Written evidence from Bloomfield Financial Consultancy (APS0034)
Decisions consumers take when accessing their pension savings invariably have many dimensions to them. These are very important long-term financial decisions which can have profound consequences and are often irreversible. Most consumers are ill-equipped to make such complex financial decisions.
Some customers will benefit from regulated financial advice. But many, so called ‘non-advised’ customers, are effectively making the decisions themselves. Evidence is already indicating, for example, that many people are taking income at a level which is not sustainable. The perils of doing this might not come to light for very many years – when the customer’s pension pot has dwindled to nothing – by which time it is too late.
The risk of consumer detriment is clearly heightened where they do not benefit from regulated financial advice. This response to the Committee therefore focuses on non-advised customers.
In terms of good outcomes for customers, the evidence points to:
FCA’s Investment Pathways – a big tick in the box
The Investment Pathways initiative is most definitely a force for good. The risk of consumer detriment is certainly reduced by the introduction of four outcome-focused objectives which are readily understood. Consumer research shows that 9 in 10 savers found an Investment Pathway option which matched their needs.
Following the implementation of Investment Pathways in February 2021 there will doubtlessly be a lot to be learned from their application in practice given they are, in many ways, a new concept. And so it is welcomed that the FCA has committed to a full review in 2022.
Customers in trust-based schemes – let down by DWP and TPR
The consumer protection provided by the FCA’s Investment Pathways is not afforded to customers who are in trust-based schemes. DWP and TPR do not appear to have offered so much as an explanation as to why trust-based customers do not deserve similar protection. And this is all very concerning given the joint regulatory strategy that is supposed to exist between the FCA and TPR.
DWP and TPR must be encouraged to break their silence and explain what their plan for protecting consumers is and the reasons behind it.
Customer communications on Investment Pathways – product provider efforts wide of the mark
Having chosen an Investment Pathway, it is incumbent on the product provider to communicate to the customer the riskiness of the investment solution in a way that enables them to assess whether it is right for them. With customers having chosen an option to match their needs, you’d have thought the risk would have been described in terms of possible outcomes. Wrong – most communications, regardless of the Pathway chosen, are just based on the risk that the investment solution might fluctuate in value. Such an approach fails to recognise that each of the Pathways is designed to meet a different customer objective.
When considering taking income in retirement, the single most important factor which needs to be taken into account when communicating risk to consumers is related to their ability to take risk with their income (which is often called capacity for loss). An approach based on the risk that the investment might fluctuate in value is largely meaningless to consumers who want to know what level of sustainable income they can potentially take and what fluctuating investment performance might mean to their retirement income.
When it comes to communicating risk to consumers, the FCA review in 2022 cannot come soon enough.
Annuities have a part to play – but product bias in favour of drawdown is being applied by some
When projecting income in retirement, a number of product providers appear to be using the FCA’s illustration rate of 5% pa as if it were a realistic assumption. They are showing to customers that, even after a charge of 1% pa is applied, they can take withdrawals for life at 4% pa with all their capital still remaining intact. Or, put another way, if the capital is to be also used to fund withdrawals over expected life expectancy, then a 60 year old male can take withdrawals in excess of 6% pa. Such a projection is unrealistic in current investment market conditions and represents product bias in favour of drawdown over annuities.
In using the 5% illustration rate, there is a requirement on product providers to ensure that the rate is realistic. This does not appear to be being applied. There is perhaps the opportunity for the FCA to remind product providers of their responsibilities in this area.
Guidance – can it provide the support that customers want and need?
Even were the communications to be much improved, many consumers will still want the reassurance that they are making the right choice for them personally. They might contact their product provider or Pension Wise. Behavioural science tells us that consumers do not want to be told ‘on the one hand this, on the other hand that, go figure’. Consumers want to be reassured that they are making the right decision for them.
It is imperative that the so-called boundary between ‘guidance’ and ‘advice’ is fully explored from the consumer perspective. The system should be designed so that it delivers what consumers want and need.
Were it not for pension freedoms then non-advised drawdown would not be a prominent feature of the pension landscape. Whether or not non-advised drawdown is in customers’ interests is a separate debate. In terms of pension freedoms, the regulators can only really deal with the hand they’ve been dealt by HM Treasury.
Reducing the risk of consumer detriment
It is very difficult to argue against any remedy which is effective in reducing consumer detriment. Investment Pathways focus on consumer objectives by identifying what for them are the outcomes they are seeking from their pension savings. Sure, their use in practice will identify areas where they can be further improved, but before they were introduced they were subject to rigorous consumer research and testing.
And also the consumer research carried out by NMG Consulting for L&G, which surveyed nearly 1,200 savers on what they thought of Investment Pathways, indicated some positive findings too … https://www.lgim.com/landg-assets/lgim/_document-library/capabilities/defined-contribution/investment_pathways_research.pdf.
The consumer research found that 9 in 10 savers found an Investment Pathway option which matched their needs. And 60% of respondents were positive about Investment Pathways, with Generation X in particular finding them useful for their retirement planning (almost 70% of retirees-to-be under age 55 being positive about them). There will always be a group of more engaged and confident savers for whom the concept of Investment Pathways will seem too basic. In this context the figure of almost 70% finding them useful is particularly encouraging, demonstrating that the policy intervention is targeting precisely those customers who are most likely to benefit from Investment Pathways.
Investment Pathways can never of course be a substitute for regulated financial advice. But they are most certainly a step in the right direction in terms of helping non-advised customers make better decisions, and therefore reducing the risk of consumer detriment. As NMG Consulting concluded: “Those who previously confessed to having their head in the sand told us that this was a positive first step, a relatable and simple way to make retirement choices feel tangible, with a focus on the outcome of each decision”.
Three aspects that may not be working quite so well for customers
The power of inertia
There is a step for customers prior to them considering Investment Pathways. And that includes deciding whether to remain invested in their current investments. The power of inertia – well evidenced by behavioural science – means that the forces at play will very likely give rise to a very high proportion of customers sticking with the investments they’ve currently got.
The consumer research conducted by NMG Consulting showed that 33% of prospective drawdown users will keep in the same fund(s) they’ve been in, with 25% moving into the fund provided by the relevant Investment Pathway (and with 11% picking new funds and with 30% don’t knows). Evidence tends to show that “saying isn’t doing” and so the 25% could very well be considerably lower in practice.
Ways should be explored of proactively prompting customers to consider Investment Pathways. Without such a nudge then inertia is likely to dominate. A straightforward way of implementing this could be to mandate the consideration of Investment Pathways alongside the existing fund(s) invested in (rather than positioning Investment Pathways as an alternative option to potentially think about). Such an approach would need to be supported by appropriate guidance – and this is explored in more detail later in this response.
Giving Investment Pathways equal prominence
As if inertia were not enough, some product providers – in their marketing literature – seek to actively steer consumers away from Investment Pathways. Such an approach is particularly puzzling given that the FCA requires that the option to use Investment Pathways must be presented in the consumer journey with equal prominence to the other options (of keeping in the same fund(s) they’ve been in or picking new funds).
Investment solutions selected by product providers
In selecting investment solutions for each of the four Investment Pathways, product providers will have had to make an assumption about the risk profile of the customers expected to choose each one. With Investment Pathways being a relatively new concept, product providers will have had to have made assumptions based on the current evidence available to them.
There is existing evidence that the risk profile of customers accessing pension savings is quite different to when they were in the savings phase. Customers tend to be more risk averse when accessing pension savings. And the NMG Consulting research also found that “risk looms large, with 15% describing themselves as ‘very’ risk averse”.
One of the four Investment Pathways covers income drawdown, and the NMG Consulting research found that this was the most popular Investment Pathway with it being chosen by 46% of prospective users. With these being non-advised customers it isn’t possible to know quite how important this part of their pension savings is to them – some will have other separate generous pension provision (and possibly also other assets), while for others it will be their sole source of income in retirement over and above any State Pension. And that is why, as highlighted by the FCA, the focus must be on customers’ capacity for loss – that is, customers’ ability to take risk with their retirement income.
The investment solutions selected by product providers are of course in the public domain. On the face of it some appear quite high risk, almost as if product providers have just plugged in investment solutions which have been designed for the savings phase. And, looking provider-by-provider, there appears to be quite a bit of variability in the riskiness of comparable investment solutions. Analysis is not currently possible because the assumptions made by the product provider about the risk profile of the customers expected to choose each Investment Pathways are not yet in the public domain. IGCs have a duty to assess the appropriateness of the investment solutions selected and to report on this in their Annual Reports. So one hopes that, in the fullness of time, the extent to which product providers have selected investment solutions which are in the interests of customers can be subjected to appropriate scrutiny.
FCA Review in 2022
Investment Pathways are, in many ways, a new concept – not only for product providers but also from a regulatory perspective. And so, following their implementation in February 2021, there will doubtlessly be a lot to be learned from their application in practice.
It is therefore welcomed that the FCA has committed to a Post Implementation Review of Investment Pathways in 2022.
CUSTOMERS IN TRUST-BASED SCHEMES
The reality is that consumers are not in the main able to differentiate between contract- and trust-based schemes, and nor do they necessarily choose between the two or know which type they’re in. As the protection they are afforded is not generally as a result of choice then reliance must be placed on the regulatory system.
In October 2018 the FCA and TPR launched their joint regulatory strategy. As per the press release, the strategy was “aimed at strengthening their relationship, and taking joint action to deliver better outcomes for pension savers and those entering retirement”. The press release mentioned the ways in which the FCA and TPR would work together going forward including two new priority areas for joint action, the first of which was “a strategic review of the entire consumer pensions journey – taking an in-depth look at what tools are needed to enable people to make considered decisions about their pensions”.
In order to reduce the risk of consumer detriment inherent in non-advised drawdown, the FCA pressed ahead with Investment Pathways. The FCA consulted on them twice, published a policy statement, and implemented them in February 2021.
What happened to the “joint action” trailed in the launch of the FCA/TPR strategy? Why is the consumer protection provided by the FCA’s Investment Pathways not afforded to customers who are in trust-based schemes? DWP and TPR do not appear to have offered so much as an explanation as to why trust-based customers do not deserve similar protection.
The trade body for trust-based schemes, the PLSA, surveyed their members at their Investment Conference in March 2020 as to whether trust-based schemes offering drawdown should offer Investment Pathways. Only 10% answered “No – they should be free to do something different” (with 72% answering “Yes – they should be required to offer Investment Pathways or explain why not”; and 18% answering “Yes – they should be required to”).
We met with the relevant policy team at DWP over a year ago, in April 2020, to express our concerns. The starting point must surely be consumers and ensuring that they are appropriately protected against the risk of detriment. We believe that the focus should be on good governance and on good outcomes – and most definitely not on whether a pension scheme happens to be either contract-based or trust-based. And so we said the introduction of broadly equivalent regulation on the trust-based side, in order to level the playing field, was both necessary and desirable. We explained that we thought it incumbent on TPR – given in particular their joint regulatory strategy with the FCA – to explain their thinking on this matter openly in order to help engender an informed discussion.
We followed up in writing a few days later. And, at the same time, we shared our concerns in writing with the relevant policy lead at TPR. We never heard back from DWP; or from TPR.
DWP and TPR must be encouraged to break their silence and explain what their plan for protecting consumers is and the reasons behind it. Given that consumers are likely to be oblivious as to whether they are in a contract- or trust-based pension scheme, why should they end up with very different experiences – and, importantly, different protections – depending on whether or not FCA regulation applies?
CUSTOMER COMMUNICATIONS ON INVESTMENT PATHWAYS
It is obvious that, having chosen an Investment Pathway, it is incumbent on the product provider to communicate to the customer the riskiness of the investment solution in a way that enables them to assess whether it is right for them.
Income in retirement
The primary purpose of pension savings is to provide customers with an income to sustain them through their retirement. And the research findings from NMG Consulting bear this out with 70% of prospective drawdown users saying that the Investment Pathway closest to their current needs is one which provides a long-term income – 46% “I plan to start taking money as a long-term income”; and 24% “I plan to use my money to set up a guaranteed income (annuity)”.
In recent years 4% per annum withdrawals from a customer’s pension pot has been extensively used as a rule-of-thumb for a level of sustainable income. But, in today’s economic climate, 4% is considered by many to be high.
In this context the emerging data from the FCA published in September 2020 should be noted … https://www.fca.org.uk/data/retirement-income-market-data.
For customers with a pot size in excess of £100,000, the FCA data shows that for customers taking regular withdrawals – some 160,000 pension plans – 60% are taking 4% or more (with some 23% taking greater than 8%). There are many factors at play here. But it is a potential warning sign that in excess of 60% of customers with sizeable pots who are taking regular withdrawals are likely doing so at unsustainable rates.
Risk to consumers
As noted above, with these being non-advised customers, it isn’t possible to know quite how important this part of their pension savings is to them – some will have other separate generous pension provision (and possibly also other assets), while for others it will be their sole source of income in retirement over and above any State Pension.
Therefore the single most important factor which needs to be taken into account when communicating risk to consumers is related to their ability to take risk with their income (which, in industry terminology, is often referred to as their capacity for loss). For the 70% of customers indicated by the research who need their pension savings to provide a long-term income, this means providing them with an indication of the likely level of sustainable income that they can take together with the risks associated with that (for example, what poor investment performance might mean to their retirement income).
Such an approach is also fully supported by another finding from the research – which is that customers are very focused on outcomes and are far less comfortable with having to come to terms with the investment solutions which sit behind the Investment Pathways. It seems self-evident that, with customers having chosen an option to match their needs, that the risk would be described to them in terms of possible outcomes.
Customer communications – good practice
Communicating to customers the riskiness of the investment solution in a way that enables them to assess whether it is right for them is by no means straightforward. While it requires a thoughtful approach, it is certainly achievable. The initial research we have conducted indicates that the approach taken by ReAssure represents good practice … https://www.reassure.co.uk/uploads/RE0472-220-0472-Investment-Pathways-Booklet.pdf.
By way of example, the option “I plan to start taking my money as a long-term income” indicates the likely sustainability were the customer to take withdrawals at 5%. In this way the customer is able to readily assess whether this level of risk is right for them.
There appear to be slightly in excess of 20 product providers which offer Investment Pathways, and the initial research we have conducted has focused on the 15 or so biggest such providers. Apart from ReAssure, only one or two other product providers appear to attempt to communicate the risks to consumers in this way. This is all very concerning.
Customer communication – poor practice
Based on the initial research, the vast majority of product providers base their communications to customers on the risk that the investment solution might fluctuate in value. Such an approach is largely meaningless as it fails to communicate to customers the riskiness of the investment solution in a way that enables them to assess whether it is right for them.
The approaches taken are much of a muchness. L&G is brought out as an example here, in part given the irony that it is the consumer research that they commissioned which found that customers are very focused on outcomes and are far less comfortable with having to come to terms with the investment solutions which sit behind the Investment Pathways … https://www.legalandgeneral.com/retirement/pension-drawdown.
The L&G equivalent to the ReAssure example above (“I plan to start taking my money as a long-term income”) is simply a standard fund factsheet: