2Protecting savers
A more consistent system
Automatic enrolment and pension freedoms
10.Automatic enrolment (AE) into pensions has been phased in since 2012, three years before pension freedoms. It was designed to increase both the number of people saving for retirement and the amount saved. The rationale behind the policy was to use the same lack of engagement with pension saving that had resulted in widespread under-saving to instead promote more saving.26 Under AE, workers are defaulted into a workplace pension scheme. Individuals are free to choose to save elsewhere or not at all, but to do so they must actively opt out. Whereas previously the path of least resistance was not to save for retirement, under AE it is to save. AE has been hugely successful in achieving its objectives: nine million people are now enrolled in a workplace pension scheme and total savings into workplace pension schemes are forecast to increase by £20 billion in 2019/20.27
Box 2: Accumulation and decumulation phases:
|
11.Pension freedoms takes a different approach: it demands people take personal responsibility for investing their pension savings. NOW: Pensions, a pensions master trust provider, argued that, combined, these two policies lack coherence:28
While auto enrolment recognises the problem of consumer inertia in pension saving and overcomes this, freedom and choice requires consumers to exercise a decision and to be well informed at the point of decumulation. We therefore think that there is a philosophical difference in approach in relation to accumulation and decumulation policies.
NEST, the Government-sponsored workplace pension scheme, said there was “an obvious disconnect between the assumptions about consumer behaviour” underpinning the two policies:29
One is a policy predicated on being fully engaged, whilst the other is currently enjoying enormous success by individuals doing nothing at all.
Many savers face the prospect of actively engaging with their pension for the first time at the point when they must decide what to do with a pot accumulated passively over a working life.
Product innovation in the retirement market
12.In introducing pension freedoms for the decumulation phase, the Government argued that competitive pressures would stimulate innovation in the market, prompting the “development of new products that better suit people’s changing needs.”30 Nearly three years on from the introduction of pension freedoms, we heard general acceptance that such innovation has been at best sluggish. The FCA told us “product innovation has been limited to date”.31 Peter Vicary-Smith, Chief Executive of Which?, described the performance of industry as “pretty lamentable so far”.32
13.There were differing opinions as to why innovation has not taken off. Sir Steve Webb argued that there are significant “lead times” in introducing new financial products and consequently the “industry is in the process of innovating but it will take time”.33 Similarly, the FCA wrote that “innovation may pick up as DC pots grow in size and industry is given more time to develop propositions”.34 Prudential, a pensions provider, claimed that the “surprise nature of the announcement on freedoms, and the short implementation period” meant the industry did not have sufficient time to develop new products before freedoms came in.35
14.Others pointed to a lack of competition in the decumulation market. The Pensions and Lifetime Savings Association (PLSA), an industry body, told us that “in the absence of meaningful consumer pressure, the impetus to innovate in the consumer interest is diminished.”36 Otto Thoresen argued that product innovation would, regardless, not necessarily indicate a market working for consumers, as the sector was “crying out” for simplification.37 A market could offer a simple range of products but function well if customers understood them and freely shopped around for the best deal.
15.One area of the market that might have been expected to lead the way in innovation was drawdown products. While sales of these products have increased, innovation has remained largely absent. Choosing the right drawdown product is complicated: it requires consideration of investment and withdrawal strategy and longevity risk.38 For example, failure to assess longevity risk properly can have severe consequences for individuals if they then withdraw too much each year. We modelled the difference it could make if an individual with a pot of £50,000 opted to take-out £3,000, rather than £2,000, a year.39 Taking out £3,000 a year, an individual would run out of money within 16 years, well below average life expectancy at age 65, receiving total income of £52,257. An individual withdrawing £2,000 a year would run out after 29 years, receiving total income of £67,543. These are illustrative modelling examples, but they show the complexity individuals face in trying to project how much they should drawdown as income.
16.This complexity is exacerbated by charges that are “complex, opaque and not easily comparable across providers”.40 The FCA found that shopping around for drawdown products was limited: 94% of drawdown sales made without independent financial advice were to existing customers. The FCA concluded that there was “limited competitive pressure to offer good deals”.41
17.Complexity of products and lack of consumer engagement were, in 2013, found to be key failings in the accumulation market by the Office of Fair Trading. They concluded that market was one of the weakest they had analysed.42 AE has helped remedy that market by harnessing inertia and removing the complexity of decision-making by simply defaulting individuals into an appropriate workplace pension scheme. The drawdown market bears many of the hallmarks of the accumulation market prior to AE.
Default decumulation pathways
18.We considered the replication of the philosophy of AE for drawdown products, through default decumulation pathways. The People’s Pension, a non-profit pension provider described such a system as a “necessary complement to mass automatic enrolment pension saving schemes”.43 Drawdown providers would offer a default product which matched the characteristics and needs of their target consumer group. Individuals who did not make an active choice to invest their funds elsewhere would be defaulted into that product. NEST told us that default decumulation pathways would offer “simple, straight-through routes from saving to taking an income”.44 The Trades Union Congress (TUC) called them the “best method to deal with a system that lacks a mechanism for guiding savers towards what would be the most appropriate options”.45
19.Few providers currently have default pathways.46 Christopher Woolard, FCA Director of Strategy and Competition, said that this was unsurprising given that FCA rules “do not really create the idea of a default”.47 The FCA confirmed that they are considering compelling default pathways as a means of improving outcomes for drawdown consumers.48 Stephen Barclay MP, then Economic Secretary to the Treasury, told us that the Government was also actively considering this approach, which had “worked very well for auto-enrolment at the front end and so there are some lessons to draw from that”.49
20.Mr Barclay cautioned that there was a “danger of defaulting individuals into unsuitable products”.50 This risk is both to providers, who may be held liable for default products that subsequently proved unsuitable, and to customers, whose inertia could be exploited by providers making their default option expensive.51 The FCA is considering a charge cap to “help ensure that those consumers who do not engage with their investment decisions are not subject to excessive charges”.52 A charge cap on AE saving is already in place. Similarly, workplace personal pension schemes are required to have Independent Governance Committees which scrutinise their value for money.53 The potential problems of default pathways in the decumulation phase have already arguably been addressed in the accumulation phase through the introduction of a charge cap and Independent Governance Committees.
21.Pensions can seem distant and daunting. Faced with bewildering complexity, many people simply switch off. By harnessing that disengagement to default people into pension saving, automatic enrolment has been a tremendous success. Accumulation of a DC pension can be passive. Decumulation of that pension, however, is currently active: individuals must actively choose what to do with their savings. The Government hoped that a competitive and innovative market would meet consumer needs. There is little evidence of this: too many drawdown customers are not shopping around and do not understand their options for investing their savings. They are reliant instead on getting a good deal from their existing provider. The success of automatic enrolment in overcoming market failure in the accumulation phase offers a template for strengthening pension freedoms in the decumulation phase. People would still be free to choose to invest and spend their own money as they wished. But if they did not make an active choice, they would move into a suitable and regulated default product.
22.We recommend the Government takes forward FCA proposals to introduce default decumulation pathways. Any provider offering drawdown would be required by FCA rules to offer a default solution that is targeted at their core customer group. The same charge cap that applies to automatic enrolment schemes, 0.75%, should apply to default drawdown products. Similarly, the remit of Independent Governance Committees to scrutinise value for money in the accumulation phase should be extended to default drawdown products. These protections should be in place by April 2019.
NEST
NEST and pension freedoms
23.NEST is the government-backed DC pension scheme established in 2012 to support the introduction of AE. It has a public service obligation to accept any employer and has a target audience of low to moderate earners. It already has over five million members, of whom 30% are under 30 years old.54
24.NEST was set up before the introduction of pension freedoms. Accordingly, its primary focus for members at retirement was ensuring they could access appropriate annuity products on the open market.55 Uniquely among pension providers, NEST cannot offer its own annuities or other decumulation products such as drawdown. To access the new norm of drawdown, NEST savers would have to transfer their pot to another scheme. NEST told us that 34% of its members—1.7 million people and growing—incorrectly believe that NEST will pay them a regular income when they retire.56
25.Recognising the dramatic increase in the options facing savers with the advent of pension freedoms, the Government consulted in July 2016 on the future of NEST.57 That included the question of whether NEST should “be able to offer a decumulation services for its members”.58 The consultation concluded that NEST should not be granted that right “at this time”, but promised to consider the conclusions of the FCA’s Retirement Outcomes Review and to revisit the decision “if it is clear that the market is not developing in line with the needs of NEST members”.59 As outlined above, the Interim Report of that review sets out a market devoid of switching, innovation and other indicators of competitive pressure.60
Barrier to competition or consumer benefit
26.We considered whether allowing NEST, a state-backed provider, to provide decumulation products would act as a further barrier to good consumer outcomes. NEST is backed by a loan from DWP to cover the upfront costs of establishing and administering the pension scheme. By 31 March 2017, the value of this loan had grown to £539 million.61 Sir Steve Webb argued that given that debt, it was not the time for NEST to begin doing something “well beyond what it was originally created to do”.62 However, as NEST’s asset base is growing exponentially, the DWP has increased confidence about the repayment schedule. In April 2017, citing “more stability in the forecast”, it told the Public Accounts Committee that it projects the loan will be fully repaid by 2038.63
27.NEST argued that the experience of AE showed that it had led the way in developing “innovative and value-for-money approaches to accumulation”.64 The TUC agreed, noting that “NEST has led innovation in the accumulation phase that other providers have followed”.65 The Government’s consultation recognised that “NEST has been influential in the automatic enrolment marketplace, helping to drive up standards and best practice”.66 Rather than being an obstacle to competition, NEST could revitalise the decumulation market by forcing other providers to offer better value products or risk large numbers of consumers transferring their pots into a trusted, low-cost public interest provider in NEST.
28.Sir Steve Webb suggested the current size of NEST members’ pots means few would be interested in purchasing a drawdown product. He argued that NEST members currently have an average pot size of less than £500, and “you are not going to buy a drawdown product for £500”.67 DWP concurred that “it will be several years before there is meaningful demand from newly automatically enrolled members”.68 Similarly, Standard Life, a pension provider, said that while it did not object “in principle”, there was “no immediate need”.69
29.Otto Thoresen, Chairman of NEST, dismissed this short-termist perspective. He argued that a longer time-lag would enable NEST to engage with members while they saved about their eventual range of pension options.70 NEST’s members’ panel concurred that NEST should be allowed to offer decumulation products.71 They noted that NEST’s membership was “among the least confident in making difficult financial decisions and are often unable or unwilling to access advice”, yet they would be expected to make active and informed decisions at retirement after years of largely disengaged auto-enrolled saving.72 Tom McPhail, of pension provider Hargreaves Lansdown, agreed the restrictions failed NEST members, writing that it would be “illogical and inappropriate to take them all the way to retirement and then abandon them without a decent range of retirement income options.”73
30.NEST is a growing success story. It has more than five million members, including many on low incomes, each embarking on private pension saving. Under the existing framework, all those members will be required to take active decisions about their life savings at retirement, many after a career of passive saving. NEST is currently highly restricted in the support in can offer those members at retirement as it cannot offer decumulation products. Concerns that allowing NEST to offer such products would hinder competition in the market would carry greater weight were there evidence of a functioning market currently. Indeed, the evidence from automatic enrolment suggests NEST may drive better retirement outcomes by forcing other providers to offer greater value or risk savers switching over to NEST to get a better retirement deal.
31.We recommend that the Government allows NEST to provide decumulation products from April 2019, provided it remains assured of NEST’s ability repay its start-up loan. This should include establishing a default drawdown pathway, in line with our wider recommendation. In keeping with the spirit of pension freedoms, savers would remain entitled to move their money wherever they wished.
26 Making automatic enrolment work, A review for the Department for Work and Pensions, Cm 7954, October 2010
27 DWP, Automatic Enrolment Review 2017: Maintaining the Momentum, December 2017
30 HM Treasury, Freedom and choice in pensions, p15
31 FCA, Retirement Outcomes Review Interim report, p4;
38 FCA, Retirement Outcome Review Interim Report, p102
39 To model these scenarios, we used Which’s online income drawdown calculator, assuming a moderate portfolio with middling growth assumptions, full use of the 25% tax-free lump sum, and with income rising at 2% p.a.
40 FCA, Retirement Outcome Review Interim Report, p12
42 OFT, Defined contribution workplace pension market study, pp. 14–15
46 FCA, Retirement Outcome Review Interim Report, p.101
48 FCA, Retirement Outcomes Review Interim Report, pp105–106
52 FCA, Retirement Outcomes Review Interim Report, pp105–106
53 FCA, Retirement Outcomes Review Interim Report, pp105–106
55 Ibid.
57 DWP, NEST: Evolving for the future, July 2016
58 DWP, NEST: Evolving for the future, p22
59 DWP, NEST: Evolving for the future government response, p. 23
60 FCA, Retirement Outcome Review Interim Report, p. 14
63 DWP, Correspondence from the Department for Work and Pensions, relating to the National Employment Savings Trust, April 2017
66 DWP, NEST: Evolving for the future, p. 5
68 DWP, NEST: Evolving for the future government response, p. 23
69 Standard Life, NEST: Evolving for the future government response, p. 14
73 Money Marketing, Bloated: is the Government’s plans for NEST a step too far, July 2016
Published: 5 April 2018