Pension Schemes Bill

Written evidence submitted by the Investment Management Association (IMA) (PS 16)

About the IMA

1. The IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the in-house managers of occupational pension schemes. They are responsible for the management of around £5 trillion of assets in the UK on behalf of domestic and overseas investors.

2. The IMA is strongly committed to working with Government, regulators and other stakeholders to help develop a workplace pensions regime that will facilitate good outcomes in retirement. Whether through services to defined benefit (DB), defined contribution (DC) or defined ambition (DA) schemes, asset managers have an important role to play in the savings and investment process.

Summary

3. The IMA is supportive of the Government’s plans to create an explicit space for ‘shared risk’ (DA) pension schemes in pensions legislation. The shape of pension arrangements should be decided upon between the providers and the beneficiaries of those arrangements and not influenced by regulation.

4. The emphasis on DA should not imply that DC schemes cannot deliver good outcomes for members. Whatever the nature of the scheme, one central determinant of success is effective governance. This will also have a role to play in facilitating the implementation of the 2014 Budget reforms, which we welcome.

5. While it is too early to tell what the future shape of DC default arrangements will be (and how far they extend into retirement), greater individual choice will need consistent, externally-provided guidance. Our evidence is focused on the amendments to the Bill that deliver the Government’s ‘guidance guarantee’, announced as part of the 2014 Budget reforms.

6. Choices made at the point of retirement have a fundamental impact on people’s finances for the rest of their life. We agree that it is vital that people receive appropriate guidance about their choices at this stage. But for most people, the need for guidance will not be a one-off process at point of retirement. We suggest the Government considers how the retirement guidance service could be used to provide assistance through both the accumulation and retirement income phases.

7. Guidance must give equal treatment to different types of retirement product, recognising that all options carry risks and helping people to understand what are often difficult trade-offs. Work is also needed to clarify for consumers the difference between guidance and regulated advice and how the retirement guidance service would fit with regulated advice.

Risk sharing has a role

8. The Pension Schemes Bill is an understandable response to the rapid shift in provision away from DB schemes, where investment risk resides primarily with the employer, towards DC schemes where the investment risk lies ultimately with individual scheme members who may be unwilling or unable to bear that risk. Should sponsoring employers, trustees or those responsible for scheme design wish to pursue certain forms of risk-mitigation or risk-sharing approaches, they should be able to act in what they believe to be the best interests of scheme members. The IMA believes that as a result of this Bill, it will now be more straightforward to do so, and welcomes the additional scheme design options this Bill allows for.

9. Nonetheless, DA also carries risks and is not inherently better able to deliver good outcomes for scheme members than DC arrangements. The critical element in all schemes is an emphasis on governance and a clear focus on the delivery of member-centric objectives. Reasons why DC has been perceived as a ‘poor relation’ of DB include the relative lack of governance oversight in the former compared to the latter, as well as combined average employer and employee contribution levels in DC running at half those seen in DB.

Retirement guidance is critical

10. The IMA welcomes the Budget 2014 reforms, but recognises the challenges involved. One of the most immediate and significant consequences of the Budget 2014 reforms was to bring to the fore the issue of how individuals get guidance or advice. The effective removal of annuitisation as the default method of taking an income from a DC pension and its replacement by complete control for the individual over their pension fund opens up a significant range of choices for the consumer.

11. It is too early to tell whether DC schemes will design a new approach to ‘default arrangements’ that include retirement income as well as the savings (or accumulation) phase. Given the difficult nature of some of these choices, together with well-known behavioural biases that may not incline individuals towards optimal decisions, the question of access to guidance and/or advice is a critical one. In this respect, the Government’s retirement guidance service is a key part of making these reforms work well for consumers. Choices made at the point of retirement have a fundamental impact on people’s finances for the rest of their life and we agree that it is vital that people receive appropriate guidance about their choices at this stage.

Guidance should not be a one-off process

12. However, it is critically important to recognise that guidance is not a ‘one-off’ process. For most individuals, guidance will be an implicit feature of investment through the accumulation phase, given a widespread dependence on auto-enrolment and default strategies. Accessing retirement savings will not, for many, take the form of a one-off product purchase and on-going support may be needed into retirement.

13. For example, an individual might choose to access some of their pension fund via cash withdrawal or a drawdown strategy in the first years of retirement, with a view to possibly annuitising the residual fund at a later stage. In such a strategy, individuals might need guidance on the sustainability of income withdrawals over time as well as the optimal age to annuitise and the kind of annuity to purchase. While it might be appropriate to seek regulated advice in such circumstances, individuals may not choose this route and such a scenario suggests that the assumption behind the guidance guarantee cannot be that retirement income is a once-and-done decision at a given moment in time.

14. In this context, we note that, further to detail provided by the FCA in its recent consultation paper on the guidance guarantee [1] , the government envisages the retirement guidance service being targeted at individuals on retirement – on a per-fund basis. We are concerned that this approach does not give individuals the guidance they need throughout their savings lifecycle, and by focussing on the pension fund that triggers the guidance discussion, risks giving individuals only a partial picture of their financial situation as they consider their retirement income options.

15. We recognise the costs of providing this guidance mean that limitations will necessarily have to be put on individuals’ ability to access the service, but we think there is potential for greater benefit to be derived by re-thinking how the service is accessed. Allowing the individual access to the service each time they access a DC pension fund for the first time will not deliver the most benefit for the money being spent on the service – especially since the nature of guidance (as opposed to advice) means the information received is likely to be fairly generic. How much value is there to the individual of receiving the same generic guidance multiple times? Retirement planning should be holistic and the guidance service needs to be able to operate on such a basis. In this respect, serious consideration needs to be given to the practicalities of facilitating a holistic approach, bringing together all private and state entitlements.

16. By re-thinking how the service is accessed – for example giving people a set number of sessions over their savings life-cycle e.g. in their 50s, on retirement and once or twice through the retirement period – greater benefit could be derived from the same expenditure by giving consumers the opportunity to benefit from guidance at other stages in their retirement savings life-cycle and not just at the point that they access a DC pension fund.

Clarity over what constitutes guidance

17. The other key issue arising from the creation of the retirement guidance service is the distinction between guidance and regulated advice and the boundary between them. For many individuals, guidance and advice will be seen to be the same thing – the distinction between them will not necessarily be appreciated. Consumers may access the guidance service thinking that they will be directed to specific products.

18. It is therefore important that the guidance providers make very clear to consumers what the difference is between the guidance they will receive and advice which they may choose to pay for. In particular, consumers must be helped to understand exactly what is provided under the guidance service and what is provided under paid-for advice. This should include the guidance service signposting people to regulated advice or other sources of information on retirement financial products where appropriate. Making sure this clarity exists will help avoid any disappointment with the service on the part of individuals.

Guidance on product types must be neutral

19. We highlighted above the significant expansion in choice that will now face consumers following the Budget. The IMA believes that the right product should be available to the right people at the right time. For many people, some form of annuitisation will still be desirable, particularly later in retirement. In addition, there is considerable scope for investment products, such as income funds, to support retirement provision in a more widespread manner. In order for people to come to a decision on the right product for them, guidance must give equal treatment to different types of retirement product, informing members of all the risks faced by individuals in pension saving, and not just the risk posed by falling markets. These should include inflation risk and ‘one period’ risk associated with an irreversible purchase of an annuity at the prevailing interest rate.

20. This has not been the case in the past. There has been a long-held expectation among Government and regulators that annuitisation should be the default approach at retirement, with ambiguity about whether drawdown required regulated advice. Efforts to improve retirement income through ‘shopping around’ (the Open Market Option), while positive, have arguably focused on only part of the problem. An individual might only be getting a better rate for a product that was not optimal for their circumstances.

21. The inherent attraction of annuitisation for regulators and policymakers is understandable given the guarantee of pay out regardless of market conditions and an efficient means to pool mortality risk, a particularly important consideration later in retirement, both from an individual and public policy perspective. Allied to this is little official (or industry) expectation of active consumer engagement, evidenced by the need to introduce automatic enrolment to encourage individuals to save at all for their retirement, and the tendency of scheme members to remain in default arrangements once enrolled.

22. The combined effect of these considerations was to ensure that prior to Budget 2014, there had been only muted discussion as to how guidance or regulated advice mechanisms could be developed further to help individuals plan effectively for their retirement. It appeared that the tendency to buy a level annuity was seen as an acceptable default.

23. In the new retirement landscape, this cannot be the case. Individuals’ circumstances are too different and the choices they face too complex for the notion of annuities as a default product to hold.

24. However, the greater flexibility for individuals will not result in better outcomes for them if any single class of product is still seen as the ‘safe’ default. Should uneven guidance be given, product innovation is less likely to occur, and consumers are less likely to make the best choices for them.

November 2014

Prepared 6th November 2014