Have pension freedoms limited choice?

A recent report warns freedoms are being held back by a lack of innovative products

Anyone who felt disappointed with Chancellor Hammond’s “boring Autumn Budget for pensions” must have also felt a sense of relief that he has left things alone; at least for now.

The situation couldn’t have been more different in 2014, when then-chancellor George Osborne conjured up pension freedoms seemingly out of nowhere.  Many support the basic principles of “freedom and choice”, but some commentators are critical of the way the reforms have been implemented: thrown at an industry that wasn’t consulted and wasn’t ready for it, without the full implications being thought through.

Earlier this month, the Pensions Institute published a report, ‘The Meaning of Life 2’ which concluded that although consumers now have more freedom, choice is limited. The report highlights how pension freedoms have impacted choice by undermining the annuity market and how there has been lack of innovative products providing both flexibility and guaranteed income.

Drawdown – the unsuitable default?

The author of the report, Pádraig Floyd, is concerned that drawdown has become the default option for people for whom it was previously deemed unsuitable. He is also worried that if interest rate rises lead gilt yields to “normalise” and annuities start to look better value, a sufficient annuity market may not exist when people need it.

“Many thousands of individuals have been channeled into drawdown as the only suitable default but a few years ago it was felt not to be suitable for them as they did not have sufficient capital to make it last,” says Floyd. “The majority don’t take advice so it is almost pot luck how they will fare. The FCA has acknowledged that, launching an investigation into the unadvised drawdown market.”

Although Floyd thinks freedom and choice was a “great idea”, he says people “don’t tend to buy advice” so it’s easy to make the wrong decision. “Drawdown was always going to be a sub-optimal decision as a default because it was designed as a stopgap for those who didn’t want to annuitise. But the move towards DC has placed more risk on to the individual and that’s a responsibility that most people don’t want,” he says.

Altus Consulting senior consultant Jon Dean points out that, as equity markets have had a long bull run, many people have not yet seen the downside of drawdown. “I’ve gone on record saying I believe annuities will rebound and that is an unpopular view. But I think if there is a big adjustment in share prices and it catches people in drawdown now who wouldn’t have previously qualified for it there will probably be a backlash and claims for misselling,” he says.

The Holy Grail?

Royal London intermediary pensions investment strategy manager Lorna Blyth wonders how realistic it is to expect guaranteed income and flexibility to be provided in one product. “Guarantees and flexibility are like a see-saw and there is a trade-off between the two. This was brought to life for us when we commissioned Millimans, a global actuarial consulting firm, to conduct an independent review of the UK retirement income market,” she says. “We found that the products with the highest level of guarantee placed the most significant restrictions on the financial freedoms of customers, as well as significantly reducing the amount of money customers get back. Not that surprising, as current annuity rates reflect this.”

Standard Life head of pensions policy Jamie Jenkins takes issue with the idea that there has been a lack of innovation as he says the market adjusted quickly in making drawdown available to wider group of customers. “The report assumes that product innovation is key to good member outcomes. While it is important, the real issue is how we support or advise people in their decision making,” he says.

Some commentators reject the idea that choice in the retirement market has reduced, but concede things have not developed as many hoped, partly because of the enormous regulatory pressure. “Over the next few months the industry needs to be ready for Mifid II and General Data Protection Regulation,” says Punter Southall Aspire managing director, DC consulting, Alan Morahan. “Solvency II has ramifications for the development of products which come with any form of guarantee, as companies will have to reserve for these on their balance sheets, tying up capital which could be worked in other ways.  The amount of change and the constant rumours of change leaves the industry wondering what it might have to deal with next and restricts it from assigning capital to new product development.”

Joined-up thinking

Liberty Sipp managing director John Fox believes innovation is virtually impossible given the pressures on providers.

“But there has to be innovation,” he says. “People are moving out of defined benefit schemes so why not introduce partial transfers? People can use drawdown and keep the rest in the DB scheme where the money is secure. A lot of the trustees probably won’t be interested in something like this, it’s all or nothing for them.”

Fox believes all stakeholders, particularly the Government, need to look at Floyd’s report. He says: “The problem we have is politicians interfere in pensions but they are only around for the short term. They do something without looking at the consequences and they are not here when there’s an issue. We need some joined up long-term thinking.”

Adviser view: Geraint Davies, managing director, Montfort

The fundamental problem around pension freedoms is not the limited choice for consumers but the limited ability of many advisers to successfully engage with them and convey the correct planning message. Australia has a system with high consumer awareness and many advisers there hold expert knowledge and communication skills to convey the notions around sustainable income withdrawals in retirement. The issue for the UK is not so much about product development but more about advisers being able to establish skills around client engagement. UK advisers in general need to improve their communication skills to advise proficiently, rather than being order takers.

Adviser view: Fiona Tait, technical director, Intelligent Pensions

Many retirees want the security of a guaranteed income level which will continue to be paid so long as they need it but an annuity is still the primary way of achieving this. The Government and regulators expected the industry to develop new products which would fill this gap but so far this has not happened.

It costs time and money to develop new products. Any commercial organisation would think very hard before committing to the launch of an unproven product with limited potential to deliver a profit and it is even more difficult in the retirement income space.