In its recent paper “Does the framing of retirement income options matter?” the FCA endeavours to conduct a behavioural experiment against the background of the new pension freedom rules.
Although compulsion to buy an annuity was actually relaxed in 1995, with drawdown allowed directly from the pension fund to age 75, the new rules allow greater choice over how to access pensions from 55.
So, with much industry debate around whether to annuitise or not let’s take a look at how behavioural science can shed a light on potential solutions.
First, the bad news. With contributions to DC schemes now outnumbering DB, middle income investors in their forties and younger poised to experience pensions some 30 per cent lower than those in their fifties, and a general apathy when it comes to actually planning for lifestyle needs at retirement, we have a ticking time bomb on our hands.
Consider this alongside the fact we have a perfect storm when it comes to longevity, preserving declining returns for longer and the costs for long-term care, and it appears consumers are still fairly inert when it comes to planning for a potential 30 years or so in retirement.
In its report, the FCA commissioned YouGov to ask 907 consumers aged between 55 and 75 to choose how to draw retirement income from a £100,000 pension pot. It found consumers’ decisions were down to how each choice was framed: for example, they were less likely to want an annuity if it was proposed as an investment.
This type of research is not new. In their paper “Why don’t people insure late life consumption” Brown J, Kling J et al question limited annuity demand in the face of longevity challenges. They found consumers evaluate annuity products using a narrow “investment frame” focusing on risk and return rather than a “consumption frame” considering lifelong consumption issues.
The FCA paper similarly finds that when using the investment frame annuities are unattractive, with low return for higher perceived risks. Thus consumer biases will play a significant role in how they deal with pension freedoms.
We need to aim for informed consent from consumers via product opportunities, education and risk analysis.
For example, we need to see comprehensive at-retirement sign posting, guidance and analysis completed by those offering a service to retirees. This means considering all relevant investment options against the consumer’s resources and priorities.
With “U” and “J” shaped retirement incomes banded around the industry, we see a real need for diversification of asset mix incorporating those with a proven pedigree (yes, equities). With loss aversion in mind, it will be those product providers who can offer a blend of guarantee and investment growth options that will become popular. With profits, I hear you say? Well, products that offer downside protection and upside potential will no doubt be popular.
Our own market research currently underway into the 55 to 65 year old bracket showcases a need for annuity-style products that offer flexible benefits. Tactical use of annuities will be key, blending in drawdown products or perhaps multi-asset protector funds.
Meanwhile, you cannot beat well delivered face-to-face interaction for trust and clarity. My view is that the age of the retirement planner is upon us – one that can deliver risk profiling, transfer value analysis, cashflow and market analysis, and provide clear steers for the client to make informed decisions.
The aforementioned at-retirement income needs will be crucial, particularly where longevity and care costs are concerned. As such, framing questions to produce insight and thought will be key. The good old soft skills are needed more than ever with open questions to dig deep into the consumers psyche to understand their relationship with money and risk.
It remains to be seen how successful Pension Wise will be but by using a formula for gaining informed consent based on risk analysis, product and service opportunity, all framed in a neutral format, consumers should be aware of their options and the impact of their own biases.
Chris Davies is managing director of Engage Insight