By Kathryn Fleming, Partner at hymans Robertson
It also encourages a sense of community and shared responsibility, fostering a culture of mutual support and cooperation. However, executing these solutions requires a careful consideration of their practicality and feasibility.
In developing these strategies, a member-centric approach is crucial. Many members may not have extensive experience with financial service products and long-term saving products. So, it's essential to consider the power of inertia in automatic enrolment and how it can be used to develop solutions that meet the needs of this new generation of automatically enrolled savers.
Flexibility in Retirement Planning
The ideal solution would be a flexible retirement income solution that doesn't necessarily need to meet all members' needs but caters to those less likely to make active decisions regularly. This solution should pay a regular, sustainable income, not require ongoing financial advice, offer flexibility, and provide good value for money. The goal is to blend the best of investment solutions with the best of insurance solutions, providing flexibility when needed and an income when appropriate.
Managing risk
One of the main issues is the management of longevity risk. This refers to the uncertainty surrounding the lifespan of individuals within a risk-sharing group. If an individual lives longer than expected, they may end up depleting their share of the pooled resources, potentially leaving less for others in the group. This risk can be mitigated by diversifying the group, including individuals of varying ages and health statuses. This way, the risk is spread more evenly, reducing the potential impact of any one individual's longevity on the group's resources.
Another challenge is the management of investment risk. This involves the potential for losses due to fluctuations in the value of investments. In a risk-sharing arrangement, this risk can be spread among the group, reducing the potential impact on any one individual. However, this requires careful management and a clear understanding of the market dynamics. It's also important to consider the potential for cross-subsidies, where wealthier, longer-lived individuals may end up benefiting more from the arrangement than less affluent, shorter-lived individuals.
Research has shown that people are apprehensive about losing control over their money upon retirement. They want the ability to change their minds and understand what retirement looks like before committing to something irrevocable. Balancing this need for flexibility with providing security and confidence is a significant challenge in designing effective financial strategies.
Communication is key
Communication and information are also key considerations in the implementation of risk sharing. It’s essential that members understand how risk sharing operates and what they are signing up for. This is particularly important when it comes to death benefits, as members must be aware that they will not be eligible for any death benefits in respect of the risk sharing arrangement.
Underwriting could potentially play a role in some risk sharing solutions. At the point of retirement, guidance is needed so that people who are seriously unwell and have a much shorter life expectancy can choose a different path. For everyone else, an assessment of life expectancy over time can be done using member characteristics. This won't be perfect, but it’s a practical way of doing this that captures the major drivers of life expectancy.
Implementing risk sharing through a DC master trust
Risk sharing can be delivered through a DC master trust, a structure that allows for the pooling of longevity, where members receive additional benefits, known as longevity credits, upon the death of other members. This approach, however, comes with its own set of legal considerations. Trustees must ensure that they are acting in the best interests of the members, taking into account the risks and safeguards associated with risk sharing. They must also ensure that they are acting in accordance with the trust's rules and that any risk sharing arrangement is clearly set out. Furthermore, they must exercise their discretions properly, particularly when it comes to distributing longevity credits.
The regulatory environment also plays a significant role in the implementation of risk sharing. Master trusts are authorised and regulated by the Pensions Regulator, and any risk sharing solution must fall within HMRC's regulatory framework for registered pension schemes. This ensures that payments made are authorised within existing HMRC rules, avoiding any potential tax charges on the member or the scheme administrator. Additionally, the master trust must comply with the statutory framework for occupational pension schemes, and trustees must ensure that the benefits provided fall within the legal definition of a money purchase benefit.
Lastly, implementing risk sharing solutions, like longevity pooling, is feasible within the current legislative framework. Despite the inherent challenges, these solutions offer an opportunity for businesses to innovate and may provide better options for their members, provided they're properly designed and communicated.
Article taken from a webinar on risk sharing and the role that these solutions might take in pensions to improve the outcomes for DC savers. The session included pension providers, pension lawyers, consultants and employers. I was keen to reflect and share some of the key discussion points in this summary.
For those of you who were not able to dial in, a link to the webinar has been included here.
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