The challenges ahead

Today is the day. This is the final chance for anyone who wants to submit a response to the Treasury on the new plans for pension freedom to do so.

I’ve sent my response off and here are my key points. If you would like to read my full response or to talk over any element, then give me a shout at Rachel.vahey@sky.com

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The Budget proposals are to be welcomed, in that they will give people freedom to manage their money as they see fit. And I sincerely hope this will translate into a greater attraction for pensions, and, as a result, more people invest more money to secure a more appropriate income in retirement. That, after all, is why a lot of us are here.

But we are in danger of creating a whole host of new risks, which mean that people may not get full value from their pensions savings in retirement. I strongly believe we need to do everything we can to give them a helping hand to achieve their dreams. Otherwise, by introducing this flexibility, we are not improving their lives, but instead we are merely placing them in a more difficult situation, where they are unable to live the life they want.

For this pension reform to work, we need two things.

1.       We need to deliver an effective guidance service so people are aware of the risks they face, aware of their options and aware how to get advice.

2.       We also need to create the right legislative and regulatory environment so providers can innovate to develop the best retirement income products.

The introduction of the guidance needs to be viewed as a long-term project. Put something in place by April with the right direction of travel, but continue to develop and change the service until it meets the criteria and it is right for the vast majority of customers.

The Pensions Advisory Service (TPAS) is the best placed to take forward delivering the guidance guarantee, working alongside Money Advice Service (MAS) and Citizen’s Advice Bureau (CAB). Providers should not be involved – they are not impartial.

Alongside this, the new service, the regulator and the Treasury must champion - in strong terms – two key messages:

1.       The more people who receive advice, the more people who will avoid the risks associated with the new pensions regime. We must actively encourage people to take advice.

2.       People need to shop around for the best products (whether that’s design or charges or rates). This message is still appropriate and still needs to be pushed.

The guidance guarantee is challenging but it’s crucial. We need to get it right – otherwise the implications will be catastrophic.

Something else we need to get right is the developments of new products. The new pensions regime offers an opportunity for providers to develop the right products which meet people’s needs, and, importantly, their wants and desires. Primary legislation needs to be changed so it is flexible enough to allow this development. Otherwise, people will run the risk of outliving their money in retirement, with consequences both for the individuals involved and for society as a whole.

Finally, I don’t think we should just spend next year designing the new regime and then letting it set sail into the distance. Instead, I believe we need a formal review of the implications and experience under the new pensions regime. I acknowledge the Government will monitor this. But I advise a formal review is established to report on the new pensions regime and guidance guarantee in 2020, involving external parties representing all elements of the industry working alongside the Government.

Implementing the new pension freedoms and regime is a massive challenge. But if we get it right it can only mean good things for people wanting to make the most of their savings in retirement.

A mass of contradictions

So another year of Parliament will kick off in September, and another Pensions Bill awaits us (as well as another Finance Bill full to bursting with pension amendments). Is anyone else feeling dizzy from this never-ending onslaught of changes to pensions?

We can look forward to the laying down of the rules for the new pensions freedom, as well as the introduction of the defined ambition regime – the third way, for those who don’t want defined contribution and can’t afford defined benefit.

But when laying these two initiatives side by side, it’s becoming increasingly obvious that there is no master plan behind pensions. Instead, it’s a swirling mass of contradictions, and legislation using the piecemeal effect.

Back in 2006, I distinctly remember being promised the introduction of A-day was the end of itty bitty changes and tinkering of legislation. But it’s proved to be anything but.

A few things to draw attention to.

The budget changes bring in autonomy and responsibility. It’s your money; you spend it how you see fit. But the new CDC regime is all about pooling money together (so you have no idea what’s yours and what’s not), and trusting in a higher body to give you the right amount of money at the right time in retirement. So, completely opposing views.

Next year we also get the charge cap for defined contribution schemes. Steve Webb (and others) has lamented the fact that we can only use the charge cap to control fund management charges and not total charges. The industry is in a state of worry (and rightly so) about how much the pesky transaction charges cost someone, and why they aren’t disclosed clearly and transparently.

But how much will CDC costs amount to? Or the guarantees being offered through defined ambition schemes? I strongly suspect we will never know. It seems bizarre to me that we have spent the last ten years travelling towards openness and transparency about how much your pension costs you, and now the new defined ambition regime is driving a cart and horses right through this initiative.

Will the costs fall under a charge cap? I don’t think so, unless the cap’s extended to DA as well as DC. But remember, this new regime is essentially DC. Employers’ costs are controlled – they pay a percentage of earnings (or whatever). Charges will fall to the member. It’s just they won’t have the foggiest what they are.

And the new guidance guarantee will only apply to DC schemes – not to DA or DB schemes. In a way you can understand the logic. Transfers from DB schemes to access the new freedoms won’t be allowed for public sector schemes and might be banned as well for private DB schemes. So these people don’t need guidance.

But what about those in DA schemes (indeed, if any are ever set up)? On the one hand, you could argue they should be treated the same as those in DB schemes. If there is a mass exodus of members at retirement then the pooled scheme will ‘fall over’. But I believe in freedom. People should be allowed to transfer out. It’s just the trustees will hit them hard with a market value adjustment (or whatever it’s called) to cover the scheme’s back. And that’s a tricky decision – stay in the DA scheme for the benefits you are promised (or even guaranteed), or transfer out to DC and spend your money how you want to. People will need help.

Things are happening too fast in pensions. They are not thought through. They are not joined up. There is no master plan.

Instead, politics is driving change. And that means politicians’ needs are at the centre of new developments not customers.

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.