137.The advent of pension freedoms, and the associated removal of the powerful tax incentive to use pension pots to purchase annuities, has fundamentally transformed the retirement market. According to the Financial Conduct Authority (FCA) Retirement Outcomes Review, from the introduction of pension freedoms in April 2015 to September 2017, 1.5 million defined contribution pension pots were accessed. Of these, 72 per cent were accessed by customers below the age of 65, and 55 per cent of pots were fully withdrawn. Of those pots not fully withdrawn, twice as many were used for drawdown products as annuity products, the market for which has shrunk sharply. Around 30 per cent of drawdown purchases, and 65 per cent of annuity purchases, were made without advice, and there has been a bias toward entering drawdown with the existing pension pot provider.
138.In these early days, the overall impact of pension freedoms on the welfare of pensioners is unclear. Drawing on the FCA’s Review, the main features seem to be high levels of early access and complete withdrawal of pots, a shunning of annuities and many decisions being taken without advice. However, witnesses to the inquiry emphasised that the early days were likely not representative, since the vast majority of pots withdrawn have been small. The Committee did not receive evidence to suggest that a significant number of pots accessed through pension freedoms had been spent immediately on high-value consumer items such as sports cars.
139.This chapter discusses the main themes that have emerged from the early days of pension freedoms, and indicates the future directions that policy ought to take, including some specific steps the Government could take soon.
140.Michelle Cracknell, the Chief Executive of the Pensions Advisory Service (TPAS), painted a worrying picture to the Committee in which people approaching retirement have not understood the nature of pension freedoms, lack a sense of ownership over their pension pots and are making decisions without knowing the full implications:
The pensions landscape has changed dramatically, and the responsibility that now sits with the individual to provide their own retirement income has happened in the law but it has not happened in people’s heads. A 50-year-old’s only reference point today will be to look at their parents, who pretty much had it all done for them. […]
Relative to pension freedoms, there have been a number of people who have said, “I just want to move my money out of the pension pot into my bank account,” with no specific reason for needing the cash. There is a very low level of ownership of pensions. If you trawl our database, people very rarely talk about “my pension”; they always talk about it in the third person: “Tesco pension” or “Scottish Widows pension”. People do not see it as their asset… when it is obviously so important for them to take personal responsibility for their retirement income. […]
[W]e worry about… the amount of non-advised drawdown activity… people who are ending up in drawdown lack a huge amount of knowledge about what that entails, and the decision has been driven by two things. It is either, “I just want to get hold of my tax-free cash,” and therefore the provider has said, “You have to move it into a drawdown product,” or the second reason is, “I have been told annuities are bad value, so I will buy the alternative,” not really understanding what the alternative is.
One outcome of that is people end up in a drawdown product not understanding the risks they are taking. Certainly we talk to people about going into drawdown and say, “Where are you going to invest the money? Have you thought about how to take the income and, potentially, issues when the market goes down?” and they do not even realise the money has to be invested.
141.Ms Cracknell emphasised the need to prevent these bad habits from becoming social norms, by intervening to create virtuous new social norms. These interventions would include a “mid-life MOT”, whereby people are invited for a financial check-up around the age of 50, and default guidance, whereby people will have to actively opt-out of an appointment with the future Single Financial Guidance Body (SFGB) if they want to access their pension pot without guidance:
We are strong believers that we need to create a society where it is normal to be thinking about your retirement income, and the only way we can create that new social norm is by introducing some interventions; otherwise, why would a 50-year-old think to go and get some help on their pension? They have no reference site to say, “That is what my parents did.”
We are strong supporters of the introduction of a mid-life MOT as a concept. We are also very strong supporters of default guidance, so that when somebody is making a very big and irrevocable decision about their pension, they are sent to go and have a guidance session. They can turn around and say, “No, I do not want it,” but look at the inertia impact that has been so successful with automatic enrolment. Let us book them in and get them to turn it down, because I think then you will find that most people will say, “Now I am here I might as well have one.”
Ms Cracknell also suggested that prompts to seek to financial guidance could be linked to a range of interactions with the public sector that occur during “life events”:
For example, when you go through a divorce process there is no nudge or intervention to say… “Have you done any budget planning, because these things are likely to have affected your financial position?” If we looked at the life events of divorce, death, birth of a child, etc., we could do a lot more, very cost-effectively, to nudge people to think about their finances. The evidence suggests that people are attuned to thinking about their finances at the time of a life event and they will pick it up at that point.
142.Several written submissions to the inquiry also expressed support for default guidance. The Financial Guidance and Claims Act 2018 requires the FCA to make rules requiring providers to ensure that consumers have either taken guidance, or made a decision not to, before they are allowed to access their pensions. The Act gives the FCA some latitude in how the consumer is required to indicate their opt-out. For example, they could be required to contact the SFGB to opt-out, rather than opting-out with their provider immediately before accessing their pension pot.
143.Ms Cracknell also told the Committee the TPAS had only a limited budget for outreach. When asked about whether this would change for the SFGB, John Glen, the Economic Secretary to the Treasury, said “I am very sympathetic to it but the specific way it is applied will be a matter for the body to examine.” Charlotte Clark, Director of Private Pensions and arm’s length bodies at the Department for Work and Pensions (DWP), told the Committee that the Department would be “really interested in looking at [a proposal]”.
144.The present level of many people’s engagement with and understanding of the choices available to them as a result of pension freedoms is inadequate. One approach to improving this situation is to encourage more people to take up the advice or, at a minimum, free guidance options available to them.
145.In consultations over how it will allocate its budget and priorities, the Single Financial Guidance Body (SFGB), together with the Government, should consider how a mid-life MOT could be introduced, and develop proposals for increased outreach work to engage people with pensions planning. The FCA should consider the case for introducing a strong form of default guidance before people are allowed to access their pension pots. Finally, the Government should make a cross-departmental effort to identify opportunities to “nudge” people towards pension guidance at life events where they interact with the public sector.
146.The Committee also raised with John Glen and Guy Opperman, the Minister for Pensions and Financial Inclusion, the issue of departmental sponsorship for the SFGB, which is currently given to the DWP. This followed an exchange of letters on the matter between the Chair of the Committee and Mr Glen. The Chair set out a number of concerns over whether the DWP was the relevant department to sponsor the SFGB, including: the trend away from defined benefit to defined contribution meaning that increasing numbers of pension schemes would be regulated by the FCA rather than The Pensions Regulator; and the need for the SFGB to work closely with the financial services industry. Mr Glen’s response referred to the DWP’s experience in sponsoring “similar arm’s length bodies”, but added:
DWP will be responsible for the day-to-day operational delivery of money guidance and debt advice by the body and its partners, but the Treasury will retain responsibility for the development of a national strategy to improve financial capability, people’s ability to manage debt, and financial education for children and young people, as described in the body’s strategic function. […]
I want to reassure you that we expect the Treasury Select Committee to examine Treasury Ministers on those policy matters which remain the Treasury’s responsibility. If this on occasion includes an interest in the SFGB’s delivery, we would expect DWP Ministers and the body’s chair and CEO would also be asked to provide evidence.
At the hearing, Mr Glen declined to commit to keeping the sponsorship of the SFGB under review.
147.The Committee remains to be convinced that the SFGB should not be under Treasury lead sponsorship in future, particularly given the continuing shift from defined benefit to defined contribution pensions. The Government should keep the SFGB’s sponsorship under review. In the meantime, the Committee intends to take a close interest in the SFGB and scrutinise it in a similar way as it does Treasury-sponsored bodies.
148.Increasing the take-up of pensions guidance and advice should empower people approaching retirement to make better decisions about how to use their pension pots. Nonetheless, evidence submitted to this inquiry argued that this needed to be balanced with realism about people’s appetite for guidance and advice, the intrinsic difficulty of assessing longevity risk, even for the most engaged and well-advised investors, and the prevalence of behavioural biases that can lead people to make poor decisions. That could lead both to people drawing down their pensions too quickly, or conversely to excessive caution and unnecessary frugality. In written evidence, the Open University Centre for Public Understanding of Finance (PUFin) said:
[S]ecure pensions are necessarily poor value for money. Our research suggests that open-market annuity rates prior to ‘freedom and choice’ offered fair value. However, in a further example of how behavioural biases influence decision-making, households tend to perceive annuities as an investment (offering a poor return) as opposed to insurance against longevity risk and investment risk (for which it is reasonable to pay some kind of insurance premium).
In further research, we have found that UK individuals are generally bad at estimating their chances of surviving to later old age … Evidence from other countries suggests that people trying to live off their investments in retirement either run out of income early or live in excessive frugality …
It is also important to consider the limitations of financial advice. Even with advice, households may accept higher or, more often, lower risk than would be compatible with their situation and needs. Defaults can be an effective way of achieving broadly sensible solutions for the majority, in addition to increasing the quality and availability of financial advice.
149.Despite the apparent preference for drawdown over annuities revealed during the early days of pension freedoms, the International Longevity Centre UK told the Committee about their survey of 5,000 55–70 year olds in which “75 per cent of people agreed with the statement: I would prefer a secure guaranteed income in retirement over an income that might rise or fall depending on returns in financial markets”.
150.An additional limitation of advice (as opposed to guidance) is its prohibitive cost for many people. It is not clear how solvable this is. Andrew Bailey, the Chief Executive of the FCA, has said to the Committee:
What is the answer to the question of how you get low cost advice for relatively small transactions? A lot of innovation is taking place there in the so-called robo-advice market. It is still early days to conclude where that is all going to lead to. Another route will be to have a stable of more highly standardised, relatively cheap investment products, for which you do not need great advice.
151.Several witnesses to this inquiry argued that greater levels of default investment pathways and consumer protection were required alongside pension freedoms. Michael Johnson, a research fellow at the Centre for Policy Studies, told the Committee:
[W]e cannot row back on freedom and choice [but we can] eliminate or tackle the substantial part of the risk … I proposed the idea of what I call auto-protection. The idea is that when you reach 55, which is, by the way, too early—it should be 60 or even later—if you do not take any action, some form of auto-drawdown starts to occur. You can opt out. Then, later in life, when you are in your late-70s, phase two is what I call auto-annuitisation and, again, you can opt out.
152.Baroness Ros Altmann, the Minister of State for Pensions from 2015 to 2016, focused on enhancing consumer protection, for example, from scams:
I think pension freedoms are absolutely the right way forward. What we have failed to do, unfortunately, is put in adequate consumer protection alongside them at the same time … The FCA has talked about consumer protection, but it has not actually done it as well as it could in practice.
Michelle Cracknell (TPAS) emphasised that protecting consumers against scams would require agility, and that the ban on cold-calling legislated for in the Financial Guidance and Claims Act 2018 would only go so far:
We absolutely welcome the ban on cold-calling. […] Will it be enough? No, absolutely not. We already have evidence that scammers have found other ways of contacting people. The pension is just too rich pickings, because you have people with low levels of knowledge and very big pots of money, so scammers will continue to find ways to contact people.
153.In its Retirement Outcomes Review, the FCA appears to be moving in the direction of default pathways and greater consumer protection. In particular, the FCA is proposing that providers should offer drawdown investment pathways, based on a simple set of choices from the consumer, which it will review in a year’s time. It has also advised that the Government should consider reforming the pension freedoms regime so that people can access their 25 per cent tax-free cash without having to access the rest of their pension pots.
154.The level and quality of consumer protection and default investment pathways associated with pension freedoms do not appear sufficient at present. There are associated concerns that scams are appearing and evolving faster than regulators and guidance bodies can adapt. The Government should be actively involved in working with the FCA and the guidance bodies to identify opportunities to enhance consumer protection and introducing default pathways to ensure that people do not make poor choices in retirement. It can start by responding to the FCA’s suggestion that it consider allowing people to access their tax-free cash separately from the rest of their pensions.
155.Some witnesses to the inquiry were concerned that the sharp decline in demand for annuities since the introduction of pension freedoms may have impaired the quality of longevity risk pooling in the retirement market. Torsten Bell, the Director of the Resolution Foundation, told the Committee that:
Even if you think it is optimal from the micro perspective, clearly, from a macro perspective, one of our objectives is risk pooling. As longevity rises and the distribution of longevity remains big, pooling some of that risk is a very desirable thing, as a society as a whole. That is what the annuities market should do, but for that to happen in an inexpensive way it needs to be a big market. It needs to be liquid, it needs to be large and… we are doing the exact opposite of that.
Andrew Bailey acknowledged concerns that pension freedoms had impaired the pooling of longevity risk, telling the Committee “Arguably, you can say it has. […] if you think that there has been too great a switch towards drawdown products, your point about pooling longevity risk is correct.”
156.Former pensions ministers Baroness Ros Altmann and Sir Steve Webb were more sanguine about the falls in annuity sales, arguing that they will pick up as people now entering retirement buy them in later life. Sir Steve said:
We are already starting to see a bit of a pick-up in annuity sales. We [used to buy] them too young… Actually, what we may see is people buying annuities later in retirement. You might buy an annuity at 75, not 55 … We may see hybrid products where you are in drawdown and the drawdown starts looking much more like an annuity later on. I am not too worried about what is happening in the annuity market.
Baroness Altmann added “Waiting until lots of life events have happened to you before you buy an annuity rather than locking in forever would make much more sense and could be part of later-life planning.”
157.Both also said there would need to be more innovation in product design in the pensions decumulation market in order to improve longevity risk pooling. The FCA identified a lack of product innovation for mass market customers in its Retirement Outcomes Review, but decided to give the market more time to develop before proposing remedies.
158.It is desirable for individuals to be able to insure against risks over which they have little control, including longevity risk. The introduction of pension freedoms—and the associated sharp decline in demand for annuities—may have reduced the extent and effectiveness of collective longevity risk pooling in the retirement market. It has been suggested that retirees will instead choose to purchase annuities at later points in their lives than they did before pension freedoms, which could offset some of the reduction in risk pooling. If this is correct, we can expect to see a partial recovery in annuity sales going forward. The Government should monitor this situation as it evolves, and may need to intervene in future if evidence of sufficient risk pooling does not emerge.
149 Financial Conduct Authority, Final Report, MS16/1.3, 28 June 2018
150 Ibid, and , Household finances: income, savings and debt, HC 565, Q186 and Q192
151 , Household finances: income, savings and debt, HC 565, Q181, Q187, Q193
152 Ibid, Q181. See also (HHF 0046)
153 Ibid, Q213
154 (HHF0024), (HHF0029), (HHF0032), and (HHF0037)
155 Financial Conduct Authority, Final Report, MS16/1.3, 28 June 2018
156 , Household finances: income, savings and debt, HC 565, Q219
157 , Household finances: income, saving & debt, HC 600, Q316
158 Letter from the Chair of the Treasury Committee to the Economic Secretary to the Treasury, , 7 March 2018
159 Letter from the Economic Secretary to the Treasury to the Chair of the Treasury Committee, , 15 March 2018
160 , Household finances: income, saving & debt, HC 600, Q301
161 Sir Steve Webb told the Committee “Ironically, far from the notorious sports car, the biggest worry is reckless caution; it is actually people not consuming fast enough.” , Household finances: income, savings and debt, HC 565, Q239
164 , The Work of the Financial Conduct Authority, HC 475, Q341
165 , Household finances: income, saving & debt, HC 600, Q11
166 , Household finances: income, savings and debt, HC 565, Q246
167 Ibid, Q189
168 Financial Conduct Authority, Final Report, MS16/1.3, 28 June 2018
169 , Household finances: income, saving & debt, HC 600, Q11
170 , The Work of the Financial Conduct Authority, HC 475, Q339
171 , Household finances: income, savings and debt, HC 565, Q238
172 Ibid, Q241
173 Financial Conduct Authority, Final Report, MS16/1.3, 28 June 2018
Published: 26 July 2018