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Gregg McClymont: Consumer choice is not the answer to the pension freedoms

The FCA’s Retirement Outcomes Review is winding towards its close. But what have we learnt? Mostly, that consumer choice is not the answer to the pension freedoms conundrum in the non-advised drawdown market. This is a big shift for the FCA, which has forever been attached to a view of the retail pensions market, in which the rational consumer is always capable of making good decisions – just so long as the appropriate information is available.

Nobel economic laureate Bill Sharpe called decumulation the “nastiest, hardest problem in finance”, and the pension freedoms has brought that problem into living rooms and kitchen tables up and down the country.

Much of the FCA’s response to the problem is familiar. Providers are encouraged by the regulator to think about decreasing higher drawdown charges. If not, the FCA might at some indeterminate time consider a price cap for income drawdown. Currently the range of charges for drawdown is similar to what existed in accumulation before the introduction of the charge cap on qualifying DC schemes, with no more justification.

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The advisory powers of independent government committees are to extend to retirement products. The 2013 report of the Office of Fair Trading  into UK defined contribution schemes identified the problem of conflicted interests and poor governance leading to poor outcomes in retail DC. The OFT recommendation that policy should be used to promote “robust independent governance” eventually resulted in IGCs. This model is a flawed first attempt at delivering “robust independent governance”. The flaws are that the committees are not necessarily required to be entirely independent and they are not governing either. IGCs do not have the same legal powers as trustees; they have an advisory rather than an executive role.

Information remedies continue to be prominently espoused by the FCA – “wake up” packs – despite repeated failures to change behaviours. The experiments conducted for the FCA on responses to price signals for annuities found that a large majority of people ignored them. The FCA’s subsequent research into the retirement product market underlines that large numbers of consumers are not acting as informed rational purchasers.

Two innovations in the FCA’s thinking are observable, though. First, customers will no longer be able to be defaulted into cash when they move into drawdown. This approach recognises the tension between individuals as consumers who prefer cash in the bank, but who are nonetheless purchasing a long-term investment product.

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Second, information remedies are for the first time accompanied by the reduction of the decumulation investment journey to simplified options, or pathways. Providers must offer these to customers depending on where customers locate themselves within the four categories below:

  • Option 1: I have no plans to touch my money in the next five years
  • Option 2: I plan to use my money to set up a guaranteed income (annuity) within the next five years
  • Option 3: I plan to start taking my money as a long-term income within the next five years
  • Option 4: I plan to take out all my money within the next five years

Providers must make members aware that they can select from a set of different drawdown investment pathways depending on their needs.

The thinking behind the pathways – that choice architecture should be altered to achieve specific outcomes – is welcome. What the pathways are not, however, is a potential solution except for non-advised retail drawdown.

In a master trust or single employer trust, the trustees run the scheme. They are responsible in law for the running of the scheme and the trustees are required to apply for authorisation as a master trust pension scheme. Trustees of larger schemes are treated in a manner similar to board members in a publicly listed company. Those familiar with PLC board members will know that shareholder value is a constant concern. Replacing the term “shareholder” with “member” provides a feel for how trustees operate. The trustees can sack the underlying provider if they deem it to be no longer meeting the members’ best interest. The requirements on trustees to avoid conflicts of interest are strict.

Applied to the retirement market “problem”, this governance structure is likely to ensure products which anticipate consumers’ needs through retirement. A pension scheme operating under a fiduciary obligation would risk breaching this duty if it did not have a core mass market proposition which included longevity protection. Annuities are likely to be bulk-bought from the wider market and the best wholesale price passed onto members.

As such, master trusts are likely to mimic the best international pensions practice, which combines income drawdown and an annuity, to ensure the member runs out before their money does.

Gregg McClymont is director of policy and external affairs at B&CE

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