A new retirement
[Check Against Delivery]
Recent analysis of the Budget changes and today's Queen's Speech formal announcement of a bill to permit the development of Collective Defined Contribution (CDC) is a reminder that just because we all keep repeating the truism that huge change is underway, does not make it any less true. Although I suspect the rhetoric surrounding CDC in the Queen's Speech will far exceed the reality.
Taken together the key changes introduced as a result of auto-enrolment, the 2014 Budget and DWP Command Paper add up to a permanent revolution in pension policy; a flat rate state pension, a further rise in the state pension age, the completion of auto-enrolment and price-capping at 75bps for default funds in auto-enrolment pension schemes. Not to mention a new governance framework for defined contribution contract-based pensions. But for all the policy boldness, these changes are really only the beginning of the main job of enabling a new retirement landscape to develop.
I have been asked today to take stock of this landscape drawing on our work since the Budget on the Guidance Guarantee, our broader analysis of the political and economic landscape and previewing some of the thinking emerging from the ABI's study of the retirement trends that will shape the future, which we expect to publish over the coming months.
Those trends, of course, will be shaped and determined, not just by political decisions but by wider factors, well outside the influence of domestic legislators or regulators.
There are demographic changes; the ageing population with the greater prevalence of dementia-related illnesses, the development of 'semi-retirement' patterns of working and the changing mix of asset wealth of retired people. We like to talk about this as a UK issue but life expectancy and longevity is ranging upwards throughout the world - with similar public policy and financial challenges for developed and emerging countries alike.
There are the profound economic challenges posed by the prolonged after-effects of the biggest financial crisis of the last 80 years and the continuing rapid growth of the emerging economies. Artificially low interest rates and the need to unwind QE remains a major challenge facing central bankers of the west while the economic effects of globalisation and the rapid growth of consuming classes in India and China in particular will continue to rebalance the world economy sooner rather than later.
Finally the speed and scale of digitisation around the world, the rapidity of technological innovation and the amassing of data it is allowing for is something we are still only beginning to understand, including the unpredictable interdependencies created.
You will be relieved to hear I do not propose to deep dive into all that although I will refer to these themes throughout. My point is simply that in considering the UK retirement market of the future, we have to be mindful of the variables outside our control, all of which have the capacity to create very different options for investors and boards in deciding how to allocate capital across an increasingly balanced world. It is not a given that all these factors will come together to create a healthy and prosperous UK market going forward.
So, with that caveat, let me start by talking about the Guidance Guarantee before moving onto how we think the market may evolve.
Guidance Guarantee
A huge amount has been written about this since the Chancellor sat down on March 19th and some of it has even been well informed. But let's start by going back to what HMT has actually said in its Consultation Document:
“The government wants to ensure consumers are empowered and equipped to make the most of their pension savings, and to make decisions that best suit their personal circumstances and risk appetite for the duration of their retirement. The government therefore proposes that everyone has access to free, impartial and high quality guidance so that they can make confident and informed financial decisions and access products that meet their needs.”
While I think the direction of travel was clear, I don’t think it will offend many Treasury officials to point out that we were left with as many questions as answers by its consultation document.
So our first task has been to get as clear as possible about the definition of the guidance guarantee.
And given we only have ten months until this service has to be up and running, I think we need to recognise that the guidance guarantee will be the art of the possible, rather than a perfect solution.
Firstly, we need a tightly defined scope for the guidance guarantee in terms of its audience, and its content. And the delivery timeline should concentrate our minds on this.
In terms of the audience, going back to the text of the Treasury consultation, the guidance is to be offered to “all individuals with a defined contribution pension in the UK approaching retirement”.
So the audience for the guidance guarantee is not the whole population approaching retirement, or people with defined benefit pension arrangements. In other words, its purpose is not to fix the entire unmet need for guidance on retirement income options in the population. This is vital to understand.
All people with DC pots is still a tall order – over 400,000 people are coming up to their selected retirement date every year, and we can expect there will be plenty of pent-up demand next April from people having deferred their decision until the new product and guidance regime is in place.
If the Guidance Guarantee is offered to everyone over 55, the numbers using it could be higher still.
So, what about the content of the guidance guarantee?
The Treasury document describes the choices now open to people – annuities and drawdown products, but also many more options, including accessing tax-free cash ahead of securing a retirement income or a more fluid mix of drawdown and annuity.
We think the guidance guarantee will be very valuable in helping people think through all the relevant considerations, including debt, dependants, other assets and lifestyle aspiration. But it should not seek to give answers on all these things - it must put the consumer in the position of being able to ask the right questions, and to know where to find answers. Basically, it must help people understand what they need to think about and where to get further help, including regulated advice.
So the guidance guarantee should be broad and look at all these factors, but it also has to be shallow.
Why?
Firstly, because there is a wider landscape of guidance, support and regulated advice. There are established third sector service providers helping with debt and benefit issues: Citizens Advice, StepChange, Which?, Age UK, MacMillan and others. And there are regulated financial advisers – no doubt including in this room - who can make a personalised recommendation about the right course of action for someone’s personal circumstances. It would seem odd for the guidance guarantee to seek to duplicate this.
Secondly, the pension industry is on the hook for paying for the guidance guarantee – the same industry that has just seen charge caps imposed on the workplace pensions it offers. So this has to be a value for money, tightly run process, making use of the existing systems – the industry cannot and will not sign a blank cheque for an “advice lite” process.
Thirdly, the sheer time pressure of getting this up and running inevitably means that the guidance guarantee will be more akin to an encouragement to consumers to “stop and think” before acting, rather than an in-depth exploration of all the issues I outlined earlier.
So for us, a good outcome of the guidance guarantee would be that people know there are risks in different option, that they are able to make a more informed choice about taking the pot as cash, buying a retirement income product, or leaving the money invested, and they know where to go with their other questions. This would be a big step forward from the current position.
So much for audience and content.
So how and when is the guidance triggered?
We think that realistically, this has to be triggered by the DC pension pot and individuals’ retirement timeline. As now, it could be a date ahead of the customer’s retirement date (but probably much earlier than six months out), or when the customer asks about making a withdrawal.
This clearly has the disadvantage that people with more than one pension pot will be offered the Guidance Guarantee more than once. But short of creating a central database with all providers’ pots, so that the Guidance Guarantee is offered to individuals once, and which is certainly not deliverable by next April, this is inevitable at least initially.
As I said before, triggering the Guidance Guarantee to everyone in the population over a certain age would go well beyond the Budget announcement. It may well be needed, but should not be our focus now. Again, this is the art of the possible.
Over time, pot follows member should help avoid multiple pots.
As to delivery mechanisms, I think there is a growing consensus that in a multi-channel world, an exclusively face-to-face delivery would ignore people’s preferences, not to mention the logistical challenges of delivering the Guidance Guarantee face-to-face on, say, the Outer Hebrides.
And even people in urban areas may prefer to use a telephone service rather than having to visit a guidance centre.
So face-to-face has to be an option, but the Guidance Guarantee should also be available over the phone, the web, and make use of Skype, web chats and other forms of delivery.
So who should give the guidance guarantee?
This has been the big question played out in the media, with talk of industry splits over whether pension companies should do the guiding or leave it to others with no existing relationship with the customer.
We are still finalising our view on this and our modelling work with KPMG has looked at a range of options.
But any solution must pass the impartiality test and must be on the side of the customer – objective, sales-free and neutral of commercial interest. Guidance is not about selling to the customer, but helping them understand their options and where to go for further help.
We believe organisations like the Money Advice Service and the Pensions Advisory Service who already operate in this space, must have an important role in any solution.
UK Market
But of course what ultimately matters to customers is not the process but the outcome. So what sort of market could they be heading into, in terms of the products available and the likely capacity of providers to innovate?
In the near term, we expect to see a significant number of retirees take advantage of the new trivial commutation rules – it is worth remembering that in 2013, 63% of annuities were bought with less than £30k. For them, this is probably the right decision and this is one of the areas the industry publicly urged the Government to look at ahead of the Budget. It will be interesting to see if this money is reinvested in ISAs or spent. We would also expect to see some people continue to annuitise either with their existing provider or potentially shopping around if they have a specialist need or for a more competitive offer. Finally, some people will undoubtedly defer a decision and nearer the time we will all have a part to play in emphasising to customers that April 2015 is a point at which they have wider options not a date when they have to exercise them.
For the industry, the near-term is dominated by the implementation challenges of the introduction of the Charge Cap, the completion of the OFT audit of legacy pension schemes and the continued roll-out of auto-enrolment to name but a few. No doubt all of them will also be working on products and marketing to appeal to existing and new customers for their business in the new world but it is far from clear yet that lots of new innovative products will be ready for market in April 2015, not least because regulatory and political timetables rarely run in parallel.
In the medium term (up to 2025), we would expect to see the development of a wider range of products as the regulatory climate becomes more certain. This is particular relevant to the question of whether variable annuities build up in the UK market. The Chancellor’s vision would certainly seem to encompass them but UK regulators have been lukewarm to this point because of their similarity to With Profits which they find too opaque and risky for the customer and the insurer. Either way, we would expect to see more products with annuity-style features, not least because the fundamental customer need for longevity insurance and some certainty in retirement income will not have gone away because the Government has changed the rules on compulsion. This is one of the many reasons why the predicted death of the annuity market seems exaggerated. With the Single State Pension and the DB elements that many in this cohort of retirees will have, it would make sense for many customers to defer annuitisation, possibly linked into the kicking in of care needs.
For the industry, this cohort of retirees will need products that acknowledge their likely mix of DB-DC pensions, the importance of property equity and the likely care needs component of their retirement requirements. A key unknown is whether consumers will be getting the fully regulated advice that many more of them are going to need. Either way, providers will be seeking to fully maximise direct channels to help customers with the range of choices they will face.
Inevitably the longer term is more difficult to speculate about, but given the increasing digitisation of this market and the greater technological sophistication of this cohort of retirees, we would expect Platform-based services to be a much more significant part of this market, served by an ever wider range of providers catering to active management customers will require of their DC and ISA assets. Brand trust will be important here alongside technical support and ease of use. People retiring in the 2030s will still probably be on the right side of the property market as well as having received inherited property assets from their parents but as we head into the 2040s and 2050s, we may start seeing generations of retirees whose saving capability and asset accumulation will have been impaired by their student debt and lack of access to the housing market in the first 20 years of this century.
Industry thinking and international
But of course we are not alone in facing these challenges, including that of people having accumulated enough to start with.
When it comes to spending down DC, other countries have tended to follow one of three paths; lump sums, programmed withdrawal and annuities. Interestingly in Australia and New Zealand, which have travelled furthest from the annuitisation model, there seems some early evidence of a return to interest in annuity markets - perhaps unsurprisingly given longevity risk remains, even if annuities have been out of favour.
Well, as we are in World Cup build-up and everyone seems to have a fantasy team, if we could mix and match different elements of how other countries have approached this, what would be our fantasy mix of components?
For levels of accumulation, I think we would all go for Australia, 20 years down the line from its own 1990s pension reforms with mandatory contributions increasing to 12% by 2022 and an average pot at retirement of £64,000. But we probably wouldn't go for their state element; a pay as you go means tested benefit versus our single state pension. Similarly the Singaporeans and Chileans have also gone down the mandatory contribution route with both offering a mix of programmed withdrawal and annuities.
For awareness and simplicity we may be tempted to emulate something like the United States' 401(k) plans or the New Zealand Kiwisaver account. But both offer some partial withdrawals which damages accumulation and in the Kiwisaver have low contribution rates.
Flavour of the month with Steve Webb and some thinktanks is the Dutch model of Collective DC, with generous claims made for its return vs traditional DC models. Yet would the individualist UK model - which is further entrenched by the Budget - really fit with an approach that provides no flexibility for individual circumstances and sees the younger members so directly helping the retirement income targets of the retirees? It is worth noting that the legislation announced today will only be to remove the existing barriers to the setting up of CDC schemes. It does not make it Government policy to promote them or proactively help establish them. This is significant because a largescale move to CDC would be a very profound change and would require considerable more thought and scrutiny of the implications than has hitherto been the case.
So, maybe not going Dutch after all but certainly looking closely at the Australian experience and also that of Canada which has gone down the route of mandated employee contributions of 5% matched by the employer.
But how about if we make our own rules? What would be some of the components of a healthier at retirement market?
Firstly, a reformed tax relief model. Last September the insurance industry called for a debate about the future distribution of pension tax relief, reversing its previous defence of the status quo. Providers did so because they want tax relief to remain given its vital role in encouraging people to lock away savings and agree that the current distribution makes it more difficult to defend if we are all to build on auto enrolment with higher contribution levels going forward. We would like a debate now about how a single rate relief could potentially better encourage pension saving and with the cross party backing it would need to bring much needed political stability to this issue.
Secondly, build on the guidance guarantee to develop a more engaged population which takes a more holistic view to financial planning. We cannot hope to encourage people to accumulate and decumulate sensibly when 35% of people typically say they do not understand the impact of inflation and 16% of people cannot identify the balance on a bank statement. We are developing a range of new policy ideas about how to meet these needs and help people understand their income options; a challenge not just for providers but for employers, individuals, Government and the third sector.
Thirdly, help develop a market that is capable of greater personalisation to meet individual circumstances. The Budget changes are a big step forward here but the needs of dependants, challenges of meeting health or care needs and facilitating further the use of property equity are all going to be vital importance if people are to have routes open to them that meet their specific needs. This is where economically viable advice and clear boundaries between advised and non-advised from the FCA will be important.
Finally, we need to build on the Budget reforms by ensuring a liberalisation of the regime stays simple. We have all been around long enough to know that previous attempts at greater liberalisation or simplicity have ended up being made more complicated than needed as more water has passed under the bridge. That must not happen now - and that is a message for Government, the Opposition and Regulators alike.
Political/regulatory risk
Which takes us to political risk. John Hutton covered much of this in his remarks so I don't propose to dwell on it except to say that we desperately need a return to more cross-party consensus when it comes to pensions and long term savings policy.
By this, I don't mean that the Opposition of the day is under a moral obligation to never disagree, nor that politics should somehow be taken out of the equation entirely. Neither aspiration would belong in the real world. But it is a hard fact that we will not see the innovation in the retirement, long term savings and social care markets that policymakers are so keen to see, if providers and their investors view everything as being vulnerable to a five year political cycle. Neither auto-enrolment nor A-Day could have been achieved without cross-party consensus, nor more recently a Single State Pension and the rising of the retirement age. I would like politicians of all stripes who engage in retirement income policy to do so with a mindset that broad consensus is a prerequisite of successful implementation and to reserve significant objections for issues on which they cannot agree, rather than look for territory where they can score political points that don’t hit home with voters but do destabilise the market.
But of course our regulators have a key role to play too, both prudential and conduct, UK and EU - and internationally too. And increasingly we see regulatory requirements which pose a tension with consumer and political demands of the providers. Prudential regulators want an insurance sector more heavily capitalised according to international standards. Yet domestic governments impose charge caps and customers demand ever-lower prices. Conduct regulators continue to want to pursue a significant 'legacy' agenda, yet ministers trumpet important reforms to retirement income and social care and call for industry to focus on future product development. Regulators focus ever more closely on the boundaries between guidance and advice - and with good reason. Yet, customers empowered by technology want the freedom to buy easily and cheaply. The frightening thing is that I could go on.
From a provider perspective, insurers don't sit easily on either side of many of these divides. But ABI members have to try and reconcile these conflicting demands ensuring they continue to deliver responsible stewardship for the £1.3 trillion of assets they are already responsible for, all the while competing for capital to develop their businesses against markets and jurisdictions which do not provide such challenging dynamics.
Conclusions
So I hope this has given a flavour of the ABI perspective on the at retirement landscape, two months on from the Budget, 11 months before the General Election and a year into the new UK regulatory structure.
It is a fascinating time with a huge amount at stake and the potential to end up with a much healthier, sustainable retirement landscape to suit the future needs of customers much more effectively than the old system had ended up doing.
What is abundantly clear is that some of the debates which have dominated the airtime for so long about how to get people to save and what rules to fix around annuities now feel about as current as sitting through an episode of Top of the Pops 2.
I began these remarks by highlighting the very profound changes facing our society and our wider world and it is relatively easy to stand back and marvel at the scale and importance of the changes affecting our world. But all of us who care about retirement planning - and I am sure that covers everyone in this room and many beyond - have a duty to engage - not stand back - with what these changes will feel like for the people who need the retirement landscape to work better for them in an uncertain and fast-changing world.
Amid all the talk of 'freedoms' and the benefits of living longer, we must never lose sight of the importance of ensuring that when people have saved all their working life for retirement, they get an outcome that enables them to live their final decades with peace of mind, comfort and high quality care. Delivering a better retirement landscape is not just an opportunity for this generation of policymakers, regulators, providers, distributors and advisers - it is a moral obligation. As we live longer, often with very challenging later life conditions, the quality of what we all do in this market will be tested like never before. I hope the deliberations today play a modest part in helping make that better future a reality.