New products, new defaults and new, clearer, regulatory guidelines are urgently needed to bring workplace retirement planning in line with the new freedoms. John Lappin reports
Root-and-branch reform of the entire workplace retirement income proposition is needed if the industry is to meet the challenge thrown at it by the freedom and choice reforms. And that means new structures for the delivery of advice and guidance, as well as new products.
That was the view of delegates at the recent Corporate Adviser/Royal London round table, Freedom and Choice: Workplace Pensions in the New World.
One of the key challenges for the advice market is how to deal with the sudden upswing in demand for drawdown – as an income-generating vehicle as well as for simple cash withdrawal – by a large cohort of people with relatively small funds and little appetite for paying for advice.
Not only has the Chancellor told the public they can enjoy the shiny drawdown alternative to hated annuities, but research from Retirement Intelligence is emphasising the point even further, with the hurdle rate a drawdown fund needs to achieve to preserve annuity purchasing power, while drawing an equivalent income, almost halving in the past four years as gilt yields tumble.
Given that corporate advisers are the ones who have hitherto constructed the avenues that have shepherded execution-only retirees towards annuity brokerage services, how should they approach this new, flexible world, and what products would they like to see made available at the exit point?
Barnett Waddingham associate Phil Duly said: “We struggled to engage DC savers before. We now think we are going to engage them more at the point where they are accessing their money. A lot of them will need an easy route. Annuities provide that. But while the flexibilities provide a different shape to when you take your income, I wonder how many individuals will want to manage it and think about investments on an ongoing basis, and worry about it running out.”
JLT Benefit Solutions regional director Hugh Nolan said he would like to see someone come up with a product for the £20,000 pot, allowing around £7,000 withdrawals for, say three years, and so tax efficiently. “Who is going to offer that product?” he asked.
Duly also argued that annuities should still have their place, but need a serious makeover. “We need to relaunch annuities. It worked for Windscale when it changed its name to Sellafield,” he said.
Nolan agreed mortality cross-subsidy was attractive, arguing: “We will get a new type of annuity that will have mortality protection without the same constraints on investment. You pool the mortality risk, but you get better investment growth: something like a with-profit annuity but not called that. Some guaranteed income and with the rest you draw
Delegates debated the challenge of offering a drawdown portfolio with a decent investment strategy for the long term on a non-advised basis.
Nolan said a master trust decumulator could work. It needed to offer two strands for different people: a regular guaranteed income, though not a traditional annuity, but with a strand giving flexi access.
He said it could possibly be constructed by using a guaranteed income bond, with a strategy that would gradually take more risk off the table with a view to buying a more traditional annuity at 85.
Punter Southall principal for DC Consulting Neil Latham said: “We all get to retirement and need a regular income. We know we might live too long. Perhaps short term money here, this is income, maybe a 10- or 15-year product if you want guarantees and returns on death, but you have got to get the pricing right. People would buy with-profits if it was around today.”
Royal London investment proposition manager Ryan Medlock asked whether the panel saw an appetite for products with guarantees. He suggested the possibility of adapting strategies for the last five years of the accumulation period to create a smooth glide path into decumulation, if it was possible to identify what people wanted to do.
But Latham suggested that what might prevail was effectively precipice planning, with people acting, at best, two or three years out.
He added: “We may need to build something that brings the least harm, that controls the risks, and that no one is going to look at until there’s 12 months to go. The employer will ask whether it is really their problem and say: ‘All I’m trying to do is make sure they know enough not to crash and burn.’ But we won’t know what the real behaviour is. What people say and what they do is often miles apart. The proof will be the money when it starts to flow.”
Jelf Employee Benefits head of benefits strategy Steve Herbert highlighted the issues facing broad swathes of the workplace pensions sector, where default funds have been rendered obsolete because nobody knows what they are targeting any more. He said: “We haven’t got a starting position. No one knew the freedoms were coming. All the default fund basis is out of the window and the set retirement age has gone.”
Duly added that auto-enrolment brings a different profile of person into pensions, adding to the challenge.
Towers Watson senior consultant Rudi Smith added: “That is why the stats are really useful. No one knows if a default is right. One of the reasons employers are looking at workshops is because there will be a parting of ways for different people. This is the point where we can make a difference to how people invest”.
Nolan added: “You want people to engage and choose which one is best for them. It becomes a philosophical point. Do you look at people with smaller pots of money and say they will take the money as cash in all likelihood, so we could manage their money towards an expectation of cashing out? Do you take the view that those with £250,000 pots are the ones you need to look after most?”
Delegates suggested it might be necessary to compromise and gear towards all three possibilities.
Duly said: “It is not just trying to anticipate behaviour, but also asking what their retirement age is. What path will they follow up to five or six years before the retirement age? Providers’ systems within lifestyle are usually 100 per cent or nothing so people cannot follow the path they want. Is it balanced protection as a compromise?”
Nolan said another issue would be people having plans but then perhaps getting ill in their early sixties or being made redundant. He pointed out that one thing was easier now, however: “You don’t have to buy your entire capital protection in one day.”
Delegates expressed concern about the lack of movement by trustees on rebalancing default funds to more suitable asset allocation strategies. Nolan said the situation was ridiculous. “There is a massive inertia, where trustees in particular are waiting for someone else to do something, because they don’t know what to do,” he said, warning of the risk of fixed interest assets falling as interest rates rise.
“I don’t think it is a massive risk in terms of the likelihood, but if it happens it will be a really big problem. You have two or three more years to get your ducks in a row.”
Latham argued: “If you have told employees you have to do something, and if you have put someone in the default and communicated it properly, they may be dissatisfied, they may complain, but it will be unfounded.
“If you are a trustee or employer, you know you are not in the right place today, but you are not sure what the right place is tomorrow. If you make a change, it is costly, it must be communicated and in terms of credibility you can’t afford to do it again in six months.”
Glynn Jones, divisional director of group savings & investments, at LEBC, was more optimistic. He said: “If we can engage with employees and get a sense of what might be, we can then inform the employer what to make available and then do the communications. You have got your due diligence then. Default is default, but you might have three or four defaults.”
Participants suggested that trusts and master trusts in particular were arguably in a better position than contract-based schemes to alter things, with contract-based arrangements facing the dilemma of arguably needing written consent from members before being able to change their default arrangement. But delegates agreed that Royal London’s contract-based Governed range did allow for rebalancing.
Royal London business development manager Jamie Clark said the new independent governance committees could have the power to change things if they believe a default strategy is underperforming or becoming unsuitable.
With so much at stake, delegates agreed that communication, education, guidance and advice will all be more important than ever.
Latham said: “The best communication we ever do is face-to-face, whether video or a seminar, but you can’t stick everyone in a room one-to-one because that is where costs start to rack up.”
Smith said: “We need to start thinking about workshops in the run-up to retirement. Face-to-face is hard to get away from. You can put across the message you want to get across, whether you are offering restricted or full flexibilities.”
Latham said it might work for 500 employee businesses but reaching 5,000 could be extremely costly.
However, Jones said it could certainly work where there was a possibility of moves from DB to DC, which could then subsidise the employer on cost.
Herbert suggested HR departments might be more prepared to pay for more holistic financial education that brought other benefits too, and Smith added that many big employers had already run big communications exercises and seminars when they moved from DB to DC, so they had experience of this.
But what if they wouldn’t take advice? Latham said his firm might offer guidance, though it could turn into regulated advice. “But you can’t force that on a member of staff. They have to engage with it and that is as good as it gets from an employer.”
Herbert added that trustees, consultants and insurers can only “throw up so many barriers”.
But all delegates at the event expressed nervousness about the regulatory position surrounding the border between advice and guidance.
Nolan added: “In future, you will be judged with hindsight and new governance standards for what you did 20 years before.”
Delegates also debated the potential for employers and employees to avoid NI by flushing salary through pension. Jones said: “A lot of SMEs, and small companies in particular, run their pensions and salaries very closely interlinked. Directors will make the maximum of it. We don’t know whether that will go down the employee base. There are risks there because legislatively we are in uncertain times.”
Latham said real restrictions were difficult. “Stopping salary exchange involves a fundamental overhaul of tax and NI and has all sorts of unintended consequences. It still feels good for another two years, and it is a great return on investment for an HR team to demonstrate value.
“We have seen businesses that hesitated about doing salary exchange implementing it now, albeit five years later than we suggested. But they feel it is a valuable benefit, even if it is only 18 months.”
Responding to the reform will be an iterative
process as consumer behaviour becomes clearer. The workplace pensions reform story is far from over.