 By Malcolm Kerr, Senior Adviser EY Financial Services
In the space of a few weeks we have seen two proposals which will transform the pensions landscape. First - completely out of the blue - the decision to abolish the compulsory purchase of annuities for all. Second, and less of a surprise, the proposal to introduce collective defined contribution (CDC) funds to the UK market. These moves open up great opportunities for consumers, advisers and providers. But they also present some serious challenges.
Good bye CPA
As we know, annuity purchase has been an option and not a requirement for wealthier consumers for some time. But the Chancellor’s proposal to abolish the requirement for all in his Budget speech opens up complex options for millions of savers. Recognising this, he also announced free, face to face, advice to help consumers decide what to do. Subsequently, this announcement was “clarified”. And, it now seems likely that face to face advice will be replaced by on-line “Guidance”.
Exactly what Guidance is has yet to be clarified. Apparently FCA, FOS, the Treasury and other constituencies are in the definition process. Given that we already have the Advice model, the Simplified Advice model, the Basic Advice model, the Money Advice Service (which is not Advice) and the Non-Advised model, it seems to me that providing clarity to consumers on the meaning of free Guidance will be challenging to say the least. Even more challenging will be delivering - in nine months time - whatever this free guidance is, who will deliver it and how it will be delivered
Financial advisers’ views on providing Advice within the new regulatory context seem quite polarised. Some feel it opens up attractive options for alternative and more flexible retirement income solutions. Others feel it presents challenges if, for example, clients are inclined to divest and spend or re-invest unwisely. In any event, what was an annuity broking service for most clients is now a very different process.
It seems likely that most consumers who have elected to sacrifice spending for saving in their careers will be similarly prudent when making decisions at retirement. However, what about those whose pension funds will have been created by auto-enrolment and which will, by definition, be modest for many years? My guess is that many will take the cash. And if this turns out to be then the auto-enrolment objective of improving pensioner income will not be achieved.
Hello CDC
Steve Webb has been promoting the concept of CDC for sometime – sometimes using the term “defined ambition”. This is an important initiative from a thoughtful and experienced Minister. And, I think most players in the pensions market would be interested in exploring how the costs and investment risks of DC schemes could be reduced via a new approach. However, at this stage, the approach does not seem aligned with the overall direction of travel.
The FCA and most consumer bodies are calling for more transparency around investment products. And they are looking to see a closer alignment of customer attitudes and objectives to investment solutions. CDC is pointing in the opposite direction sharing risks across individuals an generations and smoothing returns in much the same way as with-profit funds. On the face of it this doesn’t create an attractive alternative to the existing DC models.
Could CDC be a useful alternative to existing DB models? In my view the answer is probably yes. Portfolio construction would be pretty similar. But the risk is transferred to the employee not the employer. So it is not surprising that some cynics are suggesting that the CDC agenda is around changing the nature of public sector DB models rather than replacing DC.
In the private sector the CDC concept does not appear to have immediate positive resonance with employers. Most have more urgent and/or important issues on their agenda. And anecdotal evidence from The Netherlands suggests that the jury is still out on the model. So we don’t anticipate a plethora of activity in this space in the immediate future.
Improved client outcomes
Removing compulsory annuitisation will facilitate retirement income solutions which meet the real needs of consumers. These will be more flexible than conventional annuities and built to deliver income as and when required other than in a straight line. Simplistically; more income in the first 5/10 years, less for a while and then able to fund decent long term care provision for the future.
Some of the emerging solutions will offer guaranteed income – on the provider balance sheet or on some counter-parties. Some will be created by asset managers and advisers rather than life companies. These will be new solutions designed to create the best retirement income for clients but often or not without the lifetime income guarantee of an annuity. And I am optimistic that this additional flexibility will encourage consumers to invest more into their pension funds.
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