It is odd thinking of the work that goes into the valuation of Defined Benefit Schemes, that so little has been done to help individuals value their DC pots. I don’t mean by that the monetary worth of a DC pot but the valuation of what it might offer the potholder in later life.
Compare the conversations on this blog over the current state of the USS finances with the work done to date on investment pathways. In terms of rigor there is no contest, the vast weight of professional support is to the trustees and sponsor of the DB plan while those left to convert their pots to pensions are to all intents and purposes – on their own.
This is the flipside of pension freedom, while the freedoms brought choice, the freedom not to choose was binned, meaning that millions of savers will reach retirement with minimal guidance and next to no advice.
What is even worse, they will have no yardstick to tell what is “good” or “bad” as a choice. the best we have come up with so far is the 4% rule which tells a saver that by dividing the pot by 25 they can get a rough idea of what a sustainable income in their retirement might be.
So far the attempts of those in the pensions industry to improve support for DC savers has been to give them access to modelling tools which improve on the 4% rule and compare the cost of guaranteed (annuity) solutions , with market vulnerable investment (drawdown) solutions. A few modelers also help focus on tax (for instance the First Actuarial muppetometer) and the occasional lateral thinker has tried to create holistic cashflow planners that integrate pensions with other income to give savers a cashflow model for the future.
But all such tools are “self-service”, accepting that individual savers are on their own when taking these decisions.
Can we further standardize our choices?
The investment pathways, that were introduced on the first of February are an attempt by the FCA to standardise choice into four.
The direction of travel is right, at least this limits the choices to digestible options. When we started delivering investment choice to DC savers in workplace pensions , we had the same idea, most providers offered three or four “core funds” that catered for those with low , high and average risk appetites.
But this idea quickly became superseded by a single “default” option that catered for the average person and around 90% of DC savers now use this standard choice.
In the early days of workplace pensions, high dependency on the default or standard option was seen as a mark of failure and members were encouraged to engage with their own investment strategies. This too has an analogy with the current situation with DB pensions , where the Pensions Regulator is looking to standardize investment strategy through a “fast-track” approach which allows light-touch regulation in exchange for a prescribed way of doing things.
But the Pensions Regulator has found fierce opposition to such prescription from the trustees and advisers of DB schemes who see their jobs as managing investment risk their way (supported by the resources of advisers paid for by sponsors ).
The regulators may well be wondering why at a collective level, trustees and sponsors look for the freedom of “bespoke” solutions while at an individual level , savers crave for standard or default solutions.
The answer is obvious and it informs on many of the debates we are having in pensions. Solving what Bill Sharpe termed “the nastiest hardest problem in finance” – turning a pot of money into a wage for life is a lot easier to do in company with others than on your own. Firstly, collectively you have economies of scale both in the purchase of investments and the advice and administration needed to govern them.
Secondly, you can insure the risks of living too long within a pool (provided people are happy to accept average life expectancy).
Finally, by providing a default solution by way of a collective pensions, people have the option not to take decisions that they see as “too hard”.
Why self service for pension choice may not be enough.
In this blog I have made two points
- Individually, people look for standards and will herd to the average , even when they have the freedom and support to self-serve.
- Collectively, trustees are prepared to take decisions where they feel supported in doing so and do not take kindly to being fast-tracked.
When thinking of the advantages of collective pensions, experts have typically focused on economies of scale and opportunities to pool mortality, but their may be a greater advantage to them yet.
If a collective solution could be applied to defined contribution schemes, at least to replicate default accumulation in the spending phase of the pension, then the difficult choice of the investment pathways could be simplified.
Investment pathways could become like “core funds” became to workplace pensions, convenient buckets for those who wanted a degree of choice, without the kind of detailed design associated with advised solutions.
Fifteen years ago, Emma Douglas,divided DC savers into “bunnies”, “bears” and “badgers” or to use the kind of terms – pension people favor….
I suspect we are now at the same point with our thinking about how we turn pots into pensions.
I would not be surprised if the green arrow, which became the standard for accumulation , doesn’t reassert itself, this time – called CDC.
Alchemy? We have changed the label on pensions many times but polishing a turd is not a solution.
We need a productive economy to provide a living wage for the 50% of the population who have nothing left at the end of the week for saving.
QE will only widen the have/have not divide in both wealth, health and longevity
Advice is being manipulated by nudge and regulation to produce a tick box commoditised service designed to preserve the status quo. Innovation is punished
It has been said many times but you can’t solve this problem at the level of thinking that created it