Tomorrow ({Thursday 14th November, we will hear from the Government how it intends to change the regulatory landscape for pensions to encourage pension schemes to invest productively and for individuals to have greater certainty over the income they receive in retirement.

The current regulatory landscape

There are two principal means of providing a pension for yourself in the UK.

The first is to have joined a defined benefit pension scheme and receive a certain pension from your employer, when taking into account the liabilities of the Government’s portfolio of unfunded DB pensions together with the Local Government Pension Scheme and the largely closed book of corporately sponsored DB plans , this remains by far the most efficient way to get an income that lasts as long as you do.

The second is to have joined or more recently been auto-enrolled into a DC retirement savings plan which will not pay a lifetime income unless an annuity option is selected. Only around 10% of savers use annuities.

There is a third option that may emerge. This is called CDC and it provides a pension in a similar way to DB but it is only funded by a defined contribution so the benefits cannot be guaranteed.  So far there is only one CDC scheme in place.

We have two regulators, the first is the Pensions Regulator, which oversees the activities of trustees , sponsors, scheme funders but not advice to members. Advice is regulated by the Financial Conduct Authority who also oversee pension plans that aren’t written under trust but contract law.

The distinction between the guidance offered to trustees by the Pensions Regulator and the rules based regulation of the FCA is stark. There are some grey areas, such as the annuity market which is unregulated and the offer of some defined benefit schemes to exchange pots for pensions.

I am only touching on the complexity of the pension system and hardly doing justice to the mammoth weight of the FCA rulebook and the various guidance regimes put in place by TPR. So extensive and varied is the landscape that many advisers confine themselves to talk about their area of expertise with little knowledge of what happens in other areas of pensions. This appears to extend to the regulators themselves who are ill-acquainted with each other.

There are two negative consequences to this complexity.

The first is that in seeking to give people freedom to do what they like with private pensions , we have created a great deal of trouble for those promised pensions. The transfer of hundreds of billions of pension liabilit9ies from DB to DC schemes has meant hundreds of thousands of us have swapped pensions for pots, often for the flimsiest of reasons. Many people did so to be able to pass on their pension pot without inheritance tax, they are now finding that their pot may be taxed at a marginal rate of 67% following the budget. Many people with pots , have no idea how to turn pots to pensions and workplace pension plans have no mechanism to enable this to happen by default.

The second is that the system that worked so well in paying certain pensions under the defined benefit regime has been stymied by an excess of caution in the valuation of liabilities which has led to funding problems. Instead of offering an advantage to recruitment and retention of staff, corporate DB plans have become a millstone around sponsor’s necks to a point where many will pay a 20% premium to be shot of them.

As John Hamilton has said in a recent podcast (relayed by this blog on Monday) trustees are  now assumed to aspire to an endgame which involves exchanging pensions for annuities. The concept of a pension scheme investing for the future with no endgame is not part of the regulatory landscape (unless the sponsor is using the LGPS).

This diagram, which I have used many times, shows the value destruction that occurs when a DB scheme closes for new entrants and then for future accrual.

Uncertainty leads to short-term thinking

I am regularly told by TPR that there is uncertainty about the regulatory landscape and that any plans that assume long-term investment beyond retirement are likely to fail TPR’s member protection guidelines.

This basically restricts the investment of pension schemes into long term assets to the accumulation phase of DC. So long as DB schemes are closed, they have to sell long-term assets – either to meet the requirements of annuity providers or those of the DB funding code.  Since most DB schemes are significantly mature , there is insufficient duration of liabilities to justify investment in productive finance. Most DB schemes invest purely in gilts and bonds, allocations to growth assets, especially the kind of assets the Government wants pensions to invest in, are now nugatory.

But the situation is little better in DC where the process of de-risking before the taking of benefits can begin as early as the members 45th birthday. Since it is assumed that savers will not want to take on “risk” in later life, each member is put in short-term investment strategies through the lifestyle process.

So both DB and DC schemes are invested with short-term horizons for all but young members. The trouble is that the young members have small asset balances. The net result is that only a tiny fraction of long-term pension plans are invested in long-term assets. The regulatory landscape for both TPR and the FCA assumes de-risking at a very young age and wherever there is a choice between taking on risk or de-risking, the latter is considered the right answer.

This must change

The pivot point for pension planning is not 55 or even 60. Many of us will live for 30-35 years beyond minimum retirement age. We have learned how to save – using real assets to invest for the future, but we have forgotten how to spend our pots, choosing to spend the pension last (for tax purposes) or to clumsily drawdown without any proper cashflow plan. The FCA’s retirement income study continues to show that most people with DC pots have very little plan and that what plans they have are frankly not good plans.

This must change. We need to allow two new ideas into the regulatory landscape. Firstly we must think of retirement as a period of investment, returning to collective decumulation schemes and investing without a fixed duration.  We must also encourage DB schemes to “run on” and even take on new members and open schemes to future accrual where members have not left employment.

This can be done by easing the rules on funding , by allowing elements of CDC (such as conditional indexation) and by allowing DB schemes to take in DC pots and exchange them for pensions.  All of these ideas can be entertained within the current guidance if regulators are prepared to take on a degree of flexibility in their approach. It will mean relaxing g some aspects of the DB funding code. the rules around transfers into DB schemes will need to be relaxed (so that these don’t prompt a red flag from ceding administrators) and we will need to start thinking of pensions as permanently open again.

This may sound a big ask, but it really isn’t. It requires a change of mindset, something we have been promised for some time,. but yet to see evidence of. We need innovation and to embrace innovation, things must change.