Written evidence from B&CE Ltd (PFC0079)

Introduction

B&CE is the provider of The People’s Pension. The People’s Pension is a master trust serving in excess of 3 million mostly low and medium income savers in the auto-enrolment market.

The People’s Pension is an efficient, not-for-profit alternative to the government-funded state intervention of NEST. It is not reliant on state subsidy of any kind. We are run under a trust in the interest of our members. As part of B&CE Holdings, we have been providing welfare and employee financial benefits for the construction sector since 1942 (B&CE also provides a stakeholder pension for the construction industry, which served a further 476,000 members and who are currently in the process of transferring to The People’s Pension).

Summary of response

• Freedom and choice can be seen as a necessary act of destruction. It meant that people were not forced to buy annuities at the age of retirement when (i) annuity products had been rendered poor value by the low interest regime adopted to cope with the Global Financial Crisis (ii) and rising longevity meant that a combination of drawdown and a later life annuity probably represented better value than an annuity for most people.

• However, freedom and choice was an incomplete reform because it did not require the putting in place of default at retirement vehicles which were the necessary complement to mass automatic enrolment pension saving schemes.

• Information remedies such as use of Pension Wise and the development of the Pension Dashboard are important and useful information remedies. They will work very well for a proportion of the population. If however we want a pension system that works for everyone, then we also need defaults solutions at retirement.

• Default solutions at retirement mean that part of the population will have a passive engagement with pensions throughout their lifetimes. This could potentially be exploited. This means that the counterpart for the provision of retirement default solutions must be high quality standards enforced by regulators. Just as we now have in the saving phase.

Detailed response

•                               What are people doing with their pension pots (including defined benefit pension entitlements) and are those decisions consistent with their objectives? Is there adequate monitoring of the decisions being made?

We offer defined contribution pensions, so our focus is on retirement outcomes for those saving into defined contribution schemes. It’s important for any review of pensions freedom to focus in particular on this group of savers for two reasons. First, savers into DC schemes now outnumber those into DB and, second, only a minority of savers in DB pensions should be considering switching out of DB in order to exercise pension freedoms.

Our comments on the effect of pension freedoms on DC savers are informed by a qualitative longitudinal study conducted by Ignition House (sponsored by ourselves and by State Street Global Advisors)[1]. This study has followed a group of people aged over 50, with a pot of at least £30,000 and who are primarily reliant on a DC pension as the source of their retirement income[2].

Our findings include:

(i)                  People find the search process of finding the right product stressful and unpleasant and often just give up;

(ii)                 Those that the process ultimately renders happiest are those that spend their money rather than those who invest in products which will deliver a retirement income

(iii)               More information makes people more confused

(iv)               The majority of those who remain invested move their money to cash products, potentially creating huge future risks for themselves.

Our qualitative findings are consistent with the FCA’s quantitative findings with respect to a more widely drawn sample:

“Accessing pots early has become ‘the new norm’. 72% of pots since pension freedoms have been accessed by consumers under 65, most of whom have taken lump sums.”

“Over half (52%) of the fully withdrawn pots were not spent but were transferred into other savings or investments.”[3]

NB The FCA caveat that most savers had other sources of retirement income, other than the state pension, does not apply to the group selected for the Ignition House study. Participants in the Ignition House research were deliberately selected on the basis that they were reliant on their DC pension. (It should be noted that in order to generate an adequate income in retirement, it has always been calculated that people needed to save into a workplace pension as well as receive a state pension. The Turner commission estimated that someone on an average wage would receive a 30% replacement rate from the state pension and a 20% replacement rate from an automatic enrolment workplace pension).

•                               Are people taking proportionate advice and guidance and if not, why not? Are people adjusting behaviour in response to advice and guidance?

No. We have no evidence that people are taking proportionate advice. Many commentators have raised concerns that price could prohibit people from taking appropriate advice. However, at the People’s Pension, we have negotiated a bulk deal using institutional buying power on behalf of our members to get full fact advice from LV= at the extremely low price of £49[4]. We expect take up to increase but at this point it is relatively low.

Research by LV= has found in general that 60% of people retiring do not intend to take advice[5].

In terms of the subsidised free hour’s guidance subsidised by the government and available to those retiring, the estimation is that less than 10% of those retiring are using the service[6].

We are not surprised by these findings. The creation of an automatic enrolment workplace pension regime for the saving phase of a pension was based on the analysis that for a host of behavioural reasons, people will not engage with a pension. Therefore the emphasis under George Osborne’s Chancellorship of increasing information as a primary public policy response to potential market failure in the retirement phase was surprising and in direct opposition to existing government policy. Such an approach ran against the earlier political consensus based on the analysis of the independent Turner Commission and which had informed the design of automatic enrolment. This is not to say that the pension freedom policy was a bad one, but that it lacked both the very necessary default underpin for unengaged savers and the kind of information infrastructure such as a dashboard which would assist potentially engaged savers[7].

A reliance on information-based remedies alone, as opposed to the kind of default remedy proposed for the saving phase was in particular surprising because:

The UK government has been a leader in promoting solutions based on analysis drawn from behavioural economics. It has a first class resource available in the Behavioural Insights team, a social enterprise, partly owned by the Cabinet Office. It’s very first publication, called “Mindspace”, a guide to the application of behavioural economics,  and which came out in 2010 underlines the importance of defaults in pensions[8] (pp45-48).

Second, this awareness of the importance of behavioural insights is not restricted to the Cabinet Office. FCA economists published an excellent paper in 2013 entitled “Applying behavioural economics at the FCA” which pointed out that information remedies may be ineffective where behavioural biases affect how consumers assimilate information[9] and that defaults may be the most effective remedy[10].

Third, we already have practical recognition of the problem and a solution in front of us in pensions. We have split workplace pensions into two elements in the UK, a saving phase and a drawing down of income phase. Collectively, we’ve already recognised that the inability to act in the face of complexity, amongst other behavioural biases, is deadly for decision-making in the saving phase and have introduced regulated defaults to counter it. The use of defaults is widely considered to have been a successful response, not least by the DWP Select Committee, to severe under saving into pensions[11].

We think there are several contributory factors to the discrepancy in the approach to the saving phase and the retirement phase of pensions:

One may be an ingrained belief that markets must always work well until they demonstrably do not. Of course, in many circumstances this is a very sensible belief. However, when the UK competition authority has told us that unregulated markets did not work well in the saving phase for workplace pensions[12], FCA evidence finds they have not worked in the provision of annuities[13] and the Ignition House evidence underlining the same for retirement generally[14], it would seem that a solution ought to be put in place pre-emptively rather than waiting for large numbers of people to be left without a workplace pension. One of the merits of opting for defaults, as government has done for the saving phase, is that it does not drive out unregulated markets. It leaves scope for people to opt for an unregulated market solution, if they have the ability and they take the view that the market solution is genuinely better.

Second, the hold of the more specific assumption drawn from classical economics that consumers are rational profit maximisers has been very strong. Policy makers with such a reflex tend to gravitate towards a view that if consumers only had enough information then they would make optimal choices. The recent FCA investigation into annuity sales may be instructive in this respect. The FCA has put in place a remedy which consists of the provision of an enhanced set of information, even though the research on which the FCA relies shows that this will not improve outcomes for the majority of savers. Their figures show that 80% of people would benefit from switching but the enhanced prompt only increases switching from 7 to 25%[15]. Absent a particular mind set, one might have expected policy makers to reach for a default solution in the face of that kind of evidence. We note that the FCA is now actively considering a default approach (described in their report as Remedy 1) for the market for drawdown products[16]. We would very much support such an approach for the retirement phase. It would protect the consumer interest. It would also assist trustees and others running pension schemes as there is no current common definition of what constitutes a quality offering. This hinders their construction of a product and/or their willingness to recommend that scheme members take products from third parties.

Third, there is differences in the objectives of different government departments. The Treasury’s objectives have tended to take precedence and the Treasury’s focus is increasing revenue (and minimising spending). This could have implications for how concerned it has been at people making bad decisions at retirement since such decisions increase tax take. If people cash in their pension pot then they pay tax at their marginal rate. An FT adviser article earlier in the year suggested income from this route had significantly exceeded the Treasury’s published expectations[17]. A cynic might perhaps conclude that the Treasury has shown an acute understanding of behavioural economics but has used this to improve state finances rather than pensioner outcomes. However, it is highly questionable whether such a policy ought to be sustained, it may improve public finance today but it creates significant risks for both public finances and private outcomes in the future.

• To what extent will pension dashboards enable consumers to make more informed decisions about their retirement savings? What are the remaining obstacles to their creation and success and how should those obstacles be overcome?

As a pension provider we are strong advocates of the pension dashboard. We expect it to be a great tool, helping to drive a feeling of ownership of a pension which is a precursor for engagement. Currently, it’s not easy for people to establish how much they have saved across multiple pensions nor where they are. But we recognise that engagement is likely to be true only for a minority of savers amongst the current generations reaching retirement.

There are a number of features of rules that should be adopted around the dashboard to ensure that it is fit-for-purpose:

• The basic dashboard should be designed so that it can eventually facilitate low-cost transfer and amalgamation of different pension pots, reducing charges taken from the pension pots of individuals.

• Legacy schemes should be prevented from excluding some pots or building a system with high transfer costs.

• There should be a staged approach to implementation. A dashboard should seek in the first instance to include the state pension and workplace defined contribution (DC) pots, and have a rapid timeline and plan for the addition of defined benefit (DB) schemes. While participation could be voluntary initially, participation for all schemes should become mandatory. A timetable should be published to provide industry certainty.

• There is a need for high quality regulation of funding, governance and data protection. The basic public interest dashboard should be owned for a not-for-profit public body such as the successor to the Money Advice Service. The sharing of individuals’ data must require consent.

• Furthermore, as well as making it easier for people to connect with their pensions, the dashboard also presents a huge opportunity to reform and modernise the pension system. The recent announcement that the DWP will be driving this forward is welcome news and means that the programme will be focussed on member outcomes.

•                               Is Pension Wise working? If not, how should it be reformed? Are there any implications for the proposed creation of a new single public financial guidance body?

Access to Pension Wise currently requires an active choice from savers who are confident enough to engage. The research referred to above tells us that such a group of people is a minority one. Given this context, we believe Pension Wise as a service is currently working as well as it can be expected to work.

As noted above, Money Marketing estimated that 10% of those eligible to use the service were doing so.

A requirement that those seeking to access their pension pot had to use Pension Wise would be a positive step and would lead to better outcomes for some people. However, as our Ignition House research found, there is a large group of people for whom advice and access to information on pensions do not help. Default strategies for retirement are necessary for the latter group.

•                               Are there persistent gaps in the advice and guidance market and what might fill them? Is automated advice and guidance filling gaps as expected?

We provide access to very low cost (£49) automated advice and guidance service. However currently a minority of members who could use the service, do so. However, this may change as pot sizes rise and a choice of options becomes feasible.

What is needed to fill the gap are regulated default retirement products which do not require active engagement.

If the government did want to promote default retirement products, this would require government and regulators to look at how advice and guidance rules should operate with respect to such products. Currently, the rules would likely inhibit the offer of such products.

For the reasons we explain above information remedies are not going to work for the mass market brought into pension saving through automatic enrolment.

•                               Is there evidence of product market competition resulting in cheaper, clearer or a wider variety of products for consumers? Are people switching from their pension provider in accessing their pots? Is an adequate annuity market being sustained?

The lack of consultation and overnight removal of the requirement to buy annuities meant that initially market providers had no time to develop alternative replacement products.

Providers are now developing and marketing alternative products tailored to their particular markets. The People’s Pension, for example, has an online portal which has been widely praised for making the available retirement options comprehendible to ordinary people. The options available include a product that allows people to draw down capital in regular lumps sums. See: https://thepeoplespension.co.uk/employees/your-retirement/

There has been comment from government that the market needs to develop innovative solutions and it is keeping under review the need for NEST to enter this part of the market if private providers do not offer such solutions[18]. However, in so far as they can providers, including ourselves, have already begun to respond. The issue is not simply one of the creation of a product. Low cost drawdown products from reputable providers already exist. (For example, the not-for-profit LV= provide a drawdown product at 0.22% annual management charge). The issue is primarily about building member journeys – through engagement for some, which would have to be built around the dashboard, and via defaults for many. Developing the latter will require government and regulators to tailor the rules around advice and guidance to facilitate the creation of default journeys.

It is appropriate that providers such as the People’s Pension have initially concentrated on offering well designed capital drawdown products. This is because the average pot in the People’s Pension is £790. Over time, mass auto-enrolment providers will also roll out drawdown/later life annuity products. However, for such products to be value for money for members, we would typically consider that they ought to have a pot size of £50,000[19].

The attraction and merit of such drawdown/later life annuity products is likely to be enhanced where mass auto-enrolment providers can use their collective buying power to insure entire cohorts of retirees against longevity risk. The magnitude of the charge which insurers or reinsurers would ask of the pension provider would vary considerably. Any charge would depend on the risk arising from fluctuations in the value of the assets backing the guaranteed income for the savers. This charge would then directly and significantly determine the size of the guaranteed income which pensioners would receive. This is why economists have long called for the government to issue longevity bonds with a higher interest rate which could be bought by insurers to back annuity guarantees. See for example the work of Professor Blake which fed into his independent review of retirement income report in 2016[20].

The Ignition House findings show us that the current system is not adequately delivering for people who are reliant on DC in addition to their state pension. However, at this point in time, the salience of the issue is likely mitigated by the prevalence of DB pensions amongst the wider population of those retiring; a mitigation which will be a declining feature over time. In addition, those brought into workplace pension saving for the first time through automatic enrolment have not yet built up pension pots that permit multiple options in retirement. To solve the existing problem and the potentially much larger problem in the future, government needs, as we describe above, to support the dashboard and Pension Wise for the engaged and make changes to the rules around guidance and advice which will facilitate default pathways for the unengaged.

•                               Are the Government and Financial Conduct Authority taking adequate steps to prevent scamming and miss-selling?

The government’s approach so far has been based on channelling information. Encouraging people to obtain appropriate advice and encouraging them not to listen to bad advice. The government is also considering a ban on cold calls. However a system that now requires financially unsophisticated mass market customers to go to market creates enormous opportunities for scammers that government warnings are never going to be sufficient to block.

A merit of a default based system is that it permits those who are not equipped to negotiate with the market/avoid scammers to remain with their provider. However, the required counterpart to such a system, just as it is in the saving phase, is that the pension providers are regulated to provide low cost high quality products so they cannot exploit passive customers.

•                               Are the freedom and choice reforms part of a coherent retirement saving strategy? To what extent is it complimentary to or undermined by other policies?

Freedom and choice can be seen as a necessary act of destruction. It meant that people were not forced to buy annuities at the age of retirement which had been rendered poor value by the low interest regime adopted to cope with the Global Financial Crisis.

However, freedom and choice was an incomplete reform because it did not require the putting in place of default at retirement vehicles which were the necessary complement to mass automatic enrolment pension saving schemes.

At the same time as promoting Pension Freedom, the Treasury advocated ending up-front tax relief. It would like the tax regime to move away from one based on relief in the savings phase (which requires a government top up to pension saving) and taxation on retirement income.  Instead, Treasury would like no relief to be paid in the savings phase and people to have tax free income from those savings in retirement. The historic policy reason for tax relief is that a government contribution incentivises saving into a pension. It also provides for significantly higher pensions due to the cumulative interest savers obtain on the government contribution to their savings. For individuals, removing up front relief would remove the incentive and shrink the size of pension pots considerably. For the Treasury, removal would increase the tax take, given the proportion of people who earn at higher rate but retire on a level of income which only incurs basic rate tax. Whether an intended consequence of pensions freedom or not, large numbers of people emptying their pension pots rather than buying retirement income products helps undermine the justification for up-front tax relief.

Unable to persuade the government of the merits of its preference for tax relief in 2015, the Treasury promoted the Lifetime ISA instead. The intention was to provide a “voluntary” mechanism by which people could opt out of the pension system and move to the kind of tax regime which the Treasury favoured. The Treasury were prepared to offer an equivalent of lower rate tax relief to encourage this (though presumably able to anticipate that the ability to access pots would mean that many would trigger a repayment feature of the product and end up eventually paying back the government contribution).

October 2017