PensionsJul 31 2018

Survey: Clarity awaited on income drawdown

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Survey: Clarity awaited on income drawdown

Twelve months later, the situation is exactly the same. Business continues to boom, and advisers and providers alike are still awaiting details of exactly how this scrutiny will increase. But there have been subtle changes to the way drawdown preferences are perceived and dealt with, by industry and regulator alike.

The common thread over the past 12 months has been the FCA’s retirement outcomes review. An interim report was published last July, followed at length by the final report at the end of June this year.

The wider context is that the full implications of the pension freedoms sea change will not emerge for some time yet. Opinion can be canvassed about the ways in which consumers are engaging with their drawdown options, but it will take many years before potential faults in areas such as sequencing risk become apparent.

In the meantime, the number of retirees opting for drawdown arrangements continues to rise. Our survey this year encompasses 35 providers – one more than in 2017, albeit via the inclusion of some different companies – meaning it is once again a representative sample of the industry. Table 1 shows that many providers have seen a material increase in customer numbers over the year. Rapid growth rates are observable at smaller firms, such as Alltrust, as well larger providers like LV. Both have seen a 20 to 25 per cent rise in customers over the period.

There are signs that growth rates are starting to come back down to earth, however: around half of those who disclosed figures achieved growth rates of between 4 and 12 per cent. At worst, these levels are sustainable rather than disappointing, and a drop-off is hardly surprising given the industry’s rapid rise since 2015.

Transfer trends

One caveat is that this year’s survey is a month earlier, meaning the period since the last analysis is 11 months rather than a full year. But any resultant hit to figures is likely to have been offset by the defined benefit (DB) transfer boom that continued throughout 2017.

James Jones-Tinsley, of Barnett Waddingham, says the “pent-up demand” released with the introduction of pension freedoms “has now had time to work its way through”. But with drawdown continuing to prove twice as popular as annuities in the new era, and a wave of retirees on the horizon as a result of demographic trends, the sense is that this is still just the start. 

Enter, then, the FCA’s analysis of retirement outcomes. As tends to be the case with regulatory reviews, the study’s conclusions were given a cautious welcome by the industry.

Lee Halpin, technical manager at Atsipp, says the findings reflect the watchdog’s role in seeking to guard against unwanted outcomes thrown up by the pension reforms.

“I don’t envy the FCA in that it faces an almost impossible balancing act. On the one hand, the government is as committed as ever to the pensions freedom regime – and freedom for all irrespective of means and financial literacy. On the other, the FCA is tasked with protecting the less engaged from poor outcomes,” he says.

There are many points of the regulator’s proposed remedies that still require ironing out. Indeed, at 121 pages, the FCA’s consultation on its planned changes is longer than the 78-page final review itself.

The watchdog flagged three particular aspects of its consultation as being of interest to the drawdown market. The first of these is the plan for three default investment pathways for non-advised consumers entering drawdown, based on whether a retiree wishes to take all their money over a short time period, dip into their cash occasionally, or wants it to provide an income in retirement.

Some have suggested this proposal is in conflict with the government’s recent observation that it is “not convinced” by the Work and Pensions Committee’s own suggestion of default pathways. There is a difference between the two, however. The FCA has said retirees should choose one of the three options themselves, whereas the government felt the committee’s interpretation would see individuals defaulted into a single product. In its words, this “would be inconsistent with the freedom and choice reforms”.

The FCA consultation acknowledged firms may wish to make these pathways available to advised customers. But it also acknowledged that self-invested personal pension (Sipp) providers are a slightly different group, and asked whether Sipp operators focusing on advised customers should be exempt from its plans, stating:

“Traditionally, the role of the Sipp operator is to facilitate self-investment by consumers, rather than offer ready-made investment solutions for them. Some operators may focus on advised consumers and sophisticated investors. We recognise that some Sipp operators may find it difficult to implement investment pathways, for example, if they lack the resources, expertise or permissions.”

Jessica List, pension technical manager at Suffolk Life, describes this potential flexibility as “good news for the industry and consumers”.

Charges

The regulator’s consultation has also asked questions of drawdown providers’ fees, saying charges “can be complex and unclear, so they are not easy to compare”, adding that it “also found wide price dispersion”. As a result, it has proposed changes to mandatory key features illustrations (KFIs) in an effort to ensure costs are appropriately highlighted to consumers.

Table 2 shows updated costs and charges for drawdown providers. As was the case last year, most fees have remained static despite the potential to derive economies of scale from growing books of business. In recent years, there were signs the industry had begun to shift towards annual charges, cutting back on certain one-off fees in the process. The latest figures suggest this process has, at the very least, been put on pause. Most providers continue to levy a variety of fees, but the FCA’s influence could yet prompt further change.

The watchdog has said it plans to amend its rules to ensure KFIs include important information on its front page, including a pounds-and-pence figure for real charges in the first year. Notably, this must also be provided to customers using existing contracts to move into drawdown or take an income (including uncrystallised funds pension lump sums) for the first time.

On the possibility of simplifying illustrations in general, Xafinity says: “It is a tough task, but the vast majority of consumers find it difficult to understand all the assumptions on inflation, mid and low growth rates, the impact of product fees, and IFA remuneration and how regular withdrawals affect the overall pension pot.”

Hamid Nawaz-Khan, chief executive of Alltrust, says drawdown “has become more complex with time” and that illustrations remain just a starting point. He highlights the usefulness of modelling actual scenarios for clients. “A lot of advisers are doing this… it gives a client far better understanding as to the nature of the drawdown that suits them.”

Cash caution

The review’s two major findings on cash could have important implications for the industry. The first centres on a proposal raised by the interim report: the possibility of “decoupling” the tax-free lump sum from the need to move into drawdown. 

The FCA suggested this because it found many consumers move into drawdown solely so they can take this lump sum. The final report has retained the recommendation for the government to consider this option, but with much less emphasis than in the interim review.

While some providers had been in favour of the move, others had said the complexity involved would make implementation onerous. This can be a common complaint by providers faced with regulatory change, but the final report did make an apparent nod to this argument.

“[It] would require major changes to the pension tax regime and we recognise that there are detailed policy and practical issues which the government would need to consider,” the report said.

Suffolk Life’s Ms List adds: “If the other proposals in the consultation are successfully explored and implemented, it’s hard to imagine that such a monumental change would be necessary.”

Table 3 outlines the proportion of their pots that customers are taking, and the findings here do show one notable difference from last year. In fact, the number of customers drawing nothing from their pots has fallen markedly at several firms. The likes of Atsipp, Barnett Waddingham, and LV all report double-digit falls in the proportion not drawing. This trend is not yet consistent across the industry, but will be worth watching in the coming years.

Pause for thought

When it comes to full pot depletion, numbers have stabilised or fallen at most providers, but there is the odd exception. Walker Crips, for example, now reports 20 per cent of non-advised customers have drained their drawdown savings, compared with just 6 per cent last year.

There remains little evidence of the typical customer being too reckless with their money. Prior to the pension freedoms, the fear was that many consumers would rush to spend their retirement savings without giving due thought to the length of their lives. While it will take years for an accurate picture to emerge, the regulator now points not to excess risk, but undue caution on the part of some retirees.

It notes that a third of non-advised drawdown customers are invested wholly in cash, a decision it deems to be inappropriate for “over half” of this group. While this equates to just 5 per cent of the drawdown market in total – as Table 4 shows, the majority of drawdown business continues to be conducted on an advised basis – the FCA is keen to act.

The regulator is to consult on rules that will prompt non-advised customers to make an active choice to invest wholly or predominately in cash, rather than being “defaulted” into such a decision. It is also proposing that firms give simple, generic warnings to consumers before they make such moves. 

In order to deal with legacy customers holding cash, the watchdog is also considering making firms repeat these warnings until they receive a response from the retiree.

It is this focus that led Seven Investment Management co-founder Justin Urquhart Stewart, writing for FTAdviser.com, to state: “I’ve never seen so much sense in a consultation paper.” He thinks these moves by the FCA may start to call into question the very premise of so-called lifestyle funds: the concept of automatically de-risking as retirement approaches.

 These ideas also speak to the importance of collaboration when it comes to drawdown. Kay Ingram, director of public policy at national IFA LEBC, says the regulator’s review risks an “over-reliance on providers [that] could perpetuate the problem of consumers…simply accepting the line of least resistance”.

Ben Franklin, assistant director of research and policy at the International Longevity Centre think tank, goes further, saying: “The regulator can only go so far. Public policy, industry and consumer bodies will need to work together to ensure this shift does not cause excessive consumer harm.”

In this context, signs that the government may be backing away from the pensions dashboard (see page 8) do not spell positive news for future attempts to engage and protect retirees from making poor decisions. Like it or not, the onus appears to remain firmly on the industry for now.