A little architectural vision needed!

Well I’m back from 10 days in India where I saw the very rich and the very poor but not much in the middle. I saw some very fine architecture which showed me what can be done when people pull together.

One of the first emails I opened was from a friend wanting thoughts on whether we need to compel good behaviours at retirement or direct through strong defaults.

It’s a question that interests me enough for me to sit in jet-lagged stupor and pour forth!

The Past

The context for the question  is “DC pensions” ( we have a default system of scheme pensions for DB- from which you can opt-out by taking a CETV – provided you aren’t receiving your pension and are in a funded scheme). Whether there are such things as DC pensions is open to question. Most people refer to DC pots and leave the matter open!

The Australian bias towards compulsion is well known, you are compelled to vote and compelled to participate in the Super System. You can screw up your pension in Australia but each new raft of rules makes it harder. The Australians are moving towards compulsory annuitisation as fast as we move away from it!

Should Britain return to a system of strong defaults (as we did with the system of compulsory annuitisation that prevailed before the announcement of Pension Freedoms in the 2014 spring budget)?

Well let’s not forget just how much damage those semi-compulsory annuities did to people’s perception of pensions. The decline in voluntary saving into personal pensions may have been in part to do with the value for money of the savings vehicle, but I suspect it was more to do with the perception that you were locked into buying “rip-off” pensions.

It was no use arguing that you’d have done better if you’d shopped around, if you still felt ripped-off once you had. People looked back on the pension file to the SMPI illustration they were given twenty five years ago, saw they had completed their side of the bargain and asked why the pension on offer was so much lower than that which had been illustrated.

So pension outcomes have been lower than people (including the Regulators who sanctioned SMPI assumptions) anticipated. The markets may have contributed but people don’t listen to that kind of talk. They invest with insurance companies to get an insurance against market failure, not its product.

The Present

If the Pension Freedoms were the political answer for a Chancellor in search of a Rabbit, they have not (so far) translated into a practical answer for those with DC pots.

At the top end of the market, those who have invested in drawdown products where their pots remain invested in equities have benefited by a strong bull run in equities which has protected them not just from the impact of sequential risk (aka pounds cost ravaging) but from the impact of high charges. After advisory, platform and fund management costs, many people in “wealth management” programs are paying over 2% pa of their savings in costs. Add in the hidden fees and the average is estimated by Nucleus to be nearer 3%.

In short , people are having to beat inflation on their investments to break even, clearly this is an unsustainable state of affairs. The cost of advised drawdown will have to come down a long way, and come down fast, if it is not to be the next financial scandal.

At the bottom end of the market, the DC pots are small enough to be considered inconsequential and are generally being cashed out. The perception of “inconsequential” is the financial services industry’s. To those with say £30,000 in a DC pot , that sum is a major windfall in terms of immediate cash-flow. The problem is a pension is for life and not just for Christmas.

In the middle of the market are those with DC pension pots of upwards of £30,000 but below the typical minima for advised drawdown. The minima differ but let’s say £200,000 is typical.

For such savers there are three options if you want your money now, Do It Yourself drawdown, annuity purchase or cash-out. The evidence is suggesting that more people are deferring these choices and waiting till something better comes along, or they can wait no longer!

The Future

Back to the question. Where other countries (notably Australia – though also Obama’s administration) have recently been moving towards compulsory annuitisation, there is no political appetite for this to happen in the UK.

We have no more taste for guarantees in our private than we do in occupational pensions.

It is a well known behavioural phenomenon that when asked what they want from their pension freedom, two thirds describe an annuity (source Aon and others).

People want an annuity but aren’t prepared to pay for the guarantees. What they appear to want is soft annuity, rather like a with-profits fund that promises but doesn’t guarantee.

As those who run pension schemes know, promising may not be the same as guaranteeing but consumers (well at least their lawyers) are good at conflating the two things into one and demanding payment on the expectation.

What is needed in the future is a less burdensome form of annuity with protection for the provider against the kind of class actions that cost them dear with endowment shortfalls, with pension transfer shortfalls and most recently with the gap between PPI expectations and PPI outcomes.

A general answer to the question

I see no appetite in Government to compel people to spend their retirement savings one way rather than another. We are still too close to the policy success of Pension Freedoms for that, the damage of current pot-spending patterns has yet to emerge.

A far-thinking Government would be planning for the future and sinking money into the Research and Development of products that might offer annuity-light structure, either through innovation (the smorgasbord of Defined Ambition approaches considered by the last Government, or by the proper protection of CDC schemes from either failing their pensioners or failing because of their pensioners.

The distinction being that a badly run CDC scheme can (as with-profits predecessors) simply over-distribute. A well run CDC scheme can distribute properly but be brought down by members wanting too much too soon.

A strong Government would recognise that pensions have always been paid by the State or by large institutions with the scale to ride out market calamities. Occupational pension schemes have underwritten calamity and so have insurers. There is absolutely no evidence anywhere to suggest that a default solution of a self-invested personal pension with a drawdown strategy has ever worked as a default strategy for a nation.

A specific answer to the question

Given the very high risk of market failure in individual drawdown, it is amazing that the Government has not promoted (as it started doing in the Pensions Act 2015) a more structured and collective approach to pension decumulation using the Defined Ambition regulations that were worked on from April to July 2015.

By establishing the structure by which a collective decumulation approach could work, the Government could then encourage CDC providers to operate within safe-harbour rules that protected them from over and under distribution. This type of approach would – to a degree- satisfy the thirst from the public for something like an annuity without the costs of the guarantees.

That it would remarkably like a defined benefit scheme prior to the introduction of guaranteed benefit structures, is very much the point.

In answer to the lady’s question, we do not want compulsion, we do not to pay for  annuities as we know them but we want some certainty beyond what can be provided by individual drawdown.

The only way this “product” will appear, is if the Government gives it the safe-haven status accorded to highly-regulated collective schemes. The answer to the problems of pension freedoms are strong collective decumulation arrangements into which DC pots can be defaulted

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Thanks to all who came to yesterday’s lunch- I was otherwise engaged and sadly missed it!