Slide towards retail investing faces backlash

Of course, with a world of new possibilities comes a hefty responsibility.

Arguably the biggest single change to the pensions landscape over the past 20 years, the reforms enabled savers to avoid falling victim to poor pricing in the annuity market, but at the same time opened up other threats to their retirement outcome.

If freedom and choice was a landmark event, it can also be seen as part of a broader trend placing greater responsibility on the individual saver, one that is as much a result of changes in longevity and market conditions as Treasury policy.

We can do something that introduces through a default the collectivisation of life expectancy

Michael Johnson, Centre for Policy Studies

“It kind of stems from the decline in defined benefit pension provision,” says Jinesh Patel, senior vice-president investment consulting at Redington.

The transition to DC embodies the trend whereby the saver’s own behaviours are the primary driver of their financial future.

But are policymakers and regulators doing enough to protect consumers from the dangers associated with this new freedom, and should elements of risk sharing be reintroduced to pensions?

Unintended consequences of freedoms

One person well placed to comment on the transition toward individualism in pensions policy is the chief architect of the freedoms, Centre for Policy Studies research fellow Michael Johnson.

He says the “fundamental event that really crystallised” the direction of travel set by David Cameron’s government and its Built to Last paper was freedom and choice, which killed off the annuity.

“It was dying anyway because of quantitative easing, but freedom and choice absolutely compounded that,” he adds.

Curiously, Johnson now expresses some regrets about the policy’s impacts, mainly the fact that it brought about the end of risk sharing for savers.

“We can’t go back on freedom and choice, it’s too popular to kill. But we can do something that introduces, through a default, the collectivisation of life expectancy,” he says.

The policy intervention he mentions is auto-protection, a system that defaults a member’s pot into drawdown at between 4 per cent and 6 per cent from a retirement age (which would be increased to 60) to the age of 80. At that point the residual savings would be annuitised by default.

Politicians share concerns

Johnson is not the only one to back the use of defaults in retirement based on the idea savers are shepherded by inertia towards an at-retirement decision they are not always prepared for.

Neither is he the only one to identify issues with the freedom and choice regime he helped devise.

The Work and Pensions Committee has recently launched an investigation into the impact of the reforms, with a view to seeing that “people are equipped to ensure they don’t make decisions they subsequently regret”, in the words of committee chair Frank Field.

It is also probing the issue of pension scams, which have increased in frequency since the introduction of pension freedoms.

The inquiry is spurred on by the Financial Conduct Authority’s retirement outcomes review, which found that while savers are not squandering their pension savings, they do take questionable decisions around their withdrawn pots.

A third (32 per cent) of savers who withdrew their full amount put the majority into current accounts or Isas, which if held in cash can be eroded by inflation. This might have been influenced by a lack of trust in pensions, also highlighted by the review.

Drawdown can work

Steve Webb is less concerned. The Royal London director of policy and former pensions minister says of Johnson’s apparent regrets over freedom and choice: “He’s wrong that he was wrong.”

Webb argues that good drawdown provision should take investment complexity out of the hands of the consumer, rather than leaving them paralysed.

“You don’t have to make the decisions for yourself about how the money is invested,” he says.

People can’t be trusted to take decisions which are in their long-term financial interests

Mark Futcher, Barnett Waddingham

As for the danger of savers running out of money, Webb says this is unlikely to happen on a large scale.

“Taxation does act as a bit of a brake [on spending]. I often say it’s the brake on the Lamborghini,” he says. Retirement defaults are unsuited to the huge variation in savers’ post-retirement circumstances, according to Webb.

In truth, it may be too early to conclude that savers are not making the right choices with their pots. Many retiring today still have sources of DB income alongside their DC savings.

“The evidence could be skewed by the fact that the amounts of money are very small,” says Richard Butcher, managing director of trustee company PTL and incoming chair of the Pensions and Lifetime Savings Association.

Nonetheless, he favours the introduction of defaults by providers. “We need to describe what a good outcome looks like… such that the member can compare themselves against it,” he says.

We are not saving enough

With its warm embrace of auto-enrolment defaults and statutory minimum contribution rates, the accumulation phase of the DC journey cannot be said to leave responsibility entirely in the hands of the consumer.

However, that is not to say commentators are satisfied with the current landscape.

Mark Futcher, head of workplace wealth at consultancy Barnett Waddingham, characterises the current system as one of tension between legislators who are bringing workplace savers closer to the status of retail consumers and “oversight from the regulators, which is more looking... to go away from retail”.

Greater use of defaults and even compulsion are needed, according to Futcher, who points to a recent study by asset manager BlackRock suggesting seven out of 10 savers would actually prefer compulsion to drive their savings.

“I’m sorry, but [people] can’t be trusted to take decisions which are in their long-term financial interests,” he says.

Getting accumulation right is also likely to feed into consumer behaviours at retirement. The bigger a saver’s pot is when they finish work, the more the gravity of their decision will be impressed upon them.

Current auto-enrolment legislation will see combined contribution rates rise to 8 per cent of band earnings from April 16 2019.

“What’s disappointing is that they’ve delayed telling us what the next stage is going to be,” says Futcher, who suggests setting a well-publicised increase rate of 1 per cent every year between 2020 and 2025.

Savers don't understand minimums

The problem in accumulation may be an educational one. The commission headed by Adair Turner that recommended auto-enrolment originally envisaged statutory minimums as strongly encouraging “a baseload of earnings replacement”, with further saving to be enabled on a voluntary basis.

“A very high percentage of people think that the auto-enrolment minimum is what’s going to get them [to a good retirement],” says Butcher.

Whether the solution to that problem is to improve education or use more compulsion is unclear.

Futcher says he hopes that financial advice will be redefined to allow more savers to access helpful information when making choices, in recognition of the fact that in the less binding world of drawdown, consumers can “probably afford to make a few mistakes”.

But as so often with pensions, some commentators merely hope to be allowed some legislative peace and quiet.

“There’s just been so much change in pensions that actually we should probably just give it a chance to do what it’s designed to do,” says Patel.