European regulation Solvency II could be hampering a possible solution for creating long-term retirement income for the mass market.
Solvency II requires insurance providers to keep enough capital to ensure the likelihood of being ruined during the year is no more than 1 in 200.
This requirement, coupled with uncertainty around how long people are going to live, makes it too expensive for insurers to create a standard solution to the problem of providing the UK’s retirees with an income in later life, according to consultancy Aon Hewitt.
The comments came as the government and regulators are considering whether to introduce a default retirement solution for people not taking advice when going into drawdown.
Aon Hewitt pointed to a concept designed by the Australian government as part of its comprehensive retirement income review of 2016/17, which, it said, could function as a default solution.
The product would see people buy a deferred annuity towards the end of their working lives for when they reach age 85, while simultaneously starting to draw income as their regular earnings start to decrease from about age 65.
They would also have access to a flexible pot of cash for ad hoc withdrawals running alongside their plan.
Kevin Wesbroom, senior partner at Aon Hewitt, said a similar system could work in the UK.
But the problem was deferred annuities were too expensive because of the onerous regulatory requirements included in Solvency II on risk that could not be pooled, he said.
“If you buy a deferred annuity at age 65 that doesn’t kick in until you are 85 a lot of the people that buy those will be dead so that should mean buying that insurance is quite cheap.
“The problem is given the uncertainty about how long people are going to live it’s possible that there will be a lot of people still alive at age 85.
“The Solvency II one in 200 scenario is not that most people are dead but everyone is living. [It] kills off the price of deferred annuities.”
Mr Wesbroom said a way to go around the problem was to introduce collective defined contribution (CDC) schemes, which could pool the risk.
He said: “Deferred annuities don’t exist yet but they will do [if CDC legislation comes through].”
The government is currently looking at rewriting legislation to allow for CDCs, in an attempt to take the pressure off firms struggling to maintain defined benefit schemes.
CDCs are schemes that see an employer contribute the same each month but at the same time offers members a targeted payout after they retire.
Already used in Holland, they see risk shared among members, who typically come from across an industry rather than from a single employer.
MPs are keen to have some sort of default plan in place for those not getting advice but who do not want to pick their own investments in drawdown.
Sophia Singleton, head of DC consulting at Aon Hewitt, said: “I can see these type of solutions be default solutions. You have those three distinct elements to your savings. And it’s packaged so you don’t have to work out when to buy an annuity or income.”
Aon Hewitt also said the product would only be sustainable for people with funds worth at least £50,000.
The regulator has been calling for more innovation in the pension space since pension freedoms were implemented in April three years ago.
But so far little has happened although government backed workplace pensions provider Nest launched a blueprint for a retirement income strategy similar to the Australian model in June 2015.
Aon Hewitt believes employers have shied back from innovating for fear of being the first in the firing line while providers were still catching up on pension freedoms.
Pete Glancy, head of policy at Scottish Widows, said the problem with CDCs was more of a market issue.
He said: “For CDCs to have any traction in the UK it will most likely be across very large workforces where the typical worker has a job for life.
"Over a lifetime, an individual will have around 11 different employers, with a mix of pension schemes comprising defined benefit, occupational defined contribution, personal pension and possibly also master trusts.
"Introducing another and quite complex ingredient for those with multiple jobs and pension pots could make the picture much more complicated.”
Nathan Long, senior pension analyst at Hargreaves Lansdown, said the problem lay in the final design of CDCs.
He said. “You need to have the ability to transfer out of CDC for it to be compatible with pension freedoms and we anticipate many would favour the ability to personalise their retirement rather than being tied into a product for life.”
The industry has been fiercely critical of default drawdown solutions as proposed by MPs, saying one size fits all would not work in drawdown and it would lead to more consumer disengagement in retirement.
Mr Long said the idea of deferred annuities would need to be factored into the overall scheme design.
"It will be almost impossible to get someone to voluntarily part with money to pay for a guaranteed income to kick in from an age they may never reach.”
Alistair Wilson, head of retail platform strategy at Zurich, agreed it would be difficult to convince consumers of the merits of deferred annuities.
"Our recent research found just 5 per cent of people currently in flexi-access drawdown see an annuity as the solution in later life, suggesting the annuity market still requires a lot of modernisation."
Ricky Chan, director at IFS Wealth & Pensions, said: "My experience with guaranteed investment products or the like is that they typically aren’t worth paying the premium for.
"I can imagine many clients would be unwilling to pay for something that might not happen and possibly losing the capital sum used to buy the longevity protection.
"If the client were concerned about longevity risks at age 65 and did not have sufficient secure income, then perhaps they shouldn’t be in drawdown or at least not over the medium to long-term."
carmen.reichman@ft.com
