Radical reforms of the pensions market announced in recent weeks are forcing insurers to fundamentally re-evaluate their business models, with analysts spotting opportunities alongside the market panic.
First, Chancellor George Osborne announced the biggest shake-up to pensions since the 1920s, opening up new financial planning opportunities for advisers and their clients but sending the share prices of a number of insurers spiralling downwards.
Then pensions minister Steve Webb last week confirmed plans to cap pension charges at 0.75 per cent for auto-enrolment, with the threat of further cuts when the rules are reviewed in 2017.
All schemes written on commission basis will see such payments banned retrospectively from April 2016 in a move experts warn could cost the advice sector £150m and up to 1,000 jobs.
Webb linked his charge cap move with Osborne’s radical pensions flexibility plans and declared: “This is a full-frontal assault on poor value for money from a Government on the side of people who save.”
However, insurers may have been forgiven for thinking that policymakers had waged war on the sector last Friday morning when reports broke that the FCA was looking to review up to 30 million old policies and potentially impose today’s regulatory standards on features such as exit penalties.
Again, the share prices of a number of insurers, including L&G and Phoenix Group, took a pounding, with the FCA taking six hours to make an official statement to clarify the review would be much narrower than originally reported.
The radical reforms outlined in the Budget are set to transform the long-term savings market but some experts suggest the stockmarket may have over-reacted.
Budget bombshell – a huge market overreaction?
In a speech at the Morgan Stanley investor conference last week, Legal & General chief executive Nigel Wilson predicted individual annuity sales would plummet 75 per cent next year from £11.9bn to just £2.8bn as a result of the Budget reforms.
Wilson expects the retirement market to divide into three broad segments from next year – full withdrawal, annuities and drawdown/new products. He estimates the size of each of these segments will be £4.9bn, £2.8bn and £5.8bn respectively. “If you have a small pot, less than £10k, you will likely cash it in, in its entirety,” Wilson says.
“£10k-£30k pots which currently deliver £2.2bn in premium will only produce £400m as they will be split across cash, drawdown and annuities.
“Even for pots above £80k, we are predicting a market fall of more than two-thirds, from £5bn in premium to £1.5bn.”
Independent industry experts argue the reforms announced in the Budget may not reduce the flow of money to the insurance sector.
Ned Cazalet, chief executive of Cazalet Consulting, says while annuity sales are likely to drop next year, more people will save into a pension as a result of the Budget.
“In the individual decumulation market, the Budget changes do not impact the amount of retirement savings that individuals have by one penny,” he says. “What is changing is that the range of options open to people will be hugely expanded.
“There is an enormous decumulation market out there and we will see more assets coming in from savers because pension saving now looks more attractive.”
Ernst & Young head of insurance advisory EMEIA Shaun Crawford says: “This will force insurance companies to reboot and look again at their business models.
“Lots of providers will be thinking very carefully about their D2C proposition as a result of the Budget announcement. This is a massive opportunity for this sector.”
Partnership, which saw a 60 per cent fall in its share price after the Budget, says City analysts have got it wrong.
Managing director of retirement Andrew Megson suggests much of the coverage has underplayed the desire for people to have a security of income in retirement.
He says: ”As this bombshell dropped anybody who could read a paper was picking up the consumer facing press and saw complete freedom with no risk.
“Do we think the City have got it wrong? Absolutely. It will take some time to right that but our fundamental business is sound and we will just carry on.”
Experts say the Budget is also likely to present a number of tax planning opportunities for advisers, with immediate reviews for certain client segments required.
MGM Advantage pensions technical director Andrew Tully says: “Taking all your pot at once comes with obvious tax risks but with a bit of planning, split over tax years, people will be able to gradually strip out enough to just fall under the 40 per cent tax threshold. Tax planning will be an even bigger part of advice and guidance moving forward.”
Taxbriefs editorial director Danby Bloch says advisers need to start taking action now to ensure their clients make the most of Osborne’s “pensions revolution”.
As a starting point, he says, advisers need to look at clients in a number of different situations.
These include those with small pots, those who had previously decided against investing in pensions due to a negative view of annuities and those already in drawdown who might be able to take advantage of Osborne’s interim measures such as lowering the flexible drawdown minimum income requirement from £20,000 to £12,000 and increasing the maximum income a person can take from 120 per cent to 150 per cent of GAD. (See Danby Bloch’s Budget analysis of client opportunities on page 52.)
Charge cap “stupidity”
Webb heaped further pressure on providers last week when he announced tough new quality standards for automatic enrolment.
Charges for auto-enrolment default investment funds will be capped at 0.75 per cent of funds under management from April next year, with a review scheduled for 2017.
The DWP has set out a high level principle of a limit on member-borne charges, rather than capping AMCs or TERs, to prevent providers from creating new structures to work around the cap.
The DWP estimates the cap will cost the pensions industry £195m over a 10-year period, with savers expected to benefit directly as a result.
Active member discounts and adviser commission payments will also be banned for auto-enrolment schemes from April 2016 in line with recommendations made by the Office of Fair Trading. Aviva head of policy John Lawson has previously suggested such a commission ban could cost the advice sector £150m and 1,000 jobs.
“Lots of providers will be thinking very carefully about their D2C proposition”
While Royal London chief executive Phil Loney supports Osborne’s new pension flexibility, he accuses the Government of “stupidity” in pushing ahead with its charge cap reform.
He says: “Price controls sound like tough action but make no difference to the underlying economics of the market. In practice, price capping will mean lower pension pots for savers in the long term and perversely higher charges than necessary for many.
“Many larger pension schemes are already charging below 0.75 per cent and should expect further reductions in their charges as auto-enrolment expands pension saving and competition drives prices down.
“But now the big shareholder- owned insurance companies will use 0.75 per cent as a floor to protect their margins in a market where charges have been falling.”
Rowley Turton director Scott Gallacher agrees, saying: “A charge cap is a bad idea, especially in the middle of auto-enrolment.
“The fact it is retrospective is not good and sends out a negative message to the rest of the world. Who is going to launch a pension scheme in the UK if, after the event, the Government swoops in and cuts your charges?”
FCA legacy review
Having seen the Chancellor obliterate their at-retirement business model and the DWP clampdown on workplace pension charges, providers were dealt a further blow when the FCA confirmed it will review old life insurance policies to ensure customers are being treated fairly.
In an embarrassing few days for FCA chief executive Martin Wheatley, he was forced to admit that failing to correct media reports about the scope of the review for six hours was “not the FCA’s finest hour”.
The FCA has since clarified that its supervisory work would not include individually reviewing 30 million policies, “nor do we intend to look at removing exit fees from those policies providing they were compliant at the time.”
The insurers have recovered much of their losses since Friday’s market panic but advisers suggest the review could still have big implications for them.
Insurers are also working on an OFT-inspired review of legacy pension charges which should report later this year.
Syndaxi Chartered Financial Planners managing director Robert Reid says: “High charges on legacy products is where the Government and the regulator should have been focusing from day one. I think some providers will struggle to justify the exit fees they levy on people’s pensions.”
However, analysts at Barclays suggest the insurers have little to fear from this review. They say: ”The policies outstanding today are either likely to have guarantees which are valuable in today’s interest rate environment or they have terminal bonuses which are maturing soon and are valuable to the customer and this business is maturing anyway over the next few years.
“In our view, the back books which are more at risk are the aggressive business written pre-RDR by the commission players.”
With all commission business having to be rewritten and adviser payments stripped out by April 2016, they may well be right.
Expert view: Tom McPhail, Hargreaves Lansdown head of pensions research
Now the Government has torn apart the pensions rule book, the challenge for all of us is to formulate a new set of regulations that ensure people are given the help they need as they approach retirement. The current FCA rules around at-retirement communications simply do not allow you to do that and will need to be rewritten.
Steve Webb rejects concerns that many savers will blow their whole pot
Pensions minister Steve Webb has rejected concerns savers will take their entire pension pot as cash from age 55 following a radical liberalisation of UK tax rules.
Reforms announced by Chancellor George Osborne during the Budget last month mean that, from April next year, anyone aged 55 or over will be able to take up to 100 per cent of their fund as cash.
While the changes have been broadly welcomed by the advice sector, some commentators have warned savers risk being left worse off in retirement if they are handed greater freedom over how they spend their savings.
Speaking to Money Marketing, Webb says: “The risk of people blowing the lot as a result of these reforms is greatly overstated. I do not buy this notion that people will deliberately do this for the joy of living on housing benefit.
“An earlier Government would have been much more wary than we could about doing this because of the single-tier state pension.
“Simple arithmetic suggests the drawdown rules can be relaxed with a different state pension system.”
Webb also warns providers against devising a “cunning ruse” to work around the 0.75 per cent auto-enrolment default fund charge cap.
He says: “I do not quite divide the industry into good guys and bad guys but there is clearly a spectrum. There are forward looking companies who offer good value without anybody making them and there are others who have exploited consumers’ lack of awareness and complexity.
“When we draw up the regulations on the detail of the charge cap we will have to carefully define the default fund but if any provider tries to get around the charge cap by some cunning ruse, that is not in the spirit of what we are trying to do, we will be on them like a ton of bricks.”