Life expectancy predictions should be for life

Steve Webb’s idea of providing people with a life expectancy calculator received mixed reviews. I happen to think it’s a good starting point. People really do underestimate how long they are going to live. Even if we are given tables of average figures, most of us automatically deduct at least a couple of years (for bad behaviour!).

MGM Advantage recently did a survey which found men thought they were going to die at 81, where the average is 86. And women thought they were going to die at 79, and the average was 89. So, it’s obvious most of us need a sharp prod to get a more realistic idea of how long our money has to last.

But until we get that sci-fi DNA code generator that can work out our exact date of death, we are talking about averages and statistics here. So we need to emphasise the possibilities of living longer than the average. We should be giving people the statistical possibility of them living to 90 or 100. These risks need to be drawn out. If you are aware you have a 15% chance of something happening you may adjust your behaviour and choose to cover/address that risk.

But this cannot be a one-off prediction issued to people only when they ‘retire’. Firstly, because the longer you live, the longer you are predicted to live. So, my predicted life expectancy would be greater at 75 than it would be at 60.

And secondly because things will change. Medical factors will change. Lifestyles will change. (For example a decade ago the Government began pushing companies to reduce the salt in processed foods with the result we ate 15% less salt in 2011 than in 2003.) Even the way we predict life expectancies will change.

So, the conclusion has to be people need to regularly receive life expectancy predictions.

In fact, life expectancy predictions should be for life, not just for retirement.

And that leads us onto how we deliver the original prediction and any subsequent updates. Steve Webb’s idea is life expectancy predictions should be delivered as part of the guidance guarantee. Sure, we can leave people with a calculator to revise the expectancy whenever they want. But will people really do that, and if they do, will they, as a consequence, take any different or new action?

So following this train of thought the guidance, shouldn’t be a one off event either. And when you think about it, it’s inconceivable that it would work that way. The days of people making a single (irreversible) decision at retirement are long behind us. People will need regular and consistent help to make sure their money lasts for their lifetime. However long that may be.

The world has just turned upside down

As far as rabbits went, this was a whopper. A soft long-eared carrot-munching cotton-tailed whopper.

Budget 2014 – and the announcement people can just take their money from their pension without securing any type of income and pay marginal income tax - has just turned the pensions world upside down.

For so long, the Treasury’s mantra – whenever it was approached with an idea of increasing flexibility in the retirement income world – has been “not if it depletes people’s pension funds and increases the chance of people having to rely on the State in later life”. This whole ethos now appears to have been thrown out the window.

It’s early days yet. The dust is still settling and it’s difficult to make sense of how the retirement income world will evolve following this announcement.

Certainly the current model, to some extent, was broken. Not enough people were shopping around, nor taking advice, and instead were carolled into buying an expensive and inappropriate product. Especially if they were in poor health and just rolled over into the ceding provider’s annuity.

What we now have is the ultimate flexibility. Manufacturers have free rein to design the right suite of products for their customers. That doesn’t mean annuities are consigned to the dustbin; these new products could include an annuity from the word go, or the ability to flip over into an annuity in later years.

No doubt some people will blow their entire pension pot within a few years of getting their hands on it. But the vast majority won’t. They realise it has to last them a lifetime. So, the biggest risk may be ‘reckless conservatism’. Some people can’t stand the idea their capital might fall so put it all in the bank. But after ten years of steady withdrawals and no growth, they may just find they run out of funds.

So, where our major challenge lies is making sure everyone – and I mean everyone – gets access to the right guidance to help them make the best retirement decisions.  (Actually, what I really want is everyone to get face-to-face advice, but I just can’t see how we can achieve that.) However, we are starting from a position where the market has failed because too few people could be bothered getting any help or advice, or making an active decision.

This brave new world is going to be exciting. Full flexibility should increase the desire to save and give people a tangible reason to be interested in their saving, like it has in Australia. Manufacturers can now develop and enhance products to meet peoples’ needs.

It’s a fantastic opportunity. But the guidance and advice piece of the jigsaw needs to be firmly in place to make it work.

Another nudge needed

Big day tomorrow. Budget Day is usually when pension geeks cower behind the sofa ready for some new tax onslaught on pensions. But, instead, this year we are hearing encouraging noises that the Treasury might increase the trivial commutation limit up to a (quite honestly) startling £15,000. That would help thousands of people avoid having to buy an expensive and tiny annuity.

In other news, Friends Life reported they had staged 274 schemes for automatic enrolment. But it also reports a ‘significant’ number of employers are only paying 1% employer contribution.

Automatic enrolment is being heralded as a roaring success. Already more than two million new AE pension scheme holders have started saving for retirement. And the 9% opt out rate is eye-wateringly good. But there are challenges ahead – with the so-called ‘twin peaks’ of employers enrolling this summer, and talk of provider capacity crunches.

But I wonder what percentage of employers are only paying the bare minimum in contributions. I haven’t seen any stats on this from the DWP or the tPR. But I’m willing to bet it’s a high percentage. Automatic enrolment is great as a ‘get-them-starting-saving’ vehicle, but we all know that size matters. And the more people save, the better their retirement. Increasing contributions is so much more important in the big scheme, than, say, fiddling around with charges.

So, wouldn’t it be great if the Treasury came up with some money in this year’s Budget to encourage employers to pay more than the minimum 1% into their pensions? Some sort of tax break to reward good employers.

Great. But, I suspect, very unlikely.

No S**t Sherlock – FCA states the obvious

Shock! Horror! The internal annuity market is broken.

So, claims the FCA in its long-awaited Thematic Review of Annuities, published today. In its 36 page report, the FCA states 80% of the people who buy annuities from the ceding provider could have got a more generous retirement income if they had shopped around and bought from a different provider. It goes on to say one in six people could increase their retirement income by more than 10% if they changed provider, and for people with severe health conditions the figure is potentially much higher.

It also has the startling news that the situation is worse for those with pots of less than £5,000 as only a handful of providers offer them annuities.

And what’s the FCA’s answer to this? To conduct a competition market study and further supervisory work.  More reports, which we probably won’t get to see for at least another 15 months.

In a way, I get why FCA had to do the report. It has to get actual proof of the situation, to prove the internal annuity market doesn’t work. But on the other hand, I am staggered it has taken 13 months to state the obvious, to tell us what we already know. And to leave us dangling in the same position, with only the promise of more reports.

This doesn’t take us any further forward. It doesn’t help the hundreds of thousands of people who will retire this year. And it’s not as if its hands are tied. The retirement income market is well aware it has problems. The social media and websites are awash with ideas of what we can do to improve the situation. It’s just a mystery why the FCA doesn’t stop, listen, and act.

For example – I’ll give you five quick hit ideas. None of these are original – there are several providers or organisations recommending these today.

1.       Give people a simple pension passport – gives people all the information they need to shop around. ABI or FCA could introduce this.

2.       Get the provider to obtain a completed health questionnaire – this will highlight the client’s health situation and, if suitable, will push them towards an enhanced annuity. ABI or FCA could action this.

3.       Get people to sign a disclaimer if they stay with the original provider, This means we put in front of them in big letters “are you sure about this? you might be doing the wrong thing”, Again, one for ABI or FCA.

4.       Remove commission. Introduce adviser charging style fees and disclosure for the non-advised channel, so people know –and agree to - exactly what they are paying. One for the FCA.

5.       Finally, get the trivial commutation rules sorted. We should be talking about a level of at least £10,000. HMT should be actioning this.

Please FCA, ABI and HMT. Do something. Don’t just write reports. We need Steve Webb’s idea of a taskforce to identify some quick wins. Because the longer this goes on, the more damage is done to the market, and the more people lose out.

The charge cap: to be or not to be, that is the question?

Today’s announcement from Steve Webb about the potential pension charge cap had half the pension commentators cheering and the other half tearing their hair out.

After asking last Autumn for the fastest consultation period possible, today Webb confirmed the decision on the charge cap has been delayed. Instead he wants the cap to come in by April 2015 (and not April 2014 as previously mooted), and said he will give employers at least 12 months’ notice. The reason for the delay? He was worried about the amount of time employers would have to make changes to their schemes.

This policy is Steve Webb’s baby. His great legacy of this coalition parliament. So, to delay it means it was either a massive victory for industry lobbying or he came under some very uncomfortable pressure from the Treasury. Or both.

Webb definitely wants a charge cap. Although it was headed up as a ‘consultation’ there’s little doubt, despite the OFT’s view, Webb was always going to introduce a cap. We can now expect a paper next month, and Webb’s intention is to introduce the charge cap by April 2015. The problem with Webb’s plans is we need the cap in legislation, and with a general election in May 2015, there’s a real possibility this might get caught up in a legislative traffic jam as the coalition government tries to pass all the remaining legislation milling around as the clock ticks down. And whilst we know this policy is important to Webb, it may not be as important to the rest of Government. Including, significantly, the Treasury.

We do know the cap’s going to apply to all qualifying pension schemes – in other words ones being used to automatically enrol people, or those where the members are people who would otherwise qualify for automatic enrolment. We also (probably) know that active member discounts will go, and will have to be unwound for any scheme set on that basis.

What we don’t know is the level of any charge cap. It’s very unlikely to be above 1%, and much more likely to be 0.75% or 0.5%. And we don’t know what charges the charge cap will cover. Although the talk was of AMC, several have lobbied for all charges to be included including all the pesky fund charges (even the known unknowns and the unknown unknowns – to sort of quote Donald Rumsfeld). And we don’t know what will happen about schemes previously set up on a commission basis.

So, what can we do now? Well, avoid AMDs to start off with. They will only cause problems later on. Only set up schemes with probably at most a 0.75% charge – if that’s possible – to err on the side of caution. And start to look very closely at existing schemes being used to harbour potential automatic enrolment employees. If they are on an ‘old’ basis, they will need to be unwound or shifted, and we may have about a year to April 2015 to take action. But groundwork can be made now.

The charge cap is not yet home and dry. There is still a significant possibility it could be kicked into the legislative long grass. Webb wants qualifying schemes to be pristine clean with low charges and no fiddly AMDs. And the ironic thing is even though he has faffed around with this policy, employers, providers and advisers have all started making the changes necessary for the introduction of the cap. So we could end up with the peculiar position of no charge cap in legislation, but a charge cap in practice.

Transferring annuities - a nil sum game

The pensions industry was woken sharply from its post New Year lull this weekend when Steve Webb put forward the idea of transferring annuities. This idea was, sadly, met with, dare I say it, derision by most of the industry.

Why do I say sadly? True, it was a half thought through idea. First the option already exists, although only a few providers offer it – presumably through lack of interest from annuitants. Second it will never quite get the results people want. People want to transfer to increase their income, probably because their circumstances have changed. But you have to remember transferring is almost always a nil sum game. Generally, actuaries don’t let people work options against them.

So, if you choose to transfer because you have developed health problems and you now want an enhanced rate, then the ceding insurer will work out the transfer value on your new current life expectancy and the instalments yet to pay. You may be able to get slightly better rates in the open market – but it won’t be a step change. Especially when you factor in adviser costs involved in transferring.

What about the incredibly unlikely scenario that rates increase and you bought your annuity at the nadir of the market? I am willing to bet my house actuaries will think about this possibility and work into the original pricing enough cushioning to make sure it doesn’t hurt if this situation arises. Some reckon that would reduce starting annuities by 25%. For everyone. Regardless of whether rates go up or not. Regardless of whether they transfer or not.

So the idea of transferring annuities is not really a flyer.

But it was sad it was met with so much mockery. At least Webb is putting forward a solution. Over the past six months we have spent much of it wringing our hands and saying isn’t it dreadful the annuity market isn’t working. I think the time of analysing is past. We now have to work together to come up with some proper tangible ideas about how to achieve better distribution of annuities and better incomes for pensioners. Let’s hope the FCA review  sparks off a few good ideas.

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The other piece of pensions news this weekend was that David Cameron committed to providing the triple lock guarantee on the state pension for the duration of the next parliament. This is not a light decision. Such a guarantee costs money. But as the PPI has shown it is by far the best way of providing a decent pension, and much more effective than tinkering around with charges. I only hope that in 25 years’ time when I retire the triple lock is still around. But I seriously doubt it.

Charges fiddling whilst low earners’ pensions burn

The Pensions Bill makes a reappearance in Parliament today after the summer recess. Greg McClymont, the shadow pensions minister, is still concerned with getting amendments made which will force providers to disclose the whole of the charges to the pensions customer including all the little investment nuances. And Steve Webb will tomorrow publish his reply to the OFT report, calling for a 0.75% charging cap for workplace pension schemes to attack ‘the scourge of high charges’.

Now, don’t get me wrong. Low and transparent charges are important to the success of automatic enrolment and pensions, and these guys are right to be waging this particular war. I get all that.

But.

The PPI has over the last couple of weeks published some interesting stuff about how people can get an adequate pension in retirement. And what has struck me is the importance of the triple lock guarantee for state pensions. For example, one chart shows that for a lower earner the probability of getting an adequate retirement income from private and state pensions is 63%. But if the triple lock guarantee gets replaced by linking the state pension only to earnings, then that probability plummets to a mere 36%.

Yep, down from 63% to 36%. Slashed.

Another chart shows if someone wanted to replace two thirds of their income using a traditional lifestyle investment fund, then, assuming 0.5% amc and that the state single tier pension has the triple lock, they would need a 11% contribution rate.

Change that to 1% amc and the contribution rate needed understandably goes up to 12%.

But change the triple lock guarantee to earnings linked only and the contribution rate goes up to 14%.

Concluding that the triple lock guarantee is way more important than charges. But so far, no political party has committed to continuing with the triple lock guarantee in the next parliament.

So, pension politicians. Yes, carry on with your crusade to get low and transparent pension charges because it is important. But please can we shift the focus and also include the triple lock guarantee. Let’s get their promise that the triple lock guarantee will be there after 2015. Because that will make the all important difference in making sure lower earners (and everyone else) get an adequate income in retirement.