The guidance guarantee is a key element of the soon-to-be implemented reforms that will offer increased flexibility and choice to pension scheme members.
However, its success will rest on whether people use and value it. It will not be helpful if it is not used.
Bearing in mind the saying: “He who pays the piper calls the tune,” then thought should be given to whether the guidance service should be funded – at least partially – by those whom it is designed to benefit.
In their initial announcement, the government recognised the importance of supporting the new flexible pension framework with free and impartial guidance. More recently, the government clarified that this service would be funded through a levy applied to financial services firms, suggesting that “those firms that are likely to benefit from consumers who are better informed about their needs and the choices available to them… should help to fund the delivery of the service”.
Arguably, the end investor benefits more than financial services firms. There is significant value to be gained from increased choice and flexibility. At the same time, individuals also face significant risk if they do not engage or seek out guidance or advice along the way, and end up making ill-informed, irreversible decisions that lead to poor outcomes in retirement.
For both these reasons the end investor will value the guidance guarantee more than anyone else. They also have the most at stake in terms of ensuring that it delivers on its promise. With this in mind, the importance of member engagement cannot be overstated.
The current proposal suggests that members should be made aware of the service through ‘signposting’ four to six months before their retirement date. Any business that has launched a new service knows that increased awareness is often not enough to change consumer behaviour. Given the member inertia that has challenged pension providers in the past, it is unlikely that signposting will be the panacea for this long-standing behavioural trait.
The design and delivery of the guidance guarantee should incorporate an understanding of the theories and best practices that drive individual behaviour. Empirical studies demonstrate that incentive frameworks – such as this one, which encourages people to seek out guidance by making it available for free – often bring about unexpected behaviours.
Professor Francesca Gino of Harvard Business School carried out a study of the impact of free advice versus paid advice. Gino’s results show that during a decision-making process, people are more likely to rely on paid advice. The main results of this study were:
• Paid advice is subject to a ‘sunk cost’ effect; people do not want to waste their investment so will be more like to use advice that they have paid for.
• When advice is acquired at a cost, participants weigh their personal opinions less. When advice is free, they weigh their personal opinions more.
• Consumers infer price as a signal of quality, and therefore give free advice less credence.
In the context of the proposed guidance guarantee, this would suggest that a free service is likely to suffer from low levels of user confidence, leading to a scenario in which members may rely more on their own incomplete knowledge, behavioural biases and instincts. If the government wants to encourage engagement and use of the guidance service, consideration should be given to whether individuals themselves should be responsible for funding it.
If individuals fund the guidance service, this also creates an alignment of interests between those who are paying for the service and the delivery partners who are providing it. Paying members will hold providers to a high standard, and providers will feel more accountable to deliver a service that meets the evolving needs of their paying customers.
Another argument to support the idea of members paying for the guidance service relates to fee transparency. Recent regulatory attention on charges has highlighted the importance of understanding the value that is received in exchange for the fees that are paid. If financial services firms are accountable for funding the guidance service, it is likely that their business models will be adjusted to reflect these additional charges. While the total cost and net accounting impact is unknown, it is likely that these charges will impact the end investors in some way – potentially through increased fees or reduced service standards. If members pay for the service directly, this ambiguity is removed, and fee transparency is improved.
In practice, a member-funded guidance service could be structured in a number of ways, such as applying a levy to the value of a member’s assets each year, or charging a flat fee to each individual member account.
Based on market estimates, a 1 basis point (0.01 per cent) levy on £276bn of total defined contribution assets would generate £27.6m in funding each year. Alternatively, 3.6m active defined contribution members paying a flat fee of £7.50 a year would generate a similar level of funding. Given that both assets and number of active members are expected to grow over time, this funding can continue to support the ongoing evolution of the service and ensure that capacity is met over the long run.
These fees could be calculated and collected by the scheme administrator through a redemption of units. Employers who value the service could choose to pay this fee on behalf of their members through a top-up of units or a special contribution each year. While some may question the practical application of this suggested approach, the precedent set by Ireland in 2011 of establishing a pension levy to fund a jobs initiative could be used as a benchmark for implementation.
It is not expected that a change like this could be made in the short term. While the government did not consult on who should fund the service, it is expected that this decision would be reviewed over time once the service is in place and stakeholders can assess its value. Given the importance of this service in guiding investors towards better outcomes, the system needs to be designed to incentivise members to use the service.
Stephanie Condra is retirement markets strategist at Axa IM
Key Points
* The success of the guidance guarantee will rest on whether individuals use and value the service
* The design and delivery of the guidance guarantee should incorporate an understanding of the theories and best practices that drive individual behaviour
* A 1 basis point (0.01 per cent) levy on £276bn of total defined contribution assets would generate £27.6m in funding each year
