What will the industry have to do if the Department of Work and Pensions' statutory money-purchase scheme illustrations show real rate projections that are only around 40 per cent of current FSA point-of-sale projections?
MC: The key issue is to manage customer expectations in the short, medium and, most importantly, long term. Nobody has a crystal ball as to how economic conditions and their impact on investment return will change throughout the natural course of a pension plan. But it is right that customers are given meaningful information to help them realise their funding requirements. We need to be realistic with investors so there are no hidden surprises when they come to retire. This would enable better financial planning and go some way to addressing the key issue of underprovision.
LG: I assume the 40 per cent is a maximum reduction and not an across-the-board figure. If the reason for the reduction is the move to real term projections, presumably, the red-uctions are lower the older the person is.
This does not eliminate the problem but makes it less of an issue for those close to retirement who would be less unpleasantly surprised by the new statements than younger people might be. The industry has to ensure that policyholders do not get the impression that their pension has in some way been devalued. Given other recent press reports on pension schemes not supporting previous benefit levels and the impact of lower investment levels on bonuses, it would be easy for investors to get the wrong message. However, the purpose of combined benefit statements is to make people aware of the real value of the pension they are likely to receive. If the current regulators have now decided that a new basis should be used which is more sensible, they must ensure it does not reflect badly on providers.
SF: Consumers are already confused enough and I do not see how adding another tier of projections will ease the confusion. The value of an illustration is relative to the likelihood of the data shown rem-aining unchanged. For inst-ance, will investment assumptions be borne out, will contributions increase or remain level, will the client move to a different basis within the company scheme?
The inclusion of real rate projections would increase the advisory requirement when the tolerance both of employers and their staff to additional advisory costs is in question. The industry will have to address the major communications exercise that any disparity in projections will create. Resolution comes at a cost and it is important that this is factored in to any proposal for change.
What does the future hold for contracting out, given William M Mercer's recent estimations that rebate levels are so low that Serps/ state second pension are the better option?
MC: The industry made strong representation to the Government that the rebate levels to apply from April 2002 needed to be greater to include incentives for contracting-out purposes. However, the revised rebates were set at a level which, in the opinion of most experts, does not include such incentives and this makes contracting out a higher-risk option for customers in the future.
This means all investors (including those already contracted out) must have all pros and cons made clear to them so that they can decide their future actions. A number of providers, including CIS, have stopped writing new rebate-only business, which is a strong indication of what the future holds for contracting out.
LG: As I read it, the comments about state benefits being demonstrably better and possibly leading to wide-scale contracting back in applied to final-salary schemes. On def-ined-contribution schemes, the position is more finely balanced. The days when the Government might skew the reb-ates in favour of contracting out are probably gone and with it the usefulness of pivotal ages. Contracting-out decisions for defined-contribution schemes are now more about investor confidence in the durability of the state benefit terms and the likelihood that the necessary investment return can be achieved.
SF: There are still ages above which contracting out should clearly not be recommended and initial estimates suggest about 57 for men and 50 for women. The problem is that current investment assumptions when combined with current rebate levels do not provide for a confident recommendation that it will remain the best option for people below these ages. However, this has to be assessed against the current assumption that state benefits do not decrease.
I cannot believe that a Government which has identified the savings gap as a major policy issue will permit it to bec-ome attractive for big numbers of people to return to state pension provision. The current proposals for S2P are very complex and unlikely to remain unchanged. With the suggestion by the Government that further changes may be forthcoming, a mass return to state provision would not only be a costly exercise for the industry but premature.
How feasible are the Government's proposals in its annuity consultation for limited annuities and its proposals for transferable annuities?
MC: It is pleasing that the Government is looking at a wide range of options. However, flexibility of this nature comes at a cost. For transferable annuities, the paper rightly identifies that complete freedom to transfer would lead to less attractive rates for customers in good health. While the middle course allowing transfers at certain given points may be helpful, additional costs would arise because people will need additional information.
More important, further complications will be introduced into the process and customers should then seek (and pay for) advice each time an option arises. It must be questioned whether this is likely to lead to more cost-effective outcomes for the majority of consumers, particularly those with relatively modest annuities.
Similarly, limited-period annuities would introduce additional flexibility which is likely to be attractive only to those with bigger retirement funds. Again, with more flexibility, the greater the need for advice. Both options will mean there will be more categories and layers, with perhaps the need for more ongoing advice. But how many people in the grand sch-eme of things will these moves affect? The key issue remains that most people in this country will retire with inadequate levels of retirement income and the existing annuity regime cannot be singularly blamed.
LG: The limited annuities proposal is a good idea. It is good for the customer because it will allow someone to buy a short-term annuity to fill a gap in their income while leaving the bulk of their retirement fund invested until full annuity purchase is necessary. This sort of flexibility is what is needed in the annuity market. But it is both good and bad news for the provider. It is good news since it will allow annuities to be sold without having to worry so much about the pricing implications of people living longer but bad news because it is likely that there will be a very competitive market in limited-period annuities and margins will be small.
Transferable annuities are more of a problem. For future sales, transferability is not necessary as the customer will be able to choose a limited-period annuity which gives them the option to reconsider at regular intervals. For existing business, transferability to another provider would transfer the current mortality risk between providers and not always at a fair price. Transferability within the same provider might work and would allow customers to benefit from forms of annuity which were not available to them originally.
SF: The proposal for limited period annuities is largely aimed at enabling consumers to avoid making long-term decisions about income requirements when circumstances are unknown. However, with 80 per cent of annuities being written on a level (that is, maximum) income basis, this would tend to suggest that a prime driver is the requirement for as much income as possible, at least in the initial stages of retirement. The paper recognises the potential for higher income if shorter periods of investment mitigate the mortality risk deriving from longerterm annuities.
The possibility of transfers out of annuity funds has major implications for the pooled concept and could lead to selective practices to attract the most financially attractive annuitants. This may result in a requirement to underwrite transfers out based on the then current mortality experience of the transferee. This would protect the integrity of the pool for remaining annuitants but would carry a processing cost which would need to be factored in.
The FSA's recent consultation paper on decision trees aims to help the industry update the trees at low cost. What will it really achieve?
MC: Providers have a duty to update decision trees to keep stakeholder alive and relevant and to keep consumers inf-ormed. I know of people who have been in the pension industry for many years who are struggling to understand fully how the pension credit will work, so what chance does the man on the street have?
While providers are fighting with costs, we cannot rely solely on decision trees to bridge the savings gap. They must be seen as having a part to play within a bigger picture with roles for Government, regulators, employers and providers alike.
LG: It seems odd that we have a consultation about detailed changes to the selling process for stakeholder when the Government has indicated that more wide-ranging changes may be imminent. Perhaps what the proposals really ach-ieve is to get providers to print and keep an up to date standard document which, arg-uably, should be provided by the regulator as part of its education brief.
SF: We are less than a year into the process of using trees and already there are amendments. The lack of decision trees for contracting out leaves a large advisory hole and every amendment brings with it a requirement to amend existing literature requirements for providers. In reality, the changes represent yet another additional cost which providers will have to meet from this low-margin environment.
Leslie Gray, Pensions and investments development director, Scottish Mutual
Steve Folkard, Head of pensions, Axa Sun Life
Martin Clarke, General manager (marketing), Co-operative Insurance Society