DC pensions: Providers and regulators need to work on innovation

Innovative thinking is need to make sure DC pension scheme members receive the income they’ll need in retirement, warned Hymans Robertson in its report Risk sharing: an age old solution to an age old problem. 

The report claimed that greater innovation in the options offered by providers and financial advisers to savers could increase their retirement income by 20 per cent.

Jon Hatchett, senior partner at Hymans Robertson said millions of people in the UK were heading towards retirement outcomes that were worse than their parent’s generation. 

He said: "The PLSA’s retirement living standards maintain that a moderate standard of living in retirement will cost about £23k per annum, a target that is currently out of reach for most. This is far from ideal.  Members will be simply losing out on the chance of increased income in retirement by the industry’s inertia and resistance to change the ways in which DC pension are accessed."

Pensions freedoms

Hatchett pointed out it had been eight years since the introduction of freedom and choice which removed the compulsory requirement to buy an annuity by age 75.

He said it had completely altered the DC pensions landscape and that drawdown remained by far the most popular choice for retirement yet it did not give a typical retiree any way to efficiently manage their pension pot.  "Any individual, whatever their life expectancy, might spend a year in retirement or 40 years. And they cannot know in advance. This longevity uncertainty trumps investment volatility for most DC savers."

“Each year, UK retirees are ever more reliant on DC pensions.  For most this income will be insufficient as they haven’t saved enough, and are unlikely to be able to, even if they increase their contributions now."

"It might be too late for those in their 50s and 60s to save enough, but not too late for the industry to help.  R“Providers and the pensions industry need to quickly develop some of the ideas that are emerging into tangible solutions.  This will deliver retiring DC savers increased incomes when they’ll need it. “As an industry, we cannot afford to get this wrong for savers.”

Paul Waters, head of DC markets at Hymans Robertson, said the report outlined a number of options and risk-sharing ideas that could increase the sustainable income people can draw from their pension pot, allowing them to plan their spending with confidence and reduce the risk of running out of money. Some of these ideas are tried and tested  while others are emerging and more are yet to be developed such as longevity pooling and deferred annuitisation.   "The report also recognises that, in search of the optimal outcome for members, we could see the blending a number of these different approaches as they are developed."

Growing DC savers' pensions: solutions

Annuities: A guaranteed regular income payment until death, or an earlier pre-defined term.  Members can choose between various product features such as inflation protection or not, dependant’s pension and lump sum on death. Provided through life insurers, annuity pricing is largely linked to gilt and bond yields.

Income drawdown: A method of accessing your DC pot for ad hoc lump sum or regular withdrawals, while leaving it invested. Members can choose to take tax-free cash first and also select the investment strategy for their pot.

Longevity pool:  A way of pooling longevity risk and boosting income while alive. Members draw income from a flexi-access drawdown fund, within limits. Upon death of a member the remaining pot is spread fairly amongst surviving members of the pool, rather than going to the member’s estate.

CDC (Collective DC): A way of pooling investment and longevity risk. Members join a collective scheme with their pots invested together and benefits determined by performance of the scheme (investment returns and member deaths) and calculated by actuarial assessment to offer a fair return to different cohorts over time.

Later life longevity protection: A decumulation design that has built protection against longevity risk at a pre-determined age e.g. 85. Designed to combine flexibility in the early years of retirement with the security of a later life protected income, which could be delivered through annuitisation or a longevity risk pool, without requiring too much active planning and decision making from the member.

Investment pathways: An FCA mandated option for customers in non-advised income drawdown, where customers are given a choice of four options based on how they plan to take their income over the next five years.  A single investment default is created for each of the four pathways.