Today we are talking about how the industry can help future pension savers make better decisions.
One of the biggest changes influencing the way people currently make decisions about their income in retirement took place this year, in the form of the ABI’s Retirement Choices Code and I will talk about that in a moment.
The code applies to all insurers who are members of the ABI, and has changed the way member firms communicate with and guide those making retirement income choices.
As part of the development of the code we researched people’s behaviour at retirement and we have carried out more research recently to establish a benchmark of current practice to measure the impact of the code as it takes effect.
But today I want to look beyond our Code. I want to consider what a ‘good’ outcome will be for the needs of the retirees of the future as the impact of pension reform changes forever the retirement landscape in the UK.
How will the increased likelihood of a need for long term care in their retirement years impact how industry, Government and savers respond to planning for later life?
How will the development of enhanced annuities that are increasingly personalised and require some form of underwriting affect the process of making decisions at retirement?
How will we deal with the sheer numbers of individuals reaching retirement with a defined contribution pot which they want to turn into a retirement income?
How will we engage a generation of automatically enrolled savers to start thinking about their needs and options at retirement early enough to make a difference?
And can we begin to take a more holistic approach which accepts that pensions planning can't ignore the impact and challenges of personal debt levels?
We will need a new approach and now is the time to start thinking about this approach.
We are moving into a world where people will need more flexibility and choice in later life, and as a result, will have more choices to make.
It is the pension industry’s job to respond with retirement solutions. And our regulators (all three of them), in their role of making markets work well, will need to be at the table at the start with us as we develop these solutions.
The regulators will also need to find ways to enable customers to benefit from the right framework for advice and guidance in this new retirement world.
I want to look at the social and demographic factors affecting our changing world and shaping the retiree of the future and talk through the challenges and opportunities we have in delivering the best retirement outcomes for them
How far we have come
A decade ago, the Pension Commission set out to see how pension policy could be adapted to tackle the challenges of rising life expectancy and a chronic lack of saving.
We have seen a lot of changes since then.
One of the Commission’s recommendations, auto-enrolment, is underway and will see millions of people saving into a pension – most for the first time.
And we have seen a clear timetable to bring in the single-tier state pension, a key part of the reform agenda.
In the same twelve months that the most significant reform to UK pensions savings was rolled out, the largest industry-led transformation to the way people currently buy annuities was also launched.
The ABI’s Retirement Choices Code will do what it says on the tin – give people more information on the choices they can make at retirement to get the best pension income for their needs.
The code will provide clear, timely information to help people approaching retirement understand what their options are.
At least two years from retirement the insurer will encourage the customer to consider their options.
Six months from retirement, and again at least six weeks from retirement, the insurer will send details explaining the various options, such as combining small pots, and shopping around for the best annuity.
It will explain the different ways to take a retirement income. This will include providing for dependents, taking account of lifestyle or medical conditions that may mean they are eligible for an enhanced annuity and the opportunities to protect against the impact of inflation.
And it will encourage shopping around for the right pension deal.
The benefits of shopping around among other providers will be clearly highlighted along with sources of further advice to help customers make the right choice.
Insurers will no longer include annuity application forms, so there will be less chance that the customer will buy from their current provider without first shopping around.
So in the last decade, we have seen major changes to help get people started on saving for retirement and changes designed to make them better able to deal with their decisions at the end of the pensions savings journey.
It is a good start. But what needs to happen next?
The first point I'd like to make is that predominantly, today's annuitants are arriving at retirement after having had a ‘retail’ experience up to this point.
They will have been advised by an IFA, or if they have been saving for ten years or more, potentially by a salesman from one of the large direct sales forces which existed in the insurance industry in the 80s and the 90s.
They may well have stopped saving after only a few years, and will have suffered from disappointing equity market returns over the last decade or so.
And they will have arrived at retirement at a time of historically low interest rates, with a consequent effect on annuity rates.
They will, on the whole, have found themselves over time with less contact from their adviser or salesperson, and more of a direct relationship with their product provider.
The ABI code reflects that, and is significantly about improving the interplay between customer and product provider in the months before the retirement decision has to be made. In other words, our code sets out to make the system work better for the current generation of retirees.
Future generations of retirees will make their decisions in an environment which is different in a number of respects.
Firstly, there will be an employer involved far more actively than now.
The employer will be well aware of the imminent retirement of their employee and will be dealing with the pension decision along with a number of other important human resource issues.
Next, the provider - whether it is NEST, or a large insurer, or a sector wide collective scheme - will have a relationship in most cases with the employer and the rest of their employees and a long-term relationship with the employee.
Given the approach of auto-enrolment, it is likely that the employee will have continued saving right up to retirement, and possibly saved more as the years have passed as a proportion of salary.
And, in all probability, for all these reasons, the size of the pension pot accumulated will be significantly larger than is currently the case, particularly with a pot-follows member solution.
And, as I've said, the range of options available will be significantly wider than is currently the case, and the income calculation will almost certainly extend to a consideration of total assets, rather than just the pension pot.
Bigger pots and much more volume.
Many more people making more complicated decisions.
So scalable advice and guidance will be essential.
And for me the workplace will be a key to making this work effectively and economically.
So how do we make sure all of these people get good outcomes?
As I have said, it will need a new approach.
The pension industry will need to respond to the increased amount of choice and flexibility customers will demand.
Government, working with us, will need to take an active role to ensure that the millions of people it has automatically enrolled are prepared for and guided through the decisions they have to make at retirement.
And the regulators will have the dual role of supporting the pensions and advice industry to deliver products for the changing needs of employees, and making sure employees are able to get the advice and guidance they need to get the best outcome.
It is true that automatic enrolment is built on inertia and the concepts of behavioural economics.
But I believe that as people begin to get some scale into their pension pots, the key will be to move from inertia to genuine engagement.
Ownership of their retirement future is, to me, a key component in encouraging people to do more than the minimum during the saving period and get the best outcome in retirement.
This challenge will need to be at the heart of the new approach.
The reforms will hopefully see an influx of lower to middle income workers saving for retirement.
These people have, quite frankly, never had these decisions to make before.
They are not typical of the clients advisers operating in the post RDR world are focused on.
And they are likely not to be the most engaged or experienced at making what may be complex financial decisions.
So how do we guide and help the increasing numbers of people we are bringing into the system? How do we encourage them to take action over their retirement?
I want to consider first what people do now. We can learn from some of the behaviours we see today as we think about designing the system of tomorrow.
Learning from current behavioural patterns
The ABI’s recently published research – findings of which are included in your pack today – was primarily designed to give us some benchmark measures against which to track improvement over time.
But it also gives us insight into what drives different types of behaviour at retirement.
While our Retirement Choices Code will help savers become more aware of their options, ultimately, these are decisions only the individual can make.
We also have to remember that the research we have just carried out is into a different group of people than those that will make up the vast majority reaching retirement in a defined contribution world twenty or thirty years from now.
Our sample is from a retail market, rather than employees from a workplace pensions world.
Let’s look first at the process of alerting people to the upcoming decision.
Our Code is designed to prevent people sleepwalking into a default option at retirement and encourage them to shop around for their best option.
To help do this, pension providers will include clear information on shopping around in the packs they send out to customers ahead of retirement.
However, our research found that currently, over a third (36%) of people do not read these ‘wake-up’ packs.
It reinforces the point that many people find the language and concepts of finance challenging, and their natural inclination is to ignore the material, even when they know the decision is a critical one.
Our code acknowledges this too, building in to the customer service process key stages where the customer is alerted to the fact that the wrong decision could be an expensive one in terms of their future retirement income.
It reinforces the need for positive engagement between the pensions provider and the individual, well ahead of the decision being made.
Our code proactively alerts the individual at least two years before the retirement date which is held on the records of the product provider.
This first discussion may well be about when the customer thinks they will wish to retire, since this will almost certainly be a different date from the one they had in mind when they took out the pension plan, perhaps 20 years ago.
Remember this was a retail market, not the workplace market we will be dealing with in the future.
Of those that do read the wake-up packs, our research showed various factors influencing the extent to which they take action to shop around.
90% of people are aware they can shop around, yet only two thirds do so.
Not surprisingly, the lower the level of understanding that the customer has of the way that pensions work, the less confident they feel about shopping around and the less aware they are of the potential benefits.
People who spent time and effort and used more ‘formal’ methods of shopping around, such as help from an adviser, were most likely to gather quotes from different providers and switch.
Size matters when it comes to whether people shop around at retirement.
Our research showed a clear correlation here – the bigger the pension pot, the more likely the person is to shop around.
The proportion of those shopping around at retirement rises to 80% for those with pots of £50,000 or more.
And it isn’t just about income levels.
It's also about the best type of annuity for the customer, depending on age, health, dependents and other sources of income. And that's where guidance and advice come in.
The next generation of retirees
But what about the next generation of retirees?
Let’s first look at the social and demographical developments characterising the future generation.
- They will work longer
- Most will have had a number of jobs during their period of full employment
- Many will use a combination of retirement income and earned income to live in retirement
- Many will have a number of ‘families’ for whom they are responsible (because of multiple relationships) and potentially a number of generations (their parents and their children)
- Many will move into retirement with significant levels of debt
- They will utilise other assets (their home as a key example) as a source of income
- They will see the risk of needing care as an issue they wish to address safely
- And, it will be the norm that the annuity solution reflects the state of health of the retiree and their dependents (where a joint annuity is taken).
It seems to me - and this is hardly a new insight - that we can't look on the decision point around retirement as a 'cliff edge' or ‘one dimensional’ decision.
In many ways, I think our approach has to start, let's say, at least ten or 15 years before it’s a possibility.
This would give the employee a chance to start thinking about a target income in retirement rather than a capital sum.
It would give them a chance to think about some level of guarantee on that income, at a price which might be affordable to them.
It would allow them to consider their family situation, those likely to continue to be dependent on them, the level of debt they were carrying and what steps they can take to manage that.
And their state of health generally and how long they felt able to carry on working, full or part time.
A more holistic approach to life stage planning, in which retirement is a significant element, but other aspects of lifestyle feature also, makes sense to me.
The timing of this proactive intervention would be driven by the level of the employee's pension pot also.
As the individual gets more engaged with the fact that they are beginning to establish a level of financial independence, we should start getting them to think about how they can build further on what they have already achieved.
The industry has work to do here too.
We have started work on clearer disclosure of costs and charges, and a better 'bank account' style of statements for employees and other pension savers.
It is essential that people are persuaded (because it’s true) that they are getting value for money from their pension provider and that they know where they stand.
For me, the next step after getting the basics right, will be utilising the mobile technologies which already exist to allow employees to ‘scenario plan’ the income their pot might generate in the future.
We can already use apps on our multimedia devices to do so many things in this area, but there is much more that we can achieve.
It is vital that we continue to upgrade the ‘plumbing’ of the retirement industry as we aim to improve the outcomes for the current generation of retirees.
But we need to think ahead to what will be a very different environment for those retiring in ten to 15 years’ time, as pension reform changes the landscape for the ‘at retirement’ market.
Changing work patterns, changing lifestyles and a different population of retirees need as significant and as radical an approach to ‘at retirement’ as the Turner Commission's approach to pension saving was ten years ago.
We need to pool the expertise of the pension industry, the regulators, politicians of all parties and the DWP to develop a sustainable and effective approach to the massive challenge of retirement in the 2030's and beyond.