In its Retirement Outcome Review (interim report), the FCA were clear on evidence of a problem
The blame lies not with thick consumers but with lack of competition
If competition is not working effectively and consumers make uninformed retirement income decisions this could lead to different types of harm, such as:
- paying more in charges and/or tax
- choosing unsuitable investment strategies
- missing out on valuable benefits (eg employer pension contributions) or investment growth
- running out of pensions savings sooner than expected
We will carry out further work to assess the harm these emerging issues may cause.
In the full report, the FCA point out that
Stakeholders identified several barriers to innovation, including the pace of political change, lack of demand from consumers for new innovative products, overall consumer inertia and lack of engagement and small pot sizes of the current cohort of retirees
The FCA issue a threat to the private market
If the market fails to deliver innovative products for mass market consumers, there may be scope for NEST to fill an important gap.
NEST have published their own blue print, which while limited in scope, offers the mass market who cannot afford advisory fees to drawdown or the limitations of a guaranteed annuity – an alternative. You can read the details in section 14 (NEST blueprint)
The relevance of collective solutions
Until recently, a collective occupational pension was accessible only to employers. However, recent legislation (PO/08) has meant that individuals can choose to invest in master-trusts (if the master trust allows), independently of their employer.
What the FCA and NEST have in mind, is for individuals who have built up a retirement pot (rather than a “DB” right to a pension) to transfer that money into NEST for NEST to pay what amounts to a scheme pension to that person.
Personally I find NEST’s blue-print a little unambitious, it does not employ the kind of collective pooling which it could, but it does embrace many of the principles of Collective Defined Contribution Schemes (CDC) , that could counter the market problems outlined by the FCA.
NEST is structurally no different from any other master-trust, if NEST can take such money, so can the 70 odd master trusts currently being used for DC purposes in the UK.
Is the NEST Blue-Print fit for purpose?
The difference between what NEST is offering in its Blue-print, and what defined benefits offer seems small but is massively important. A defined benefit scheme is managed to provide a pension ( a regular series of payments) till the death of the pensioner (or sometimes a surviving spouse/partner).
Occupational schemes can offer to pay till death because they pool the risks so that people who die sooner subsidise those who die later. This is life insurance in reverse.
NEST cannot currently offer its own pooling and therefore proposes to rely on the annuity market to offer individual annuity products to those getting to advanced years. This creates a cliff-edge which is likely to be seen as a bad thing by ordinary people used to being looked after by seamless products like the state pension and occupational DB schemes.
Even if NEST was to implement its Blue-Print, I don’t think the proposals to annuitize at a set age (say 75) would meet with popular approval.
Why doesn’t NEST just offer scheme pensions like DB schemes?
The DB occupational pension scheme offers certain guarantees, most importantly the guaranteed that there will always be enough money in the great big pot , to pay all the pensions. Traditionally, occupational schemes have had to have a sponsor willing to top up that pot in the case of it not being big-enough to meet the guarantees.
But recently, a new type of collective pension has emerged that aims to be self-sufficient of future funding. Such a pension relies either on an initial injection of cash (BHS2, British Steel Pension Scheme 2) or income from a business it takes over (Kodak) or from pre-funding by the rest of occupational schemes (PPF). Another model is being put forward by the CWU to the Royal Mail which scales down the guarantees of a DB scheme till the sponsor can almost see it like a DC scheme.
All of these models will provide people with scheme pensions (the kind of pensions that last as long as you do but are paid from the central pot rather than by an insurance company as an annuity.
What’s stopping NEST from joining in?
Here is the problem NEST and other occupational DC plans currently have in providing the kind of scheme pension that people want (a pension for life).
As soon as a DC pension promises to pay a pension for life, it becomes a DB pension. NEST cannot be a DB pension nor can NOW or Peoples Pension or Blue Sky or any of the others.
The only way they can take on this kind of obligation is by dropping the guarantees and by moving to a “best endeavours” approach. This would be possible if legislation ,enacted in the Pensions Act 2015, was completed in its detail.
But in 2015, this detailed drafting work was stopped because the Government did not see the need for a new kind of third-way pension scheme. DB might be dead, but employers would not commit to a non-guaranteed version – for fear that at a later date, they became on the hook for promises made on a best-endeavours basis.
This line of reasoning was flawed. It was not employers that the DWP should have been talking to, it was employees and even the self-employed. Infact all the people who are struggling now to know what to do with their pension pots.
These people would benefit from NEST or any of its rivals paying scheme pensions without guarantees. It is precisely the system under which defined benefit pensions were established in the fifties to the late 1980s. People paid into pensions with the hope of getting their pension paid in full but without the guarantees that were introduced from 1987 onwards.
Can people stand any degree of uncertainty?
We have yet to test the market on this question. Currently people are given a binary choice between certainty (annuity) and uncertainty (drawdown of various kinds).
The non-guaranteed scheme pension provides a higher level of certainty than drawdown but a lower level than annuity. It depends on mortality pooling (the principle that those who die sooner subsidise those who die later), it depends on actuarial prudence and it depends on increased efficiency from pooled investments and pooled administration.
It should not be dependent on capital markets (hedge funds, derivatives and other exotics), scheme pensions should be payable through a clear mechanism which has transparency throughout. Money invested should be transparently invested, the funding position of the great big pot should be totally clear and there should be clear rules about exiting the arrangement so that people who wanted to transfer away, knew in advance how they would be treated.
This kind of scheme can be arranged quite easily on paper, but it cannot currently be put into place, because the secondary regulations, which began to be drafted in 2015, have yet to be completed. I’ve spoken to the people who started the job and they reckon there is two to three years of work left to be done.
I nearly typed “NEST steps”,
The FCA are worried there is no innovation, there is no real innovation in the mass market because there is no regulatory space in which to innovate.
In the short-term, master trusts like BlueSky and Salvus are already offering the NEST Blue-Print through Alliance Bernstein’s Retirement Bridge product. The FCA could see innovation at work. But these products are still not offering what people really need which is a scheme pension payable for life (without guarantees on how much).
The FCA need to test whether people will accept more pension ( than an annuity will give) for less certainty. They need to do their market research not on companies but on people.
If they find that people are prepared to give up some certainty (particularly about guaranteed pension increases but also about the fundamental floor of income from the scheme pension), then they should allow products to be built to meet this demand.
This will mean allowing the products to be developed in lock-step with the regulation, so we have a reasonable chance of delivering scheme pensions to the mass market in the early part of the next decade.
If we do not do this work now, then we will continue to come up with partial unsatisfactory solutions which don’t provide people with a real alternative to drawdown or annuities (being a combination of both).
I urge Big Government – as the Pensions Regulator, the FCA, the DWP and the Treasury to take these next steps , resume work on the Defined Ambition regulations, consult with the occupational master trusts and most importantly , start the work of managing expectations of what people can expect in the complicated risk/reward trade offs explored in this blog.