The Budget pension changes mean scheme design must go back to the drawing board. John Lappin finds more questions than answers
To say that the Budget changes mark a retirement income revolution with profound implications for workplace pensions is probably something of an understatement. Chancellor Osborne’s pensions revolution is arguably the biggest change in the system for 90 years.
Seven words in Osborne’s Budget speech have changed the world of pensions: “No-one will have to buy an annuity.”
The speech caused share price carnage for many big UK life offices amid dire predictions of the death of the annuity, before they made up some of the lost ground later on Budget day.
While most experts say annuities will survive – though probably becoming more popular later in life – the implications for company pensions and for employers, providers and corporate advisers are far reaching.
Scheme design and in particular the design of default lifestyling and other derisking strategies will have to change radically.
Communications strategies will also need to be overhauled, while employers may even start to wonder why they should contribute generously if employees can access it all.
Deloitte pensions advisory partner Tony Clare says: “Trustees and providers are grappling with the sort of investment strategies they should offer. Nest has publicly said it is reviewing this, as are most providers. We are being asked to second-guess what member behaviour will be in years to come. These may be people who are not particularly pensions knowledgeable, with relatively small pots. We have to second-guess what they will do and when they will do it. The industry will gravitate to a more liquid investment to allow trustees or providers to release money very quickly with a process of greater member consultation.”
He argues this could involve people who expect to annuitise being offered lifestyling, people who want to take all the money targeting cash and those intending to use income drawdown targeting the equity income sector.
“We will be trying to get members to respond to those questions. There has to be greater member engagement but the challenge in explaining it in plain English.”
Independent pension consultant Rachel Vahey says: “The question is how do you design a ‘one-size-fits-all’ default fund? There will be great uncertainty and variance between scheme members about when they will take their retirement funds. Some might loot the pot at 55, some at 57, some at 60, and some at 68. And what they will do with their money. Some may withdraw the lot. The majority will probably withdraw it slower than that, and a significant proportion may buy annuities (either immediately or at a later age).I don’t really see how it can be done to design the right fit for everyone, and it certainly begs the question ‘is lifestyling dead?’”
JLT employee benefits director Mark Pemberthy says: “The industry and employers have really got to think about how they support this in terms of products and advice.
“It is not quite a fundamental as back to the drawing board, but there are a whole host of design issues. What is the role of the pension in the reward system? How paternalistic do employers want to be and how do they go about doing that given the additional freedoms? It does change the nature of the role of the DC scheme in the workplace.”
“Some employers have wanted to support high levels of pension funding, so employees can afford to retire and leave the workforce. Clearly there is a risk that even with high levels of pension funding, if employees decumulate too quickly, members could be coming back into the workplace much quicker. Where up till now, there has been flexibility to take tax free cash, generally people haven’t been otherwise decumulating while they are in the workplace. The employer needs to think what their attitude is to that.”
Clare says: “Most of the money that has been built up has been paid by the employer. There is a reason for them to make sure it is not spend unwisely.
“There will be workforce planning issues if all the members take out their pensions early and buy Lamborghinis. How will we manage them out of the business? A good employer will be thinking about workforce planning. Pensions are a key part to enable their employees to retire. But we are all just starting to guess what this will be in practice.”
Decision making process
Just days after the Budget Mercer held an online conference in which 450 schemes participated. Mercer UK DC leader Brian Henderson says: “We asked when schemes thought they should give a customer guidance guarantee. Is at retirement, is it at a life changing moment, when you join, or 5 to 7 years before you retire? Just 9 per cent said at retirement. There is a mismatch and that is our challenge. We need to tidy that up, engaging sooner and earlier. We don’t need a better mousetrap. We have the bits we need, but we need to put it together better.”
Pemberthy agrees that the new reality is that pension decision-making needs to start happening much earlier working lives, perhaps in the mid to late 40s, but whatever happens around the default strategy, it will still involve de-risking.
“People need to think what the appropriate de-risking strategy looks like as well as how they are going to plan their cash flow and capital requirements into their later years. Enlightened employers will want to take a strong role in that. Others won’t,” he says.
“There is a legislative requirement to have a default fund, so it must include some form of investment derisking in later years.”
His view is that you will still growth assets in the early phases, then less volatile assets, but you need to think about that shape. “What does the default look like, what does standard look like? Will someone phase access and therefore need a more aggressive strategy or will people drawdown capital quickly with a greater allocation to cash?
He says that it is clear the majority of people will not annuitise with all their pension fund.
“I think human nature would mean most people want to retain access to more than 25% of their capital.
“You need a default and it needs to make some assumptions about how and why people access their pension funds. We will see heavily sign-posted easy choice solutions. Default one, two or three communicated around how people may use their fund in the future.”
For example he says one signpost might say “This is a default fund for those who expect to take an early amount of pension fund as cash early in their retirement”.
He predicts the development of low volatility growth strategies to ensure members are not exposed to big volatility swings from their early 50s irrespective of how they de-accumulate.
Henderson says: “In the run up to retirement, your customers will have three options. The language we are using is cash option – tax free or taxed, secured income whether an annuity or maybe a DB pension, and then variable income through perhaps earnings or drawdown.
“You are looking at default arrangements and asking what does it look like when faced with 3 distinct things.”
He says once members have a secure income sorted out, they may then top up other things and drawdown might become attractive.
He adds: “Yet with drawdown all bets are off in terms of asset allocation. Some may say I will drawdown for ten years, but others will want other periods. We will develop 3 core strategies, but I don’t think adjusting target date funds is the answer. That is smoke and mirrors.”
All advisers recognise the huge communication challenges for whoever finally gets charged with delivering the guidance that the government has pledged will be given to DC scheme members.
Pemberthy notes that it is easier to provide guidance to an active member of a scheme, although questions abound. He says: “If someone asks about guidance at 55, if they don’t start accumulating at that point can they not have that guidance again?
“Not all schemes will have seamless accumulation to decumulation processes. Some people will still have multiple pots at retirement. And with the charge cap it may be more expensive than a straightforward admin solution. Some providers will not provide high levels of functionality. Others will and that will be attractive for progressive employers and it will be a differentiator in scheme design”.
Henderson adds: “The issue is who pays for the guidance. We are not sure if it is a levy or is it paid from the 75bps.”
“It’s getting tough for employers – the DC code – the onus on DC trustees and contract based schemes with comply or explain; the consequence is companies are having to think long and hard about governance arrangements. I think you will see a leap towards master trusts. Companies are waking up to that.
“Some firms are very paternalistic and will be happy to take this stuff on. For others, on the pure commercials, it will be a big deal for them.”
Aegon regulatory strategy manager Kate Smith says: “On the guidance guarantee, there is no point giving someone guidance just before retirement. It needs to be ten years out.”
Smith wants to see changes in what employers are allowed to say to staff about pensions. “Employers are well placed to talk to their employers,” she says. “The FCA and TPR have to let employers talk to employees about their responsibilities and rights. You have to use the role of the workplace to get these messages out. It is the warm up approach. The Government has to talk about this and let employers talk about it too. The FCA has got to wake up and see how their rules fit in with this to allow employers to talk to employees without giving them the whole advice which is why we are worried it will be year till this guidance guarantee happens.”
Henderson says some paternalistic companies are looking beyond the range of at-retirement products already out there. Mercer’s thinking on this is advanced, he says, with tie ups with three insurers to cater to managing people’s money beyond retirement.
“We have all read this was going to happen, just not this quickly. All bets are off now really. It is interesting with talk of innovation being frustrated with caps forcing down costs. When people talk about that, they are talking about fund managers. The innovation is coming from companies like us.”
Clare says: “At Deloitte, we are starting to think about creating a sort of ‘pensions bank account’. People understand bank accounts, and we think it would be an attractive proposition for multiple DC pots. To consolidate multiple pots into a simple product that offers a rate of return but greater flexibility. I am not advocating a retirement strategy of cash but it needs to be a simply understood product for accessing pensions monies post retirement.”
The door closing on DB transfers
The Budget proposal to ban transfers from DB has provoked a spike in enquiries. LEBC, the Retirement Adviser director Nick Flynn says: “We have seen ETVs start building up, and since the Budget that has accelerated. A lot of it seems to be member led, while in the past it was employer led. They are thinking I don’t want to be stuck with a DB pension. This is particularly the case for the high value members who never wanted to buy an annuity or take a scheme pension.
“We have seen high value City firm people who say they want to transfer at standard transfer levels, but it is really difficult to advise because we are seeing people saying that we want to do something that wouldn’t make sense ordinarily.”
He says more generally it seems counter intuitive to liberalise the DC pension and then slam things shut for DB.
“I understand the public sector, but who is it going to hurt in private sector DB? Done properly it shouldn’t hurt anyone. But there is a risk of creating a buy now while stocks last environment, which doesn’t encourage good behaviours. In addition, there are only half a dozen advisers which have the ability, scale or desire to do these transfers. There isn’t much capacity.
“To my knowledge there is no relaxation in the rules, this possible change may be a motivation, it is a factor but it is not overwhelming, not say like serious illness. The FCA says COBS applies and there is no change in it.”