Months of plummeting stockmarkets are throwing Chancellor George Osborne’s pension experiment into doubt as thousands of customers acting without advice see the value of their savings decimated.
April 2015 saw the launch of the pension freedoms and also marked the FTSE 100’s highest-ever value at just over 7,000 points.
But in a “doomsday scenario” for the Chancellor the 10 months since have seen the blue-chip index fall to 5,500 points, wiping billions off the value of pension pots, including customers opening non-advised drawdown accounts for the first time.
Money Marketing research shows the damage wrought on the savings of customers who are managing their own funds and risk falling victims to so-called “pound cost ravaging”.
Pension providers which launched these products in response to savers’ demands for access to their pots now find themselves in a bind as fears over crossing the advice line prevent them from helping customers.
So could Osborne’s landmark reforms come unstuck as inexperienced investors flail in falling markets? Or can providers catch them before the industry is engulfed in another scandal?
Could the Government reverse some of the freedoms if pots empty dangerously quickly?
And will the Treasury’s proposals for rewriting the rules of the advice sector hand firms the power to stop consumers making damaging mistakes?
Thrown to the wolves?
In the wake of the pension freedoms, major providers launched non-advised drawdown products for the first time.
Money Marketing previously revealed the success of this new wave of retirement options, with Standard Life saying it was its “fastest-selling solution ever”. But fears are growing direct customers have been left exposed.
Retirement Advantage pensions technical director Andrew Tully says someone withdrawing 4 per cent in a typical balanced portfolio – 60 per cent held in equities, 20 per cent in corporate bonds and 20 per cent in cash – would have seen a £100,000 investment made in April 2015 fall by around 14 per cent to £86,813 today.
“This is a doomsday scenario very much of the Government’s making”
The most recent FCA figures show 42 per cent of people who went into drawdown following the freedoms did so without an adviser.
Partnership director of corporate affairs Jim Boyd says: “People who have had to draw down when investment performance is poor – without the benefit of additional cash reserves or annuities – run the risk of running out of money before they die or having to live an extremely frugal retirement.
“Without the expertise offered by regulated financial advice there is a risk many people may come to realise too late they have misbought these products, which of course runs the risk of being the next financial services scandal.
“This is a doomsday scenario very much of the Government’s making.”
Tully says the Government and the regulator may be forced to impose controls if people begin to run out of money.
He says: “If we have several bad years there is a potentially big risk a lot of people could run out of money very quickly when they were hoping it would last their retirement. We probably could see that change, in 2010 the Government dropped maximum drawdown limits to 100 per cent of the GAD rate because we had a few bad years and pots were hammered. It wasn’t popular but the Government acted when it felt it had to.
“That would be very difficult at the moment but the regulator might feel it should give guidance along those lines in that kind of situation.”
Performance figures obtained by Money Marketing show how funds commonly used by Standard Life, Scottish Widows and Aviva direct drawdown customers have fared since April.
None of the providers have an official default fund but Standard Life customers are typically invested in a three pot strategy which splits savings into funds designed for the short, medium and long term.
Up to 11 February the Active Retirement Plan 1 – where income is paid from – returned -0.26 per cent, while Plan 2 dropped -3.23 per cent and Plan 3 was down -6.25 per cent.
Head of pensions strategy Jamie Jenkins says the strategy has worked as intended and adds customers withdrawing at a rate of 4 per cent would not eat into the medium term pot for another three years.
He says: “Markets have dropped around 10 or 15 per cent and it is true if someone was invested purely in those markets they would have lost something similar. We launched an off-the-shelf solution to mitigate this risk, based on the three pots and people withdrawing money at a reasonable rate, and we would largely have protected them from the entire market drop.
“We can’t guard against someone taking out 20 or 30 per cent a year, they are going to crystallise some of those losses.”
Scottish Widows provided data for five portfolios that make up part of its series four range with an annual management charge of 0.1 per cent.
Its cash-like portfolio returned 0.5 per cent over the same period, while the other four portfolios – with varying splits of equities and bonds – were down between -5.11 per cent and -9.8 per cent.
The Aviva Investors Multi-Strategy target income fund, one of the most popular in its range, returned -0.09 per cent.
“We are not looking to introduce controls and stop customers doing what they want to do”
Aviva pensions and investment senior policy manager Alistair McQueen says the provider will not boost protection until there is evidence of poor outcomes.
He says: “No one is asleep at the wheel. We see daily data and the Government is all over this. Non-advised drawdown is still a very small element of the market, most are still using it as a way of getting their lump sum and leaving the rest invested.
“The customers that are using drawdown as an alternative to annuities have the protection of advisers.”
He adds: “We put a raft of protection measures around non-advised customers, we give them online tools, educational articles about the risks in a downturn, the FCA risk warnings, advocate advice and recommend Pension Wise.
“Had we seen any extreme behaviour in the early months we may have been more inclined to say this is not looking good but so far we’ve seen little evidence drawdown polices are being set up with unusual withdrawal patterns.
“We are not looking to introduce controls and stop customers doing what they want to do.”
But Just Retirement director of external affairs Steve Lowe suggests the FCA should look at imposing a new requirement for providers to trigger reviews of non-advised drawdown pots in certain circumstances.
He says: “Drawdown is becoming almost the default in the non-advised space, and these customers are getting no reviews.
“So should you ever allow a drawdown product to be sold when you are exposing customers to that kind of risk, unless there are some kind of instituted reviews?
“That might be a review a provider has to do by giving customers an alert every time their fund moves by a certain proportion, or a questionnaire that is sent out to determine whether it is still suitable for their needs.
“The FCA are alert to this but they need to accelerate their work because customers are exposed materially to this risk.”
In November director of competition Mary Starks noted the “significant increase” in people not moving around in retirement and buying drawdown from existing providers. An FCA spokeswoman says the regulator is to launch a retirement outcomes review in the next few months which aims to examine the impact of the reforms, including on competition and switching in the market.
Fear of crossing the line into advice is also stopping providers doing more to protect direct customers from mistakes commonly made by inexperienced investors, such as selling at the bottom of the market.
Firms are hoping the Financial Advice Market Review will include proposals that will allow them to intervene in extreme conditions without taking on the liability of giving regulated advice.
Hargreaves Lansdown is one of the biggest providers of direct drawdown but it steered away from tailored warnings before the freedoms came into effect.
Head of retirement policy Tom McPhail says: “We had a discussion before the freedoms kicked off because we were mindful of the fact the nature of the drawdown market was about to change and we might see many more people looking to enter drawdown than before.
“One of our concerns was if we set an automated alert that triggered when the market dropped 15 per cent, the FCA would come along and say ‘why not 10 per cent? And by the way, the very act of doing that means you’re accepting some responsibility, you’re giving your clients some commitment you will intervene and give warnings’.
“In the pre-FAMR world that was potentially advice and would leave us open to regulatory risk so we chose not to do that. So we went for customer education before they enter drawdown and ongoing communication. That can’t be personalised because as soon as you do that it is advice.”
“No one’s rushing into this because auto-rebalancing, for example, could crystallise losses and be quite damaging”
Aviva wants the boundaries of “information-only” guidance extended so it can provide customers with “rules of thumb”.
McQueen says: “We believe the current definitions of information-only are very restrictive. We argue some more movements in the definition of information-only would allow us to give more help to customers more broadly that wouldn’t take us as a provider into the world of advice.
“We’d like to be able to make more use of universal truths or rules of thumb – things like paying down credit card debt first or looking at joint annuities if you have a partner. We are not allowed to make those simplistic statements at the moment.”
Jenkins thinks the UK will follow the US market where there is more flexibility around activity such as automatically rebalancing portfolios on behalf of customers.
He says: “That’s probably the next step here – can you get to a stage where everybody, including the regulator, is happy for providers do something a bit more than what we’ve done here.
“No one’s rushing into this because auto-rebalancing, for example, could crystallise losses and could be quite damaging. It requires a lot of thought and is not a replacement for an adviser running a centralised investment proposition actively for their clients, but you could have something that automates at least the extremes where markets are moving quickly and you want certain safeguards.”
Jonothan McColgan, chartered financial planner, Combined Financial Strategies
The pension freedoms are fantastic. People’s money should be under their control. I worry there will be a knee-jerk reaction and the Government could reintroduce some controls. But further tinkering will just cloud the public’s judgement even more. You can’t have freedom without responsibility, and why should the industry suffer because some people do not want to pay for advice?
Tim Page, director, Page Russell
It would be interesting to find out what non-advised people have been investing in. My suspicion is lots of people will be in cash, so in the short term they might be OK but not in the long term. You would expect direct customers in fully flexi-drawdown will take out at the same rate as they started until the money runs out and by then the damage is done.
The near 20 per cent collapse of the financial markets from the date of the introduction of the pension freedoms must be the biggest headache facing the Government.
Since then it should be a matter of extreme concern to policymakers that 42 per cent of people who were encouraged to enjoy the freedom of taking responsibility for their own retirement funding strategies and who went into drawdown did so without the benefit of regulated financial advice.
Not only are they exposed to investment performance against a background of extreme market volatility – the FTSE was at around 7,000 when the freedoms were introduced – but they also have to make judgements about longevity and life expectancy which have challenged actuaries for decades.
People who have had to draw down when investment performance is poor – without the benefit of additional cash reserves or annuities – run the risk of running out of money before they die or having to live an extremely frugal retirement. Without the expertise offered by regulated financial advice there is a risk many people may come to realise too late they have misbought these products.
In addition to the many people with smaller pots who are unable to access affordable advice and could run out of income, and who may very well face debt in later life, this runs the risk of being the next financial services scandal.
This is a doomsday scenario very much of the Government’s making.
The concern facing the Chancellor must be people do not run out of funds before the next general election. Sadly for him and for many thousands of people in retirement this may prove to be a gamble which has gone very badly wrong.
Jim Boyd is director of corporate affairs at Partnership