Lessons to learn from overseas DC models
28 August 2014
We are grateful to Professional Adviser for sharing this briefing from Helen Morrissey:
The flexibilities announced in the Budget have been largely welcomed by the industry. It is expected that retirees will remain invested for longer and will annuitise later, if at all. Many have pointed to the experiences of other big DC markets such as the US and Australia -both markets where annuities play no real part - as something to emulate.
However, almost six months on from Osborne's announcements concerns have been raised as to whether the UK is going down the right path amid concerns that many retirees could run out of money. In addition, we have seen calls in the Australian market to introduce compulsory annuitisation. Interim findings of the Financial System Inquiry - a government commissioned investigation into Australia's financial system - found the retirement phase of Australia's superannuation system to be ‘underdeveloped' and ‘does not meet the risk management needs of many retirees'. According to the inquiry a quarter of people with a superannuation balance at age 55 have depleted their balance by age 70. The inquiry committee is now consulting on a range of options - including mandating the use of certain sorts of retirement income products and providing incentives to encourage retirees to purchase retirement income products that help manage longevity and other risks.
Jeremy Cooper, head of retirement income at Australia's leading annuity provider, Challenger believes the Australian decumulation market needs more work if it is to work more effectively: "We have an excellent accumulation policy with people growing decent sized pension pots: we just need to work on decumulation model as it currently works like a bank account with the balance to be drawn down," he says. "They are designed to be depleted. Is this really a satisfactory state of affairs?"
However, far from it being a problem, Tor Financial managing director David Harris believes it often makes sense for those with small superannuation balances to draw down their funds as the Australian state system is heavily means tested. "If you have a pension pot then your old age pension amount is heavily reduced," he says. "Those drawing state benefits can get big transport concessions and discounts on using telephones for instance. So if you've got a £40k pot then it makes sense to use that to pay off debt, purchase new white goods etc."
So given that a huge DC market such as Australia is looking closely at the annuity market is the UK right to be moving away from it?
The Financial Inclusion Centre director Mick McAteer has major concerns about the shift.
"The annuity market needed to be reformed but this could have been done and was happening what with the rules on allowing people with small funds to take as cash being formalised," he says. "We also had the FCA doing work on competition in the annuity market. The way things have gone now means that we are offering less value with more risk."
McAteer believes a lack of understanding about how the asset management industry works potentially means retirees will be exposing themselves to intolerable market risk if they choose to take up one of the many new investment-led solutions that will come to market.
"I have a range of concerns around the kind of products and advice that will come to market," he says. "There is a misunderstanding as to why annuities appear to be poor value for money. This is down to conditions in the money markets and low interest rates affect non annuity products as well as annuity products. To put together the same level of income with an asset management product is much more complicated and exposes the client to major market risk. Annuities bring a degree of certainty and there is less need to revisit advice. Now people will need regular reviews to ensure their strategy is right for them and the cost of advice will go up."
Vanguard's Center for Retirement Research principal Steve Utkus believes that asset managers will need to change their approach if they are to develop suitable income drawdown products. However, he believes it should be seen as a call to action for the industry to develop best practice. "The most striking thing about the UK is the focus is on asset management rather than the process of retirement income generation," he says. "In the US and Australia companies are starting to think about the withdrawal process that needs to be put in place for defined contribution. We need to work out what is best practice here."
He continues: "The challenge is a dual one. Asset managers need to move away from managing peoples' portfolios and look at how they can start delivering income streams people can rely on. Insurers also need to look at how guarantees can play a role going forward. There's a lot of deep thinking to be done about guarantees and how to develop transparency and price competition in the annuity market. The UK industry needs to look at it as a call to action to provide world class guaranteed income."
Another important factor to the UK reforms will be education. If people don't understand the decisions they need to make then they risk getting poor outcomes. In Osborne's Budget speech he launched the guidance guarantee - a service providing retirees with free guidance on their choices. However, Cooper has concerns as to whether such a service goes far enough.
"In the accumulation phase the guidance is fairly generic- save early, save hard but when you get to retirement it becomes more individual and I wonder whether the guidance guarantee is going to be good enough," he says. "The workplace can be a very good way of delivering this information and we will see particularly larger, well-funded employers looking to do this more."
Tor Financial's Harris has similar concerns and urges UK employers to get more involved in a similar way to their US counterparts. "In the US and Australia we don't have quangos such as the Money Advice Service (MAS) and The Pensions Advisory Service (TPAS)," he says. "In the US guidance is delivered in the workplace and we are seeing a ‘financial friends' ethos by which people are being engaged in their mid-50s. The approach is that people know where to go if they have retirement related questions - they can put their questions to people. Can TPAS and MAS achieve the same results with their decision tree approach?
"We should allow the US approach to proliferate with trustees given tax incentives to provide guidance and they would work with providers to do this. I'm not sure how quangos and civil servants can say they understand the needs of members better than an employer/provider approach."
Vanguard's Utkus agrees great strides have been made in the US in recent years in terms of helping retirees access information and advice and that efficient use of technology will be all important. "With 401k plans there are services you can add - financial engines - that work out cheaper than a financial adviser," he says. "These can manage income in retirement for a 40bps incremental fee. I can imagine such an experience coming to the UK."
So it would seem that the UK market has many lessons to learn from its US and Australian counterparts in terms of retirement income. However, Cooper believes that the best approach will be one where annuities continue to play some part in people's retirement planning. "It would be good if people could partially annuitise to ensure they have enough to live on and then have flexibility with the rest of it," he says. "Ideally we need to move towards a middle ground and voluntary partial annuitisation should be the way forward. I just hope that in the UK annuities don't get lost altogether in the changes."
However concerns remain for McAteer: We've gone too far in the balance between state and individual pension provision," he says. "It flies in the face of everything auto-enrolment has achieved. Some will do well and get better tailored solutions but they will be the lucky ones. Others will be put into the market at the wrong time and run the risk of running out of money. Asset managers will be the winners here."