Written evidence from the Pensions Policy Institute (PFA0032)

Executive summary

1. The Pensions Policy Institute (PPI) promotes the study of pensions and other provision for retirement and old age.  The PPI is unique in the study of pensions, as it is independent (no political bias or vested interest); focused and expert in the field; and takes a long-term perspective across all elements of the pension system. 
2. The Committee has requested evidence concerning the current situation regarding advice, guidance and information available to those approaching retirement in the light of the Governments recent Freedom and Choice reforms.
3. Organisations that work directly in this area – such as The Pensions Advisory Service and Citizens Advice – are well placed to provide evidence in this area. The PPI has not undertaken specific research in to the current situation.
4. However, the PPI has undertaken significant and detailed research which highlights the requirements of individuals approaching retirement in light of the reforms, and considered the broad approaches available to help individuals achieve good outcomes. The findings of this research are relevant to this inquiry in helping to understand the barriers that any system will need to overcome and in exploring alternative options.
5. PPI research has highlighted that:

• DC savers have, on average, low financial capability
• People tend to focus on the short-term not the long term when making decisions about their pension pots.
• People need to be protected against longevity risk. Individuals tend to underestimate how long they will survive.
• Investment risk is not well understood
• International examples show that there are options, which can encourage people to save into a pension and lead to greater engagement with pensions.
• With the new pension freedoms, people who would not traditionally used financial advice services will need guidance and /or defaults to prevent them from making decisions which could be of detriment to them in later life.

Introduction

1. The Pensions Policy Institute (PPI) promotes the study of pensions and other provision for retirement and old age.  The PPI is unique in the study of pensions, as it is independent (no political bias or vested interest); focused and expert in the field; and takes a long-term perspective across all elements of the pension system.  The PPI exists to contribute facts, analysis and commentary to help all commentators and decision-makers to take informed policy decisions on pensions and retirement provision.

2. The Committee is looking at whether people are adequately supported in light of the recent Government reforms to access to pensions and pension reforms introduced in April 2015. The Committee has requested evidence concerning the take-up, suitability and independence of the advice, guidance and information available to those approaching retirement, and recommendations for improvement.

3. Organisations that work directly in this area (such as The Pensions Advisory Service and Citizens Advice), and providers who are dealing with customers, are well placed to collect and provide evidence as to how services are being developed and used in this area. The PPI has not undertaken specific research looking at how the system of advice and guidance has been performing since April. Nor does the PPI make policy recommendations.

4. However, the PPI has undertaken significant and detailed research which highlights the requirements of individuals approaching retirement in light of the reforms, and considered the broad approaches available to help individuals achieve good outcomes. The findings of this research are relevant to this inquiry in helping to understand the barriers that any system will need to overcome and in exploring alternative options. The evidence presented in this submission is based on PPI research. [1]

5. As well as undertaking secondary research, the PPI commissioned Ignition House to undertake primary qualitative research consisting of face-to-face interviews and focus groups with individuals approaching retirement (aged 55-70) and for whom DC savings make up the majority of the private pension savings.

DC savers have, on average, low financial capability

6. Since April 2015, decisions about accessing DC pension savings have become more complex.  In order to make an informed decision about accessing DC savings and structuring income in retirement people need to be able to understand economic factors such as inflation, market-based risks and longevity risk. Therefore, people may struggle more with complex decisions regarding using DC savings to support themselves in retirement than those with DB savings who can make an informed decision based on a more limited understanding (as scheme rules generally protect members against inflation, market based risks and longevity risk).

7. Levels of numeracy in particular have been found to have correlations with ability to understand pension arrangements.  However, having DC savings and no DB entitlement is associated with lower levels of numeracy. People with DC savings and no DB entitlement will also be more dependent on using their DC savings to provide themselves with an income in retirement than those who have some DB entitlement to fall back on but may also have more difficulty making a fully informed decision about accessing their DC savings.

8. Though many people with DC savings (between 70%-80%) reported receiving information from their scheme or provider, people report finding scheme communications confusing and difficult to understand. Natural tendencies towards inertia can be further exacerbated by complexity, uncertainty and a lack of understanding.  Therefore, scheme communications, without significant redesign, are unlikely to fill the gap in knowledge or provide the support that people with DC savings might need to make complex decisions.

People tend to focus on the short-term not the long term when making decisions about their pension pots

9. There is a reluctance or inability to plan beyond the next few years, which means locking into a specific course of action either before or at retirement is generally unpopular.

10. The group the PPI interviewed had made some plans for retirement, however had not thought through their financial position or their spending in detail. Participants typically had a range of pension investments including more than one DC pension, or a DB pension, and where there was a partner, retirement planning is typically done on a joint basis. Those approaching retirement often expected to work beyond State Pension Age. People tended to focus on the short term rather than long-term income need, making it difficult to engage saver with detailed retirement planning.  Individuals tended to overestimate what they need for their essential spending in retirement.

People need to be protected against longevity risk. Individuals tend to underestimate how long they will survive

11. In general pension savers have poor understanding of both spending needs throughout retirement and likely life expectancy and, in particular, the probability of living beyond older ages, which means some DC savers are likely to underestimate the importance of having some form of longevity insurance.

12. Those interviewed for the PPI research significantly underestimate their chances of surviving to older ages (beyond 90), suggesting they may fail to understand the importance of protecting themselves against longevity risk and the value of insurance style products such as annuities.  People generally preferred to take a lump sum, and then a gradual income. However, it isn’t always appreciated how taking a lump sum might impact on their remaining income.

13. Retirement income products such as annuities and income drawdown previously had some safeguards against market-based and longevity risks built into them, and many, such as lifetime annuities, will continue to do so.  However, people who choose not to purchase a retirement income product which protects against risk with some or all of their DC saving will have to make decisions about how to protect themselves against risks, many of which are not predictable (such as inflation risk and longevity risk).  The 56% reduction in annuity purchases observed in Q3 of 2014 (in comparison to Q3 of 2013) indicates that far fewer annuities will be purchased by people with DC savings in future, and that their funds may therefore be exposed to these greater levels of risk.

14. In terms of the management of longevity risk, the UK is moving in a different direction to other mature DC markets, for example, Australia.   The Australian Financial System Inquiry report (Murray Review) has proposed default income products for all superannuation funds.  In contrast, the UK Government has argued that there should be no explicit defaults offered to retirees.[2] 

Investment risk is not well understood

15. The 55-70 year olds spoken to were also unlikely to be well placed to make decisions about investments either in the run up to, or during, retirement. They were not confident with equity markets or making direct investments themselves. Some had missed the tax implications of drawing down all of a pot at once. Some had planned to invest in property but had failed to consider the associated cost and risk. There is some indication that those approaching retirement do begin to engage more with their pension pot, however even those planning to retire in the next 2 years had an open mind around whether and when this might happen in practice, and the options that would be available to them. They were largely unwilling to engage with the idea that they might be able to choose how they would be likely to access their assets five or ten years in advance of the retirement date.

16. There is a general lack of understanding around the underlying investments in default funds, and what these funds are seeking to achieve, therefore it will be important that any defaults are communicated in terms of their levels of risk and objectives. DC savers may be reluctant to make upfront commitments about when they might lock into a certain course of action, or to hand over significant sums of capital in the early years of retirement to an insurer. However, concepts like longevity insurance and the payment of on-going premiums did resonate with the majority of those interviewed, and they were willing to make some sacrifices in income in early years to ensure they had a secure backstop should they live to higher ages.

17. There are therefore some specific risks identified which policy makers, regulators and the pensions industry should work together to address. Many of these stem from the fact that DC savers have, on average, low financial capability.

International examples show that there are options, which can encourage people to save into a pension and potentially lead to greater engagement with pensions.

18. The new pension flexibilities will radically change decumulation in the UK DC market. International examples suggest areas where challenges may arise and some possible remedies for the UK Government and pensions industry. The focus of regulation in the UK has been the introduction of a standards 
regime to ensure the quality and consistency of guidance. This includes Pension Wise, to provide free, face-to-face or telephone based guidance for individuals approaching retirement and the FCA’s ‘second line of defence’ rules. 
Australia is considering rules to ensure retirement defaults for members with some provision for managing longevity risk.

19. It is possible that further steps will be considered in the UK to ‘nudge’ individuals towards decisions that ensure they have a regular income stream over the course of their retirement. It has also been widely recognised that many individuals will need to save more than just the minimum contributions required through automatic enrolment to allow them to enjoy an “adequate” retirement, be that through a regular income or the use of lump sums.  [3]

20. International experience shows that governments have a wide range of options to promote better outcomes through increasing engagement both before and at retirement.[4]

21. In some countries, such as Sweden, allowing people to view information of all their pensions - state, private and occupational - on a single screen can lead to better understanding and engagement, and potentially increased pension savings.

22. In Denmark, the Money and Pensions Panel was launched to increase interest about financial matters, and increase public knowledge about pensions. Pension information is available on the same website as information around other issues, therefore making pensions seem as relevant as any other financial decisions. There is also an emphasis on the practicality of pensions, such as what to do when changing jobs.

23. In the Netherlands, there are Three Pensions Days every October, where the pension industry work together with the aim of informing the public about their pension. Pension scheme members are also provided with a Uniform Pension Overview, alongside an online tracking system where people can view both their state and private pension. The emphasis on Pension days trigger people to think and engage in their pension.

24. Pension savers in Sweden are provided with an annual statement, which estimates their state pension entitlement dependent on when they decide to retire. Savers who have occupational or private pensions can be viewed on the Pensions Dashboard where they can view all of their pension entitlements regardless of whether these are DB or DC pensions.

25. New Zealand also adopted the idea of a website where people could gain advice and guidance. The website provides advice around lifetime financial planning rather than focus on solely on pensions. This approach is deemed successful because its user friendly.

26. Some employers in the US (and some in the UK) use a scheme by where pension contributions escalate automatically (auto escalation) after each pay rise. Once they are opted in to the scheme, savers don’t have to make the active decision on increasing pension contributions as it happens automatically.

27. Through looking at other approaches which are used in other countries, there are some approaches to information and engagement which could be considered in the UK:
• The inclusion of information around pensions with information around other financial topics. 
• Provision of consolidated information around an individuals’ state and private pension entitlements. The intricacies of the state pension along with the move to the single tier pension however may complicate this in the UK
• Calculators that compare saving with desired level of retirement income. Some calculators available in the UK, however, a useful addition might be one that enables an individual to take into account all elements if their retirement assets and income.
• The provision of information in a layered way so that individuals can access more complex and detailed information if they wish
• Illustration of the impact of life events on the retirement savings
• Co-ordinated approaches, such as that provided in the Netherlands where the industry work together to inform the public around their pensions

With the new pension freedoms, people who would not traditionally used financial advice services will need guidance and /or defaults to prevent them from making decisions which could be a detriment to them in later life

28. The Budget freedoms are generally viewed as popular with DC savers, largely because of the negative associations around annuities and the notion of handing over your money. However, disengagement and inertia amongst consumers is a key risk without effective processes in place, either through guidance and advice or the provision of appropriate defaults.

29. People who use regulated financial advice tend to have different pension savings profiles than those who use guidance. For example, there is a correlation between the size of DC pension pots and the use of regulated advice. 50% of people with Defined Contribution pots of £50,000 or more used regulated advice, whilst only 33% of those with pots up to £50,000 did[5].

30. 77% of those with an estimated pension ‘pot’ of £100,000 or more regard themselves as ‘interested and knowledgeable’. Those who are ‘interested and knowledgeable’ are also more likely to be using or intend to use income drawdown and report much high levels or understanding of both annuities and income drawdown. Those who have larger estimated pots of £100,000 or more or have received regulated financial advice are more likely to feel at least fairly certain as to what they intend to do with their pension pots.[6]

31. Based on those interviewed for PPI research, there is a lack of engagement (even very close to, or into, retirement) and a willingness to accept a provider default or invest where one is offered– leading to the potential for consumer detriment if the defaults offered are not suitable and designed in the best interest of savers. Some have the perception that there are “safer” or “better” investments outside of pensions, which when probed are based on misguided beliefs or have not been properly thought through.

August 2015