As Budget rabbits out of the hat go, George Osborne’s pension reform plan yesterday was a pretty big one, successfully protected from leaks within the Coalition and launched to a suitably confused looking House of Commons, unfamiliar with the finer points of drawdown rules or pension tax liabilities.
Here are 11 thoughts on yesterday’s announcement from No. 11:
-
Giving people the ability to make a genuine choice about how to use their (DC) pension pot at retirement is a landmark reform which it is entirely logical for a Conservative Chancellor to make. George Osborne will hope it is his equivalent of the iconic Nigel Lawson 40% income tax reform of the 1988 Budget. It liberalises a market, enhances customer choice and tackles an area of political risk for a Government that has presided over rock bottom annuity rates (thanks to QE) and an increasingly criticised retirement income model which has had three national newspapers campaigning against it. It is politically possible in this Budget because of the unique combination of the Single State Pension reforms, Auto enrolment and the ‘Triple Lock’ promise which have provided greater certainty about future pension entitlements and the level of saving being undertaken. But nobody should be in any doubt that it makes for a less certain outlook; the range of the changes with the ISA changes and the new pensioner bond alongside the drawdown/annuity reforms make this a less predictable landscape with lots of moving parts.
- Like most landmark reforms, this involves political risk and reveals instinctive political dividing lines. Labour will worry that people could make the wrong choices and end up destitute. The Conservatives feel instinctively comfortable with the retail politics of customer choice but will want to see that a more liberal regime does not see rushed retirement choices that are imprudent or short-termist; people paying for cruises, not care. Nobody can know at this stage how such major changes will play out in the long-run but the short-term politics favour the Conservatives who can trumpet greater choice while Labour worries publicly about the longer term consequences and cost.
- People retiring before next April face an incredibly difficult set of decisions. Yesterday’s announcement included steps this year towards full freedom over savings for people as of April 2015. But what are people retiring today to do? They could defer all decisions until the complete freedom of next April but that means hoping that everything happens exactly as announced and there is inherent unpredictability with any massive reform on this scale. It is going to be a very difficult 12 months for people retiring and for those trying to help them make good decisions as they navigate uncertain and choppy waters during a time of real flux. This year has been positioned as a transitional phase, but real savers are making life changing decisions in this time and advisers, providers and regulators will need to work together to help their customers.
Annuities will remain an important retirement income product for people who wish to have a guaranteed income for life and who will still have to decide when to annuitise and how much to spend.
- Removing a bias in the system in favour of annuitisation will not nullify the customer benefits of annuities. It is easy to forget that compulsory annuitisation has already been abolished and that didn’t destroy the market. Annuities will remain an important retirement income product for people who wish to have a guaranteed income for life and who will still have to decide when to annuitise and how much to spend. Some customers will switch from their pension provider to a different provider, while others will continue to receive this product from the pension provider they have saved with and whom they trust with their money. They may also be increasingly attracted by more innovative annuities such as the variable annuities that are commonplace in the USA, although not loved by UK regulators. In short, moving to a more flexible retirement framework does not remove all the drivers for customers who want a secure, guaranteed lifetime income but of course it may affect the timing and choice of product.
- The guidance process in the new system will be incredibly important; massively challenging to set up and could prove expensive to run. (The £20m announced is just for the set-up costs) The scale of operation required to ensure face to face individual guidance would be very significant if introduced. Meanwhile the guidance itself will have to be sophisticated enough to decipher the more complex choices facing retirees, while recognising the behavioural biases which can lead people to underestimate their longevity, be overly positive about their likely retirement care needs and be too focused on near-term financial needs. In many cases, customers will not get these decisions right without full financial advice which they will have to be prepared to pay for. Given the guidance process could easily see customers drawing down their pension assets and investing them more widely, it would certainly be more equitable if all parts of the financial services sector contributed to the cost of the guidance service and the more liberalised market from which they will all benefit.
The scale of operation required to ensure face to face individual guidance would be very significant if introduced.
- These reforms will be felt in the Defined Benefit (DB) market place too. If the Chancellor succeeds in his ambition of a fully liberalised system for people choosing how to spend their DC pension pot, the pressure will inevitably fall on providers of DB schemes to offer similar opportunities. This would have significant consequences on the solvency risk of DB schemes which are reserved to pay out over a lifetime of retirement. Once the system changes the genie will be out of the bottle and future Chancellors will find it impossible to put it back again. The Treasury has acknowledged some of the short term pressures by announcing the ban of transfers but the cultural dynamic will be more difficult to influence.
- These reforms pose big questions about the Government’s ambitions for the funding of social care. With a greater number of customers more likely to access the whole of their pension pot at the point of retirement, it will become even more challenging to engage them in the need to plan financially for their future care needs. On the other hand, those customers who drawdown their pots but don’t waste them may find it more straightforward to buy Immediate Needs Annuities than those at present who have already annuitised years before their care needs manifest themselves.
- The impact on infrastructure and insurer investment in the wider economy will be one to watch in the years ahead. The long-term nature of annuity books helps the insurers who run them invest in the UK economy, especially in long-term projects like infrastructure. If pensioners take more of these assets at the point of retirement and keep them in a bank account or invest themselves in other assets (such as buy-to let) the long term investment effects for the UK economy from the insurance sector over time may be affected, including in the long-dated corporate bond market.
- Collective DC looks even more unlikely to get off the ground. In recent months, a modest head of steam has been building in favour of legislating to introduce Dutch-style ‘Collective DC’ schemes into the UK pensions mix with Lib Dem Pensions Minister Steve Webb and the Labour frontbench making common cause on the subject. While ‘hybrid’ schemes are namechecked in the Budget consultation paper, George Osborne’s move yesterday further defines the UK system in the opposite direction – as an individualistic system, built around a customer’s right to choose their own retirement income, free from any constraints imposed by the pension scheme or provider they have hitherto saved with.
There will be an appetite to engage with the challenge of a reformed framework, and make it work, just as providers in the market will innovate to meet the demand created by the new rules.
- The FCA Market Study will need revisiting. While the FCA got a line of sight on these announcements a few days ago, it will now need to think through the scope, timing and purpose of its annuity market study. However much it may say it wants to run in parallel with the Treasury’s changes, the rules of the game have been changed.
- The insurance industry will rise to the challenge. Contrary to what some of the traders excitedly dumping stock yesterday afternoon will have thought, this is not a sector resistant to change and reform. Pension providers have spent the last few years developing both products and industry led reforms to help customers make better choices, including proposed reforms to sales and guidance processes that we announced only last week when we also called for some of the trivial commutation reforms that were announced in the Budget. We are also in the middle of our own far-reaching ABI review of the future retirement income landscape. So there will be an appetite to engage with the challenge of a reformed framework, and make it work, just as providers in the market will innovate to meet the demand created by the new rules – the stakes are too high for the retirement futures of customers not to do so.
Huw Evans is Director of Policy and Deputy Director General of the Association of British Insurers (ABI).