That old
model where people were in education, then work, then retirement has changed.
It is now a lot more flexible and this
should be reflected in how people plan
for their retirement.”
Jones added: “I don’t think I have ever seen any member education that talks about deciding how to retire gradually, or that explains you can take your retirement savings in stages.”
Most people don’t know that they can take 25 per cent of each drawdown withdrawal tax free, she said, as opposed
to taking one lump sum. Similarly, many don’t realise they can still continue to
make pension payments (with the higher MPPA allowance) even if they have taken some benefits.
People may be taking benefits to tide them over to the state pension kicks in, but then reducing this again, or may want to explore the option of a fixed-term annuity. “I think the language we need to use needs to match what we are seeing people doing,” she said.
Zaprzala-Banks said that regulatory requirements around pension communications were not helping, adding current statutory money purchase illustrations (SMPI) were “a big turn off” for most consumers.
“It’s just not the right document. If you were building our industry today from scratch you would not have an SMPI as your main point of contact with the member. You would simplify this and move away from using the language of assumptions, of projections, of annuities and percentages. We know we have a huge issue in the UK with financial illiteracy and all these things are barriers and stumbling blocks that are blocking engagement because when this document comes through the letter box or pings into their inbox it just gets put in the bin or deleted.”
What would more effective communications look like? Origen director, proposition and marketing Mike Morris said that paper statements and email can only go so far. “Getting people in a room, discussing the challenge, and talking through different solutions can be far more effective.”
Morris added that a ‘people like you’ approach to contributions and pot size could help. “Is there a way using the data we have to say to a 50-year old, ‘look, you are behind average at present, compared to scheme members on a similar income profile or age’. Would this act as a spur to action, would it engage people more?” he asked.
Barnett Waddingham principal and actuary Sam Underhill warned there was a risk this could have the opposite effect and cause further disengagement. “We can see it at present with some SMPIs. People look at these statement, based on their 8 per cent contributions, and think ‘this is terrible, I’m never going to save enough for retirement’.”
But Cannon said that there were encouraging signs from the industry that communications were becoming more personalised.
Trenchard pointed out that Aegon has pioneered video statements — which again are personalised. “These video summaries are three minutes long and personalised to you. They refer to the scheme you’re in, the contributions you’re making and the fund you have built up, without any technical jargon. We find 80 per cent of members that watch, watch it to the end and 60 per cent take action based on this video. This is sent out before the pension statement and we find people are more engaged with these statements after watching the video content. It’s enabling the individual to digest the information through the channel or the mode that works best for them, and at a time that suits them.”
Regulatory obstacles
Delegates agreed that pensions’ communication and engagement challenge is hampered by a complex regulatory structure, which sees different rules applied to trust- and contract-based regimes.
Aegon public affairs director Steven Cameron pointed out that under FCA rules, contract-based workplace pension schemes must send out ‘wake up’ packs to members at the age of 50, to try to get them engaged with pension planning and outline retirement options. Meanwhile trust-based pensions, including master trusts — which are overseen by the Department of Work & Pensions and The Pensions Regulator — do not have to send out equivalent information until six months before retirement.
He called for better alignment between these different regulatory bodies. A more consistent approach would help providers but ultimately benefit members he said.
“Members do not care — or even know — if they are in a trust- or contract-based scheme,” he said. Cameron said there needs to be “less regulatory arbitrage” and a more joined up approach to ensure best practice is applied across all workplace pensions.
CDC in isolation
This fragmented regulatory approach may also be stifling innovation when it comes to more creative retirement solutions, Cameron said. He pointed out that one significant development to try to boost retirement outcomes for members has been the proposals for collective defined contribution (CDC) schemes. It is possible that these could become the default option in the trust-based world for those members who do not make a conscious decision and ‘sleepwalk’ into a retirement default.
But Cameron said: “We are a bit concerned that the DWP is pushing forward with decumulation-only CDC plans but they do not have a remit to look at some of the alternatives that could be delivered in the contract-based space. I think it is really important that if you are looking at one you look at other options, such as drawdown with guarantees as this may be easier to implement that decumulation-only CDC.”
He added: “I am not saying it is easier to deliver but at least let’s open up the data and look at both together, but there is no platform for doing that at the moment. It is just being looked at in isolation. There’s no mechanism to bring the FCA and DWP together and consult on product solutions that work across both regimes.”
However Jones pointed out that the DWP needed to change legislation to introduce products like decumulation-only CDC. She said there is not the same barrier to offering drawdown with guarantees — but there appears little appetite on a commercial basis to offer these in the market at present.
Guarantee questions
Cameron said that such products became less viable in recent years, partly due to the rising costs of guarantees on these products. He added that 10 years ago, when there these products were initially being developed “it was quite a risky area for compliance departments to endorse”.
“As interest rates fell the rising cost of these guarantees became too much of a hurdle.” Although in the current market, with interest rates rising again pricing may be less of an issue.
Morris said that the appeal of these type of retirement products, offering a degree of flexibility with a baseline guarantee are certainly attractive to investors in theory. “I think most people, if you talk to them, would say this is what they want. People would like some flexibility but with guarantees, but at the moment there is not much on the market offering this.”
Those attending the panel agreed again it came back to language: rather than talking about products, be it annuities or drawdown. The engagement has to start with a conversation about how members build a retirement income, and move away from a binary choice between annuities and drawdown to a strategy that might incorporate elements of both.
Underhill said: “It should be a mix of the two. People need to think about the necessities they need and whether they can guarantee this income, and then have drawdown on top for more flexibility.” But he pointed out that while annuities offer the benefit of guaranteed income for life, the income secured is often very low, particularly at retirement, so they go into drawdown. “This is where we need something in the middle.”
Mortality cross subsidy
Although there are fairly limited options in the UK at present Underhill pointed to examples of ‘third way’ products in other jurisidictions. “There is the Australia Retirement Trust, which is a sort of merger of a few state-run superannuation funds.” One advantage is that these huge ‘super’ funds have the scale to offer this kind of innovation.
Underhill also cited Purpose Financial’s investment product in Canada, which also has a longevity pooling element within it. “So effectively this is taking away the death benefit. But we are finding as we are talking around the industry that people won’t necessarily buy into these products if they don’t understand them. Yet this stuff has to be quite complex and complicated to work.”
LTA questions
Engagement has increased in one area of the pensions universe however. The recent announcement by the Chancellor Jeremy Hunt that the lifetime allowance on pensions would be scrapped has re-energised interest in pension from many higher earners.
Morris said: “There are a lot of senior individuals at the firms we advise who have been disengaged from pensions because they have exceeded these limits. They are interested again and wanting to discuss options which is good.”
He says this not only stimulates individual interest in pension, but can help drive interest at board level on corporate pension propositions. Morris flagged the potential problem of Labour saying it will unwind this policy if it gets into government. But he added: “I’m curious as to whether to not this will still be top of their agenda if they get back into power.
“Because if the Conservatives do introduce legislation to remove the LTA altogether from the statute book, then bringing it back seems quite complicated for not a huge amount of revenue.”
In the interim this has created opportunities, he added. While the announcement is still waiting for Royal Assent he suggested that for some individuals there’s the opportunity to crystallise pension benefits, although he stressed the importance of getting advice in such circumstances. “Anyone who’s got a pension where the lifetime allowance is a factor needs more individualised advice because the size of the fund is likely to mean their situation is more complicated.”
Morris’s point reiterates the central challenge of the retirement conundrum – the need to encourage members to make more active decisions about their retirement, and seek appropriate guidance or advice where possible. Solving these issues – whether through product innovation, better engagement, or more targeted advice solutions – should drive up standards across the industry and lead to better member outcomes.
