I’m using these cold and wet weekends we’re having, not to sit alone on my boat but to write to Government my thoughts on some of their papers that come out of the Mansion House Reforms.
The one I tackled yesterday is called
and it’s a call for evidence for the choice architecture trustees could present to savers when they get to the point when they choose- or have – to make decisions on how they spend their pension pot(s), making “pension choices”.
There are lots of options, spend it all at once, spend it chunks at a time, spend it on your heirs as an inheritance or take an income for life to replace the money that’s not coming from work. You can choose to manage these choices yourself, outsource decisions to an adviser but you can’t leave it to your pension scheme (trustees) because right now, no DC pension schemes are doing the choosing for you.
It’s place in the Mansion House Reforms is defined in the Ministerial foreword by Laura Trott
In addition to the existing choices available to members under the pension freedoms, this could include an offer of a Collective Defined Contribution (CDC) arrangement in retirement. My objective is to help savers achieve better outcomes through provision of CDC, where members can benefit from greater investment opportunities and consolidation in the market whilst supporting the wider government agenda around productive finance.
Proposal one – a default pension for a workplace pension
My first and most radical proposal is that trustees be empowered to take the choice of how you spend your pension by using the same mechanism that started you saving (inertia) to start you spending. Trustees could and should operate a default spending mechanism that turns pots to pensions.
Proposal two – the trustee determines the level of guarantee in the default
This is also very radical and I haven’t seen it written down anywhere.
There are two types of pension that can be paid to people who have saved into a workplace or non-workplace pension.
The first is guaranteed and currently takes the form of an annuity. There is also a scheme pension , where an occupational pension agrees to pay you a guaranteed pension at a set rate and reserves for this with the approval of the Pensions Regulator – TPR
The second is not guaranteed and is known as CDC, though the narrow definition of CDC envisaged by TPR’s CDC code , doesn’t yet include a pension chosen by an individual rather than an employer.
There are hybrids where an annuity is bought when it’s most wanted, when someone is close to death, this is known as “set and go” and requires the trustees to manage a person’s pot to a set point (say th 75th birthday) after which the pot becomes an annuity. Currently , this kind of arrangement is under discussion but I have yet to meet any trustee who thinks he/she has the power to force the annuity (in an age of freedom).
So “set and go” is not a pension , nor is drawdown in any of its format. To qualify as a default, the pension must be for life.
This may sound restrictive, but it needn’t be. We are at this level of architecture, only talking about the “default option”. People will have the choice of taking money away and exercising their right to do what they like – as the pension freedoms allow.
Proposal threel the Trustee provides investment pathways as Core Options for those who want some control.
There has always been a school of thought in DC pension design, that while most people want pensions “done for them” a sizeable people want guidance down various routes where they end up deciding the solution but have their direction of travel (pathway) , determined by certain core options.
We’ve got as far as knowing what these options are – they are “annuity”, “cash-out”, “roll up” and “drawdown”. Most people who do their own planning (or use an adviser) use one or a combination of these pathways and the choice of financial products is usually made with reference to the open market. This part of the market seems to me to be functioning reasonably well, though the FCA are working hard to make it better.
Trustees can maintain some influence on those wishing to follow core options by providing the pathways, for instance recommending an annuity broker, an IFA specialising in drawdown or a tax and investment advisor to manage efficient cash-out or inheritance planning.
Proposal four; the trustees provide a self-invested option (with safeguarding).
Just as choice architecture presents “core options”, so it presents people with the right to do what they want and here the only obligation on the trustee is to ensure that the money is dispatched to the member of a nominated source that is not a scam.
Proposal five; “partnering permitted “
In my view, trustees of DC schemes should take responsibility and self-manage their own defaults. But that is not realistic today for most occupational schemes. Most do not have the scale to operate a CDC pension and cannot broke annuities or provide scheme pensions. But they know organisations that can do these things.
Let’s say that Nest sets up a CDC decumulation section, then other schemes can partner with Nest to create scale within Nest. This could be done on a not for profit or for profit basis, Cushon or Smart could set up CDC sections for instance. But I’d be surprised if many employer occupational schemes would set up CDC and I’d be surprised if insurers used their master trusts for CDC – when they have strength as annuity providers.
Let’s say that an Aviva, or L&G or Standard Life or Scottish Widows, or another annuity provider also offering a workplace pension, wanted to offer an annuity as a default – let them. They would be obliged by the Consumer Duty to offer VFM – which might mean broking in some cases, and this would give confidence to occupatonal schemes to partner with such insurers, if they wanted to offer a guaranteed annuity as a default.
Let’s say a commercial consolidator – Clara or Pension Superfund for instance, wanted to open up a scheme pension option which provided an occupational pension with PPF backing as a default – this too could be a partnering option.
In the longer term, I see most workplace pensions wanting to offer an in-house , rather than a partnered solution, but that may be 10 years away. In the short-term, trustees – after consultation with sponsoring employers and members, may want to offer a default that sends people to other occupational schemes – as a default.
VFM and benchmarking
Most people will use the default offered them, we know this to be the case with pensions. But there will be people who want to test their default to make sure it is “good enough”, some will try and get the “best default” for them, because they know exactly what they want – but there aren’t many people like that.
People who don’t want to choose will have their pension “done for them” and people who want to look into the matter will be able to compare their default with other default options and switch schemes for “decumulation”. This is a choice that needs to be available. Pension Schemes that operated under the master trust assurance framework must be ready to take transfer- in from other occupational schemes – whether initiated by the trustee (partnerships ) or the member.
We must do some serious thinking about what the VFM Framework can do to help people compare default options, this is beyond the scope of this blog. I do think it right that anyone being defaulted into a guaranteed pension has a right to see what they could get from a non-guaranteed pension and vice-versa.
Finally – underwriting
People should be free to buy a pension without submitting medical details – if they choose). But this should be on an opt-in basis and a condition of operating a pension as a default should be that everyone should be given the option of basic medical underwriting at the point of making a decision. Similarly, they should be allowed to be underwritten based on postcode, lifestyle and (if rules are changed) gender.
People who aren’t satisfied with their underwriting decision should be free to explore options on the open market in a more detailed way (a core or self-selected option)
The Strait of Hormuz
Navigating retirement choice is like navigating the Strait of Hormuz, it’s dangerous and if even if you don’t get attacked by pirates, you can find yourself on rocky shores.
You need a trustee , like a boat needs a pilot. You need air and sea cover – you don’t want to do this on your own unless you are brave or foolish (or both).
The DWP have got the right idea with this consultation, but they need a firm blueprint for changes to choice architecture, this is what I have in mind.