Written evidence from Just Retirement (PFA0033)

1. Executive summary

1.1.   This submission sets out Just Retirement’s assessment of the current challenges facing consumers in the new retirement environment, including concerns and potential solutions.

1.2.   Our overall assessment is that consumer disengagement, poor awareness and levels of financial capability – in addition to past supply-side failings – make it essential for policymakers to collect, aggregate and consider a range of separate inputs in order to understand consumer outcomes. Appropriate monitoring and regular reporting will be necessary both to understand the short and long term impact of the reforms, and to the development of measures necessary to address consumer detriment.

2. About Just Retirement

2.1.   Just Retirement is a specialist provider of financial services for consumers at and in retirement. We are the largest provider of individually underwritten guaranteed income for life products, a leading provider of equity release lifetime mortgages and de-risking solutions for Defined Benefit (DB) pension schemes. We also provide care funding solutions for people who need residential care in later life and retirement-focused regulated advice targeted at middle Britain households.

2.2.   Unlike most other life and pensions companies Just Retirement does not have a back-book of Defined Contribution (DC) pension customers. This means we have no existing customer base and therefore compete for customers through the open market on the strength of the improved products and rates we offer. As such we support policy measures that drive competition and outcomes that provide consumers with good value products and services in retirement.

3. Background

3.1.   The introduction of greater flexibility in how and when individuals may use their pension savings should be a positive change for those who engage with and understand the new options. However, the available evidence suggests financial capability is often poor – with specific gaps in consumers’ understanding of their financial needs in retirement posing real threats to their financial circumstances in retirement.

4. Key issues

Demand-side issues: Engagement and capability

4.1.   It is important to consider levels of engagement and capability among those who are accessing their pension savings in the new environment. There is a wealth of analysis in this area including assessments of general UK financial capability and specific research into how DC pension customers manage financial decision-making at and in retirement.

4.2.   The Wealth and Assets Survey (WAS) is the most comprehensive survey of household wealth in the UK, undertaken bi-annually by the Office for National Statistics (ONS). ONS analysis of the latest WAS data measured participants against six dimensions of financial capability – making ends meet; planning ahead; organised money management; controlled spending; staying informed; and choosing products.

4.3.   Scored on a scale from 0 to 10 individuals performed best at making ends meet (7.0) and least well at planning ahead (2.3). The analysis also found it was unusual for individuals to score highly in all six financial capability dimensions (just 1% did so), with more than one in five (22%) not scoring highly in any.[1]

4.4.   Research commissioned as part of the Financial Conduct Authority’s (FCA) December 2014 Thematic Review[2] also identified specific concerns around how DC pension savers approach their retirement income needs. This qualitative analysis identified a tendency towards short-termism in how people approach retirement planning, with decisions heavily influenced by behavioural biases. These biases included the tendency to:

• put off planning until very near to retirement;
• not think about the lifetime value of small differences in income;
• under-estimate their life expectancy;
• want to maximise income in the early years;
• feel reluctant to consider the impact of running out of money in later life; and
• not consider the potential cost of care in their later years

4.5.   Though many participants had a reasonable awareness of average life expectancy, there was a tendency to over-estimate how many people die between 65 and 70 and under-estimate how many will live beyond 80. This was despite the fact that many had octagenarians in their family. The report concluded:

“Our research shows that, across the board, consumers may not be particularly well equipped to make decisions on how to access and manage their money at retirement, without additional support and information. Respondents generally under-estimate longevity risk and are usually not confident to make equity-based investments. They are not well informed about the tax consequences of their actions and how to navigate the tax system to ensure they are managing their withdrawals in a tax efficient manner.” [3]

4.6.   The report added that DC pension savers with medical conditions or lifestyle factors that may shorten their life expectancy, are often unaware of the additional income they could receive by purchasing an enhanced annuity. Even in the post-reform environment, this is a significant finding given an estimated 60% of individuals with DC pension savings are eligible for this increase in guaranteed income in retirement.

4.7.   The report also found participants were generally unaware that they needed to check whether their pension contract included a Guaranteed Annuity Rate (GAR), which usually provide significantly higher guaranteed income than other options.

4.8.   Consumer research conducted since the reforms went live in April 2015 has reinforced the tendency for retirees to be unaware of key risks and benefits associated with their retirement options. A survey commissioned by the National Association of Pension Funds found just over half (53%) of 1,041 retirement-age consumers incorrectly believe drawdown products offer a guaranteed income in retirement, while one quarter (25%) believe drawdown carries no investment risk at all.[4]

4.9.   This limited awareness and misunderstanding among consumers may not matter if misperceptions are subsequently addressed by financial advice, Pension Wise guidance or through consumers’ own research as they approach retirement and consider their options. But if not, and consumers make decisions without understanding important risks and benefits of the available options, past experience suggests this will lead to consumer detriment – the consequences of which may be irreversible and last for decades, rather than months or years. Given the significant fall in global equity markets in the last few weeks,  this latter point is particularly relevant.

Supply-side issues

4.10.  The potential for negative consumer outcomes arising from disengagement, low awareness of retirement risks and poor financial capability is likely to be compounded by supply-side failures. FCA investigations and activity by its predecessor, the Financial Services Authority (FSA), have identified continued conduct and competition failures which have driven negative consumer outcomes.

4.11.  An FCA Thematic Review and Retirement Income Market Study[5] identified continued failures, despite assurances from the pensions industry following similar findings in a previous review by the FSA in 2008. The FCA analysis found:

• 60% of DC pension customers were not switching providers when they bought an annuity despite the fact 80% could get a higher income on the open market, many significantly so. For those people purchasing enhanced annuities the FCA found 91% could get a better deal by shopping around.
• Consumers are deterred from engaging by the length and complexity of providers’ pre-retirement “wake-up packs” and pre-retirement processes. Consumers’ tendency to buy products from their existing provider also weakens competitive pressure, and makes it harder for challenger firms to attract new customers.

• Consumers are highly sensitive to how options are presented to them. Savers reaching retirement face a landscape that is much more complex than that for previous generations – and will need support to make sense of their options and to make choices that match their needs and preferences.

4.12.  Even before the announcement of the pension reforms in Budget 2014, the pensions industry was still working though these issues despite seven years of heightened scrutiny and regulatory oversight. The Retirement Market Study also led the FCA to propose five remedies to improve consumer outcomes based on the findings:

• new requirements for pension providers to supply annuity quotation comparisons to DC pension customers, including details of deals available from other providers;
• steps to improve how information sent to DC pension customers is framed, to help consumers understand key decisions on how they can access their savings;
• redesigning and behaviourally-testing information issued to consumers in the run up to retirement;
• developing a ‘Pensions Dashboard’ to allow consumers to view all their pension holdings in one place; and
• continued FCA monitoring to track market developments, consumer behaviour and outcomes, including take-up of the Pension Wise guidance service.

4.13.  Just Retirement welcomes these remedies and the FCA’s commitment to monitoring outcomes in the new market. However, we are also concerned by the absence of coordinated plans to monitor, report and evaluate the reforms’ short and long-term impact on consumer outcomes across a range of measures, as outlined below.

5. Monitoring – knowing weaknesses and measuring outcomes

5.1.      The Committee inquiry asks if people are adequately supported in making good, informed decisions. The simple answer is that the required information and monitoring arrangements are not in place to provide the answer. That in itself brings risks to consumers, given a range of different types of consumer detriment that may already be taking place over the short and long-term.

5.2.      There are a range of monitoring gaps which Just Retirement believes could undermine the reforms, by failing to identify and quantify problems and subsequently preventing the government and regulators from being able to act to protect consumer interests where necessary. Our assessment of those gaps can be broadly split into three areas, as set out below.

Guidance and advice

5.3.      The Pension Wise service was set up to provide free, high quality guidance for people considering how to use their DC pensions in retirement. The establishment of the service was in itself an acknowledgement of the need for trusted, impartial support for those people who need assistance to understand and decide among the new options available.

5.4.      Almost five months on from the introduction of the reforms there is no substantive publicly-available data on the number of people who have used the Pension Wise guidance service, nor details of the characteristics of those people who have used the service. The only data released so far by the Treasury is that 18,000 guidance appointments were delivered between 6 April and July 23.

5.5.      Though the Chancellor informed the Treasury Committee that 90% of those who had used Pension Wise had been satisfied with the service they received, and the FCA’s response to the Committee stated that the face-to-face service is running at 15% of capacity, details of the total number of Pension Wise users has not been released.[6] Nor is data available on the number of users and those users’ pension savings at retirement – crucial data to allow policymakers to determine which consumers are using the Pension Wise service and, more importantly, which consumers are not using the service.

5.6.      Given the importance of guidance as a means of improving consumers’ awareness of their options and the risks and benefits of each, it will be vital to consider Pension Wise usage data to form part of the overall picture of consumer outcomes. Analysis should also help identify why certain individuals and groups may not be engaging with guidance or wider support and information provided in the run-up to retirement, in order to inform policy on new or improved approaches if necessary.

Lump sum withdrawals and tax charges

5.7.      Prior to the introduction of the pension freedoms, DC pension savers faced a 55% tax charge on withdrawals not used to purchase an annuity or flexible drawdown policy. Consumers with DC pensions valued at less than £30,000 could also take their funds as cash, rather than buy an annuity. Though the removal of the tax charge allows consumers unprecedented flexibility in how consumers use their savings and the 25% tax-free lump sum option remains, withdrawals are not tax free. Indeed, consumers face the possibility of triggering large tax charges on withdrawals made without due consideration of the tax charges.

5.8.      There is anecdotal evidence of individuals who have accessed the whole of their DC pension savings regardless of the scale of the tax charge incurred. In one report, an individual withdrew £300,000 despite warnings from their pension provider regarding the high tax liabilities this would create.[7]

5.9.      Though FCA rules require pension providers to promote the potential tax charge on sums withdrawn from DC pension savings and to provide additional Retirement Risk Warnings (also known as Second Line of Defence) to consumers, there is no publicly-available data on the tax charges taken from withdrawals under the new rules. This is concerning given consumer research suggests low levels of understanding of how tax rules are applied to DC pension savings.

5.10.  Research by the International Longevity Centre UK (ILC-UK) found consumers’ lack of understanding could lead to high tax burdens falling on retirees, with as few as one in five DC pension savers claiming to understand what marginal tax rate was. When pressed on how to reduce their tax burden when withdrawing money from the pension pot, only half gave the correct answer (i.e. that individuals can withdraw it in small amounts over a number of years) and one in ten wrongly believed the most tax efficient approach would be to withdraw money as “one big lump sum”.[8]

5.11.  This research suggests a clear need to monitor tax charges being levied on DC pension savings withdrawals to check whether individuals are aware of the implications of their actions.

Product sales data

5.12.  Given the well documented supply-side failings identified by the FCA and FSA, it will be important for reporting requirements for provider product sales data to reflect the new retirement market created by the reforms.

5.13.  The government and FCA have provided assurances to the Committee that developments in the evolving retirement market are being closely monitored, including new drawdown options being brought to market. This is welcome and we believe a renewed approach to collecting and analysing product sales data is needed to effectively monitor consumer outcomes.

5.14.  We are concerned, however, by the significant gap between the product sales data gathered by the FCA from pension and investment providers and product sales data gathered in other retail financial services markets – most notably the mortgage market. Whereas the FCA currently captures comprehensive data from mortgage lenders on individual borrowers’ circumstances and mortgage contract details to provide an aggregate view of activity and potential market risks, requirements for pension providers are far lighter.

5.15.  Mortgage lenders are asked, for example, to report 109 individual data fields on each mortgage including affordability, type of mortgage, rate applied to the mortgage (i.e. fixed, tracker, discount), borrower details (i.e. first time buyer, re-mortgage, multiple-property holder), capital/interest-only or capital and interest, mortgage term, loan size and borrower income details including debt, credit impairment or borrowing history.

5.16.  By contrast product sales data requirements for pension and retail investment providers are high level and limited to just eight fields – the provider reference number; reference number for the intermediary firm or network that sold the product; whether the sale was advised (by a regulated financial adviser) or non-advised; product type; customer post code; customer date of birth; single or regular premium; and total premium.[9]

5.17.  This approach to product sales data means the FCA is not currently capturing basic information such as the rate of cash withdrawals from DC pension savings, type of annuity (e.g. joint or single life; enhanced or standard; level or escalating/inflation-linked), or details of the risk profile or funds invested through income drawdown contracts when these policies are bought. This is important because the aggregate picture provided by this data would provide an overview of some of the key information items necessary to provide policymakers with a full assessment of consumer outcomes in the new environment.

5.18.  Though we understand the FCA is currently seeking additional data from providers, comprehensive and ongoing data collection on retirement product outcomes will be needed to accurately map consumer outcomes in the new environment over the longer term.

Advice

5.19.  Just Retirement believes access to professional, regulated advice is likely to provide consumers with the tailored, specific direction required to ensure they get maximum value from their pension savings. Only a minority of consumers currently use regulated advisers to consider their retirement needs. The Retail Distribution Review has not delivered any significant increase in advice options for consumers – if anything, options have reduced – and efforts to improve the supply of advice should deliver improved outcomes.

5.20.  International analysis and Just Retirement’s own research suggests a hierarchy of income needs which consumers face when deciding how to use their pension savings. As the below model sets out, consumers commonly identify a certain level of guaranteed income for life as their first priority, to meet essential items such as utility bills, food and clothing. After this base level of income, consumers then identify the need for “rainy day funds”, money for gifts or other discretionary expenditure, and so on.

(Model based on http://www.nextavenue.org/article/2014-04/determine-your-hierarchy-needs-retirement copyright 2003 Mitch Antony)

5.21.  Consumers who receive financial advice and/or guidance from Pension Wise will receive professional assistance when deciding how to match new product or withdrawal options against income needs such as those illustrated above[10]. However, the known risks and potential impact on financial and wider wellbeing in retirement underlines the need to monitor consumer outcomes – especially among those who do not seek professional advice or guidance.

5.22.  The recent launch of the Treasury’s Financial Advice Market Review is a welcome development in this context, and should provide options for extending high quality, good value advice to the increasing numbers of people in need of assistance with their financial planning at and in retirement. We hope the Review will enable new options for extending access to advice including the development of digital platforms for consumers interested in exploring their options through this channel.

6. Recommendations

6.1.   The need to collect and then aggregate a range of inputs including Pension Wise user data, FCA sales data and intelligence from regulators’ thematic and supervisory work points to the clear need to coordinate these various activities. Evidence confirms many consumers are vulnerable to poor decision making, the impacts of which can be great and lasting throughout longer periods of retirements than most understand and are able to plan for.

6.2.   Only by addressing these gaps through an effective ‘early warning system’ will policymakers have the information needed to identify and address potential consumer detriment at an early stage. Such a system will be crucial both to improving consumer outcomes and to supporting the success and long-term sustainability of the reforms themselves. This suggestion is also supported by evidence from countries with similar retirement systems, including Australia and the US, which suggests demand-side weaknesses can deliver poor retirement outcomes for consumers.

6.3.   In Australia, analysis of outcomes from the superannuation savings system led a government-commissioned inquiry to recommend introducing a default guaranteed income policy, in response to concerns around pension fund exhaustion. The Inquiry considered evidence including the Australian Government Actuary’s analysis which showed 25% of Australians who accessed their pension savings at age 55 had exhausted the full amount by age 70.

6.4.   Given consumer disengagement, poor awareness and levels of financial capability – in addition to past market failings which have driven bad outcomes – there is a clear need for a comprehensive approach to coordinate, measure and report outcomes from the reforms. Only by doing so will policymakers understand the many different outcomes and the case for interventions necessary to ensure the long-term success of the new pension system.

August 2015