DrawdownJul 31 2018

The pluses and minuses of the retirement outcome review

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The pluses and minuses of the retirement outcome review

The remedies within the report fall into three categories:

  • protecting consumers from poor outcomes;
  • improving consumers’ engagement with their retirement income decisions;
  • promoting competition by making the cost of drawdown clearer and more comparable for consumers.

These three areas form the headline objectives of the review and final report. The proposals are borne out of significant research, which pulled out some very interesting issues with the drawdown market as it stands. But we do need to bear in mind that we have only had the pension freedoms for a relatively short period of time – certainly in comparison with the time people have been saving to access these benefits – so the market is still evolving.

It is clear from the research that drawdown is becoming a default, instead of the purchase of annuities that we have seen in the past. The report states: “Twice as many pots have been used for drawdown than to buy an annuity. A third (32 per cent) of these were accessed without advice, compared with 5 per cent before the freedoms.”

It is this lack of advice that will be causing concern. We know that drawdown requires greater engagement, which isn’t necessarily being seen alongside the shift to more complex retirement options. The path of least resistance still appears to be a big challenge that needs overcoming, and therefore this aspect features strongly in the FCA’s proposals. It isn’t just about choosing the right product, but making sure the investments chosen are fit for purpose – especially for those that have defaulted into cash or may do so in the future.

Protecting consumers

The first proposed remedy from the FCA is to prevent consumers being defaulted into cash. The regulator is considering introducing rules to stop cash being the default option for those that are at or near retirement. Consumers would need to make an active decision to move to cash. In addition, the FCA is pondering whether those who hold significant cash for a period of time need to be notified by their provider. These issues will not be formally consulted on until January 2019, allowing time for an exploratory discussion beforehand.

The watchdog is also considering mandating providers to offer default investment pathways for non-advised clients, to ensure they can still have access to drawdown but with more structure to facilitate good outcomes. Its suggestion is three different strategies, dependent on the consumer’s choice of the following:

  • I want my money to provide an income in retirement;
  • I want to take all my money over a short period of time; or
  • I want to keep my money invested for a long period of time and may want to dip into it occasionally.

Default investment pathways were previously raised by the Work and Pensions Committee and then dismissed by the government, so we wait to see if what has been proposed here comes into force. These changes don’t currently apply to providers who only have advised clients, so they are more of a halfway house than the original committee proposals, but I feel they are still missing the point that drawdown needs active engagement. This just gives another default option that may not be appropriate.

The transparency of charges is a concern, and to that end the FCA wants providers to show clients a one-year charge metric in pounds and pence across all relevant disclosures. This one-year figure will be included in the creation of a drawdown comparator to help those wanting to shop around.

This is going to be very difficult for some providers to administer, and there will need to be some practical guidance to cover what is and is not included. Providers are all very different, with different charging structures, so assumptions about what the client will want to do in that year will need to be made. 

The FCA is not proposing a charge cap, but wants to keep the option under review while the market continues to evolve. This appears to be a very good move: the market is still changing from one where drawdown was virtually all fully advised, to one where more people are either choosing to go it alone or just not seeking help. This may lead to simpler offerings that require less intervention from providers and so could be at a lower cost to the client.

Improving engagement

The FCA is also proposing that wake-up packs are sent at the age of 50 and then every five years until all benefits have been crystallised. The wake-up packs should include a headline one-page document containing key information, including fund value, guarantees and prominent details about Pension Wise. In addition, the FCA wants the wake-up packs to include pronounced risk warnings.

Wake-up packs are sometimes the first time a person considers what they are going to do with their funds at retirement. These will become more important as we move to a world where money purchase pensions constitute the majority of people’s retirement funds. Getting this right will be key to ensuring good outcomes for all in retirement.

Meanwhile, the Financial Guidance and Claims Act 2018 requires the FCA to make rules stating that firms must ensure a consumer has either received appropriate pensions guidance or opted out of receiving it before the company proceeds with an application to access or transfer their pension savings. The FCA will need to consult with the Single Financial Guidance Body when it is formed before consulting more widely on any rule changes.

These proposals may not improve guidance for consumers, particularly in light of the ‘second line of defence’ risk-warning process that providers already have to go through for non-advised clients, but assuming the changes aren’t too onerous then every little helps.

Changes to the annuity information prompt are also being proposed. These aim to ensure those requiring quotes for a certain level of income can truly benefit from these prompts. In addition, the FCA is putting forward a requirement that providers ask consumers basic questions about their health and lifestyle to determine whether a customer is eligible for an enhanced annuity. They must use this information when generating the quote for comparison that is presented in the annuity information prompt.

The regulator also wants to break the link between tax-free cash and income. This would mean clients could take their cash without the need to enter a drawdown arrangement, thus giving them time to shop around for the best option while still having access to their money. This will require significant legislative change and the FCA will be passing on its research to the government to consider the merits of this option.

On the technology front, the watchdog wants to promote and support the use of technology in retirement and decision making, and will host a Pension ‘TechSprint’ later this year. The aim of this event is to challenge tech providers and industry to come up with innovative solutions to some of the emerging issues raised in the interim report, such as a lack of engagement and shopping around.

Improving transparency

To ensure those in drawdown receive regular information even if they aren’t taking income, the FCA is proposing providers must present a key features illustration when exercising drawdown options or equivalent contract variations, and supply information on an annual basis for consumers who have entered drawdown but not taken any income.

Finally, the watchdog is working closely with the Association of British Insurers and Money Advice Service to develop a new drawdown comparator.

There are many good proposals in the FCA’s document, most of which have been taken forward for formal consultation, and we await the outcome of that to see if there are any significant changes. The impact some of these will have on day-to-day processes and costs means the pensions industry will certainly have very strong views.

Claire Trott is head of pensions strategy at Technical Connection