The market for at retirement products could prove to be a demographic gold mine in the next few years – a boon to advisers and providers as traditional sources of income falter.
Yet in the five-year period when defined contribution scheme members make their final accumulation decisions, swiftly followed by a crucial decumulation one, a lot can go wrong. Most would say a lot has gone wrong.
At retirement is still regarded as a problem area in financial services, not helped by stock market performance in the last two years.
Although some are more strident in their criticisms than others, most corporate advisers believe that simply offering advice and information at retirement is often insufficient. They point out that the value an employer is adding by making significant contributions can be eroded substantially by schemes offering or members making the wrong investment decisions, or by uniformed or underinformed members making the wrong choice over their pension income.
However if things can be fixed, the good news is that in the next five years, the amount of at retirement money looking for a home in an annuity, drawdown contract or other types of products and plans, is set to increase by 60 per cent.
Calculations by Watson Wyatt combining ABI figures and its own research suggest the market was worth £14.1bn at the end of last year, and will reach £23.1bn by 2013 despite the stock- market set-backs.
Watson Wyatt senior consultant Andy Sanders says this represents a huge opportunity for advisers. “Despite poor investment returns which have negatively affected pension savings, the at retirement market is still expected to grow in 2009 and then substantially more in the following years. This growth will be driven by the increasing number of people coming up to retirement in the next five to ten years.”
But those poor investment returns are also playing on the minds of both plan sponsors and members of corporate pension schemes.
Towry Law wealth adviser and corporate specialist Mark Miller says many investors in schemes still have their heads in the sand, while others are prepared to wait for things to come back. The third camp, he says, on Towry’s prompting, are doing something about it.
Miller says the firm is attempting to convince schemes and members to move away from poor quality default schemes. He says: “The vast majority of members are in managed funds or default schemes that happen to be managed funds, or things called balanced managed when they are neither balanced nor managed. But the employer has started to realise that if they don’t help people understand what they have got, the employer is not getting value either. If you put in a good contribution but its not going into a good fund then everybody is losing.”
The firm is urging a manager of manager or fund of fund approach and says that while TERs look higher when compared with managed funds – at 2 as opposed to 1 per cent – the risk premium shows it is worth changing. It also provides much better asset allocation and diversification. A typical managed fund’s equity exposure, for example, will be in the US and UK, despite the fact the markets are highly correlated. Miller says doing nothing to correct this will mean you will eventually “get caught in the same bear trap”.
The right strategy
Hargreaves Lansdown head of pension research Tom McPhail says there is a mixture of confusion, dismay and disappointment. There are, he says, a variety of strategies available but no adviser is able to recommend one with certainty, certainly not to those close to retirement but seeking to repair portfolios.
He says: “There are a variety of strategies, to work later, to draw on other assets. Some are asking: ‘Should we stay in the market longer? The market has taken me down, will it take me back up again?’ This is from people in their sixties. That is a pretty tough call. For anyone within ten years of retirement even with what has happened, market exposure comes with a degree of risk. But it may be a very good strategy. There is a valid argument to say you should stay in. We can talk to people about outcomes and risks, but it would be a brave individual who started to make firm recommendations.”
McPhail adds that getting information to people in corporate schemes to make these informed decisions can be more difficult and there may be another unexpected risk – lifestyling is in danger of selling out of equities near the bottom and moving into a fixed interest bubble.
While accepted as a good thing in general terms, lifestyling may have another flaw relating to redundancy.
JLT head of consulting Peter Redhead says: “I would say the majority of schemes have a default that is relatively aggressive, until within five or ten years of retirement, then a phasing into say 75 per cent bonds or cash. But where a redundancy comes around earlier, retirement plans can change pretty dramatically. In a default lifestyle plan, members can be in equities and retirement is upon them now. They need to find a mechanism for living without retiring or alternatively the pain is had.”
Most advisers believe that it is only executives who, realistically, have the freedom to choose to wait for an equity recovery. Advisers have seen no signs of tensions where some employees have wanted to delay retirement plans unless it has involved redundancy.
HSBC Actuaries & Consultants head of DC consulting Paul Armitage says: “My anedoctal experience is that the people who are still in the workplace when they get to retirement, even if they are going to retire on less than they thought they would, will still do so. You would have to be very cash-strapped to try and delay things.”
Armitage also believes that later retirement is still some distance away from being a solution to the national issue of underfunding.
“The opportunities are pretty limited. I get the impression it is a very convenient political solution to underfunding, but you need a very big change in cultural attitudes to get it to really work.
What happens next?
Most pension investors do not have the luxury of using time as a healer for their portfolios because working longer is not an option, outside the executive corridor. Nor will many want to increase equity exposure, so the pressure is on to get the decision about retirement income correct and maximise it if possible. But the market has its own set of problems with some estimating just a third of pension savers are exercising the open market option when they come to retire.
All corporate advisers questioned believe the current system leaves a lot to be desired. There is some agreement on the solution – a combination of advice where it is appropriate, or information combined with technology, although the technology is still in a developmental stage.
A new campaign group has been founded to lobby policymakers, cajole traditional providers and trade bodies, convince advisers and inform employers and savers about the open market option. The group includes providers of alternatives to classic annuities while two of the advisers on the steering group, Bluefin and Hargreaves Lansdown, operate significant businesses in the corporate market. Hargreaves Landown’s McPhail is the temporary lead spokesman. Other advisers will be able to join as associate members.
Where blame is attached, it is levelled at big pension companies serving contract-based pensions with suggestions that material may be buried in the documentation if a particular firm prefers to retain the annuity business. Some pension consultants also face the accusation that they have not properly considered the income decision when recommending schemes. But all suggest that the whole process requires greater understanding.
Armitage says: “The huge issue is a complete lack of public understanding of the dynamics of the conversion into a retirement income, the conversion into an annuity. That is exacerbated right now by the fact that people’s funds are generally worth less than they were, so when they come to do this once in a lifetime transaction the member experience is pretty poor. The process is clunky. You may be divesting funds from several sources trying to get the funds over to one provider for quite a long period of time. The fund is still moving around in value and could be falling in value. There is so much opportunity to disappoint people.”
He also believes that the OMO system works better in trust-based schemes where the employer is paying an adviser up front to talk to scheme members. He says that contract-based schemes may see pension savers decide to go with the pension provider when they receive its mandatory communication six months before retirement even when an employer or adviser may tell them about OMO at a later date.
He believes it is different for higher earners. “Because they have larger funds they will seek advice, or indeed because they have larger funds, the advice may find them”, he says. He also believes that the interests of higher earning savers and other savers are diverging during the accumulation stage due to recent budget tax changes.
However advisers say that both sets of pension savers have one thing in common – that they need to be thinking about what to do with their savings ideally at least a few years before they retire.
This obviously helps inform the decision whether someone should consider drawdown or other unsecured arrangements but even the decision on whether a saver is aiming for a level or escalating annuity can affect investment decisions.
Hewitt defined contribution specialist Andrew Cheseldine says: “If I am 50 and switching starts at 55, at 55 I need to know what kind of annuity I’m going to buy, I may have pots in different places. There are legal requirements of having to give people information 6 months before, but it should really be two to three years before. I have seen an employer with generous contributions suddenly say ‘right, you’re on your own’. I would say that they should provide some help because we know the average rate as opposed to the better rate is something of the order of 15 to 20 per cent better.”
But Cheseldine believes that employers and schemes are for the most part doing their best. He adds it will not always be cost effective to offer a full review to someone with a small pot – and a reasonable scheme pension may be on offer. Employers will also take some convincing to pay for advice for members who left as long ago as decades ago but it is not an insurmountable problem to equip someone with the information.
Tailored information provided at the right time can help too especially with small pots. For example proper graphical illustrations taking account of inflation provided in addition to raw numbers can dramatically increase the number of savers that will plump for an escalating annuity over a level one.
“You can do it in broad terms, so members can make a conscious decision. A large number will go for default. They may offload the decision about the provider choice to the administrator who will run a panel – it doesn’t have to be very onerous,” he says.
The campaigners – from Hargreaves and Bluefin – are adamant that the market must change, though once again the difference may be in emphasis. McPhail says he has seen some very poor communications from both trust- and contract-based schemes.
Bluefin director of corporate consulting David Tildesley says: “Trustees, employers, consultants, IFAs, industry bodies, Government really need to raise the profile of this issue to annuitants who are not getting a fair deal. The state of the nation is dire, it is unacceptable.”
Both firms believe that they can combine technology and information and good communication to help those without the means to get full advice, because employers won’t pay or their pot is too small, to make informed decisions.
“I reckon 75 to 80 per cent can get through this with information to get the best product they need and the best choices available in a particular product sector. I’ve got type two diabetes, high blood pressure, slightly raised cholesterol, and when I get to my sixtieth birthday I will be looking for impaired life. But we have to make sure people know their options. The education part is really important. Education and technology and access to advice,” says Tildesley.
There are differences in emphasis but all pension advisers agree on the problem and the solution. To change the numbers and stop people being trapped in bad value pensions may require a little more than a market solution. The new lobbying group, as yet with no name, will issue in a white paper in the autumn. It will be interesting to see if all still agree then.