Written evidence submitted by the International Longevity Centre UK (HHF0037)

ABOUT THE INTERNATIONAL LONGEVITY CENTRE UK

  1. The International Longevity Centre UK (ILC-UK) is the leading think tank exploring the implications of ageing and the possible policy responses. As an independent, non-partisan charitable think tank, we produce rigorous yet accessible evidenced-based research and thought leadership. We look at ageing from a multifaceted standpoint covering the following themes: health and social care, personal finances, working lives, housing and the macroeconomic and fiscal implications of ageing.

INTRODUCTION

  1. The inquiry seeks evidence on three specific domains: 1) overall savings levels and balance sheets, 2) household lifetime saving and financial planning and 3) household indebtedness, consumer credit and incomes. Our response focuses on the first two domains, setting out key evidence from ILC-UK research which has articulated the savings challenge in the UK, the financial planning and capability issues facing households and the value of financial advice in supporting better retirement outcomes. ILC-UK would welcome the opportunity to provide oral evidence to the Committee on these themes.

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SUMMARY OF THIS SUBMISSION’S RECOMMENDATIONS

The following recommendations’ are based on the ILC’s long run evidence-based research programme in the field of personal finance and saving.

Addressing the UK’s savings challenge

Supporting improved financial decision-making

In the short term: Default guidance at the point of accessing the pension pot

Guidance and financial advice

The role of financial education

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  1. OVERALL SAVINGS LEVELS AND BALANCE SHEETS

1.1 The UK’s savings challenge in perspective

  1. Our recent report, “The Global Savings Gap” measures the amount individuals in different countries will need to save in order to attain an adequate income in retirement[1]. Based on analysis of OECD data and bespoke surveys in five different territories, wbbe calculate what proportion of earnings those entering the workforce today will need to put away and contrast this with evidence of actual savings behaviours.
  2. To summarise the UK’s position, while it has a relatively affordable State Pension (in terms of projected spending as a % of GDP), it is also one of the least generous which places the onus on individuals to save and plan for retirement. We estimate that those entering the workforce today will have to save an average of just over 18% of their earnings every year in order to secure an adequate income in retirement. This is the highest value as a proportion of earnings across the OECD.
  3. On a positive note, the State Pension is supplemented by relatively widespread voluntary private pension coverage, and this is likely to improve due to the advent of Automatic Enrolment (AE) in occupational DC pensions. Nevertheless, the amount being saved is not nearly enough. Responses from survey participants suggested that only 12.4% of people in the UK are saving more than 15% of their earnings and only 9% have a savings target despite the need to save in excess of 18% to secure an adequate retirement income.
  4. Moreover, while AE will be successful in supporting increased pension coverage amongst the full time employed workforce, the UK has yet to address the problem of low earners and the increasing number of non-standard workers (i.e. those working zero hour contracts or who are self-employed) who are not yet covered under the AE reforms. The self-employed now account for over 4.5 million people and 15% of all those in employment.

Figure 1. Self-employment in the UK

  1. Even for those who are covered through the AE reforms, saving more as a proportion of earnings will be key to securing an adequate retirement income particularly given the persistence of low investment returns and slow wage growth. While the former is largely an international phenomenon affecting developed economies, the latter appears to be a peculiarly UK problem.
  2. Figure 2 shows the cumulative growth in real wages during the period 1990-2015 for the UK, USA and France. Between the mid-1990s and 2007, the UK experienced strong wage growth, in line with the United States, but since the financial crisis, real wages have fallen by around $4,000 in constant purchasing power parity terms, while wages in France and the USA have, broadly speaking, continued to rise.
  3. Figure 2. Cumulative rise in average real annual wages 1990-2015
  4. In terms of retirement income across the generations, we sought to explore whether future pensioners were likely to achieve the same level of replacement income as todays. In other words, might future pensioners experience a more pronounced fall in income once they retire than today’s pensioners? Based on anticipated savings behaviours and State Pension entitlements amongst average workers, we project that future retirees will have a lower level of replacement income than today’s retirees. To close the gap and ensure parity across the generations would require those entering the workforce to save in excess of 20% of their earnings each year.

1.2 What policy measures can support increased saving for retirement?

  1. Supporting widespread savings into occupational pension schemes is a critical pillar of any sustainable pension system. When comparing worldwide pension systems we found two public policy options to be particularly successful in this regard, one which compels people to save as per the Singaporean and French systems and another which “nudges” people to save as per the UK’s auto-enrolment. Systems that fail to have either such approach struggle to secure significant occupational pension coverage.
  2. Ensuring that people make sufficient contributions to those pension schemes, especially if we face a lower returns future will also be key. In this regard, systems that harness compulsion clearly see the highest rates of saving (i.e. Singapore), but such an approach may not be politically feasible in other high income countries (including the UK) and so harnessing behavioural nudges, such as where contributions automatically rise with earnings or over time, is likely to be the most immediately palatable approach to this challenge. We would argue for auto-escalation of pension savings so that the amount being saved can rise through the existing pension’s framework. 
  3. In addition to saving more is the need to support longer and fuller working lives. While raising State Pension Age might be the easiest and most effective incentive to support longer working lives, it can have unintended side effects, including increasing the number of people who leave the workforce before reaching this age. Widespread adoption of flexible working practises might help to prevent the retirement “cliff edge”. But for those who do drop out early, there may also be a mixture of public and private sector solutions including forms of unemployment insurance, which could be targeted specifically at this group and act as a bridging mechanism between leaving work early and retirement.
  4. There will remain those who are unable to save or work until pensionable age, and we must ensure that they do not face poverty before or after leaving the workforce.  UK pensioner spending currently provides a relatively low replacement rate for retirees compared to other developed countries. There is a case for supporting enhanced social security for low income groups. Without this measure, increased personal responsibility for retirement planning and raising SPA could result in greater income inequality before and after retirement.
  5. In the long run, raising the financial capability of individuals will be very important in determining good outcomes for consumers. With increasing emphasis on personal responsibility for retirement planning, people will need to be able to understand the benefits for deferring consumption for a later date, the value of investing in assets other than cash, the importance of asset diversification, and the virtues of buying some form of longevity insurance at the point of retirement. Financial education programmes may help to support increased financial literacy while enabling individuals to better understand their own behavioural biases. Unfortunately, there is no silver bullet in this regard, with evidence suggesting that such programmes only improve capability at the margin – this is not something that can be transformed overnight.
  6. In our savings gap report, we argue for three broad approaches for dealing with low levels of financial capability:
    1. The design, communication and accessibility of financial products and services can be better tailored to meet personal preferences while being presented in formats that make different products more easily comparable.
    2. But some financial products and services are by their nature complex which, compounded by behavioural biases, could result in poor financial choices. For this reason, there is clearly a role for financial guidance and advice coupled with technological innovation in order to support better financial decision making.
    3. There will always be some people who do nothing in the face of complexity, inertia is a human characteristic, and we need to identify ways to ensure that these people avoid the worst possible retirement outcomes. For this reason, it is important to design good default savings and decumulation products to ensure that even inert individuals save for the future and take an income from those savings at the point of retirement.
  1. DELVING DEEPER: FINANCIAL CAPABILITY AND PLANNING

2.1  Just how poor is the nation’s financial capability?

  1. Our report from 2015, launched in collaboration with Ros Altmann, “Making the system fit for purpose”, explored aspects of financial capability and literacy amongst individuals on the verge of leaving the workforce (sample of 5,000 people aged 55-70 but not yet retired or taken an income from their pension)[2]. We found:
    1. A very low level of knowledge about different relevant products such as annuities or income drawdown.
    2. Only a minority of individuals had made a retirement plan. Even for those that were less than a year away from retirement, just over 40% had not yet made a plan.
    3. Less than a quarter of the population knew what a marginal rate of tax was, and 1 in 10 said that withdrawing all of their pension in one go would be the best way of limiting their tax burden.
    4. Despite a limited understanding of different products and tax implications, there was a clear demand for security of income in retirement reflecting a risk averse population. 75% of people agreed with the statement: “I would prefer a secure guaranteed income in retirement over an income that might rise or fall depending on returns in financial markets” by comparison to 8% who disagreed and 3% who didn’t know.

2.2 Low financial capability coupled with the low investment returns environment creates the perfect storm for poor choices

  1. In the context of our findings regarding financial literacy and risk aversion, the emerging behaviours of consumers in the wake of “pension freedoms” is cause for concern. A recent report for the FCA showed an increasing number of people are entering income drawdown arrangements without taking financial advice or shopping around – 94% of non-advised drawdown sales were made to existing customers, whereas when advice is given the proportion of drawdown sales to existing customers dropped to just 35%[3]. And, as predicted, the numbers of people taking out an annuity – which provides security of income in retirement – has plummeted.
  2. Further complicating the landscape for effective decision making, is a world of low interest rates and investment returns – savings accounts and cash ISAs offer pitiful returns, while annuities continue to be perceived as poor value for money when compared with their pre-crisis performance. As we argued in our 2014 report “Freedom and choice in pensions: risks and opportunities”[4], this is an environment ripe for scammers, and indeed there have been increased reports of retirees having lost all of their pension savings to fraudsters which has prompted government to seek a ban on pension cold calling (over £40 million has been lost and this is likely to be a significant underestimate)[5].
  3. Pension freedoms has been popular, giving individuals the choice to use their hard-earned savings as they wish. This is especially important for individuals who already have good DB pensions or who wanted to use their relatively modest DC pension wealth to make improvements to their home, pay down debts, help their grandchildren or simply use their pension to enjoy life in the short term while they remain in good health. It should be emphasised that there are good rational reasons why people have embraced the freedoms. Indeed, the FCA’s evidence shows that the vast majority of fully withdrawn pots are small – less than £30,000, while over 9 in 10 consumers who have made full withdrawals had other sources of retirement income.
  4. But while cashing in the pension pot or investing in income drawdown might make sense for some, our previous research, “Here today gone tomorrow”, has shown that there remains a sizeable contingent (around 850,000 people) who have a high level of wealth concentrated in DC schemes and who will need to use it for an income in retirement – what was once called a pension – but there is an increasing reluctance to use pension wealth for this very end. Moreover, this sizeable contingent who rely on DC wealth to fund retirement will grow over the coming years due to the death of final salary schemes and rise of the auto-enrolled[6].

2.2    Supporting better financial planning through default guidance

  1. As we have argued over the past year, there is a burning need for policy pragmatism in order to embolden the principal of freedom and protect the consumer. Consider the following question – is freedom best served by individuals making knee-jerk decisions based on imperfect information, or is it best served by individuals making a long-term plan based on accurate information and advice?  Now clearly not everyone will be making knee-jerk decisions and some may have sound information about their options, but evidence suggests a sizable proportion of people fail to make retirement plans, know how much money they will need to live off during retirement and underestimate their life expectancy.
  2. If we are asking people to make big financial decisions that could have long term impacts, it is critical we equip them with the right level of support to make those decisions, to understand the implicit trade-offs and opportunity costs of certain actions. And at the very least, we must avoid what most people would consider the worst outcomes, such as taking all of the money out of the pension and into a low interest bank account, or worst of all, being defrauded by a con artist.
  3. The analogy of buying a house with a mortgage is a useful one. Taking out a mortgage is a complex process which requires us to consider our current and likely future financial position, the nature of our work as well as our evolving family circumstances in order to ensure we can repay. But human nature dictates that we don’t want to think about long run affordability, instead preferring to think about how we can best keep up with the Jones’. Such behaviours were a critical factor in the run up to the financial crisis, as individuals took out increasingly large loans relative to their incomes. Since the crisis, the UK regulator has delivered the Mortgage Market Review, which requires prospective borrowers to speak to a regulated mortgage advisor before a loan can be issued. Such activity is compulsory for most borrowers because of the risks attached to rash decision making, which were so brutally brought into focus in 2007 and 2008.
  4. While mortgage advice is largely compulsory, at the point of accessing our pension pot we are on our own. Financial Guidance – whereby an individual can have a conversation about their options with a knowledgeable and independent professional – has been available since day one of pension freedoms, but take up rates remain low – estimated to be between 7 and 17% of eligible customers on the verge of retirement. Meanwhile, financial advice continues to remain the preserve of the few rather than the many. Both are a great shame. Emerging evidence on customer perceptions of the guidance service suggests the user experience has been good and people have taken positive actions (such as calculating income needed in retirement)[7].
  5. We cannot hope to create a perfect retirement income market overnight, but we can put in place an additional layer of consumer protection in order to support more informed retirement decisions and reduce the likelihood of costly human errors. One approach which is gaining momentum amongst industry, charity groups and legislators is to make financial guidance a default option when people try to access their pension funds. This would not be compulsory – people could opt out and go it alone if they wished – but rather act to nudge them towards guidance, which after all, is a free and impartial service paid for by the industry and not out of taxpayers’ pockets.
  6. In the long run, earlier financial engagement and good defaults for the permanently disengaged will also be important pieces of the puzzle. But we are a little way away from either of these at the moment. For these reasons, adding default guidance to the current pension system provides an extra layer of protection, emboldening rather than weakening the principles on which pension freedoms was built.

2.3 The value of financial advice

  1. Allied to financial guidance, is the need for financial advice to support better consumer decision-making. But to what extent can advice change behaviours and improve retirement outcomes? Our recent report “The value of financial advice” demonstrates the value of regulated advice for the consumer. Using robust statistical methods to control for a range of factors likely to determine demand for advice – including income, wealth and behavioural traits - our results showed that those who take advice are likely to accumulate more financial and pension wealth, supported by increased saving and investing in equity assets, while those in retirement are likely to have more income, particularly at older ages. Our results therefore demonstrated, in a statistically robust way, the importance of financial advisers in delivering true value for their customers[8].
  2. More specifically those who took advice in 2001-2007 exhibit the following behaviours:
    1. 8.6 percentage points more likely to be saving in 2012/14.
    2. Rises to 9.7 percentage points amongst less wealthy subset.
    3. 10.4 percentage points more likely to have risky assets in 2012/14.
    4. Rises to 10.8 percentage points amongst less wealthy subset.
  3. And they also had accumulated more financial assets:
    1. £13,435 more in liquid financial assets by 2012/14
    2. Rising to £14,036 amongst less wealthy subset (39% more wealth than equivalent non advised)
    3. £27,664 more in pension wealth by 2012/14
    4. Rising to £30,882 amongst the most wealthy subset (16% more than equivalent non-advised)
    5. £25,859 more amongst less wealthy subset (21% more than equivalent non-advised).
    6. £773 more pension income in 2012/14.
    7. Rising to £880 amongst the most wealthy subset (16% more than the equivalent non-advised)
    8. £713 more amongst less wealthy subset (19% more than non-advised).
  4. Since advice has clear benefits for customers, it is a shame that more people do not use it – just 16.8% of adults saw an adviser in the years 2012-2014. The clear challenge facing the industry and government is how to get more people through the “front door” in the first place.
  5. In this context, our research reveals a number of issues that may help to support increased demand for advice. After controlling for a range of factors, the two most powerful driving forces of whether people sought advice was whether the individual trusts an IFA to provide advice and the individual’s level of financial capability. Raising trust and confidence in the industry and boosting overall levels of financial capability are important key drivers in improving understanding and generating greater demand for advice. But both of these elements may take time to evolve so we also identify a number of short to medium term opportunities to support increased take-up of advice: 
    1. Using advice to support the auto-enrolled: As pension pots grow, consumers are likely to take more of an interest in their savings, since the choices they make regarding the pot will have an increasingly discernible impact on their overall financial situation. At this point, the employer must have an explicit duty to ensure employees can access the best information and advice regarding their pension savings and general financial position.
    2. Default guidance for those seeking to access their pension savings: In the absence of a strong default decumulation product – which seems a relatively long way off and would not be optimal for some savers - guidance and advice are critical for consumers to make informed financial decisions. In this respect, we reiterate the points made above, that default guidance may be an appropriate strategy to ensure that people get the information they need in a complex marketplace. Such guidance should be accompanied by an effective “hand-off” to regulated financial advice.
    3. Helping to create informed consumers through the pension’s dashboard: The pensions dashboard may help to drive up the level of financial capability amongst pension savers and enable them to make more informed choices. Indeed, if we can get to a place where people review their pension savings more frequently (say on a six monthly basis) that would be a real step forward in financial planning. Ensuring that the dashboard is easily accessible and understandable, with all relevant information included and up to date, will be critical to its success.
    4. Advisers must sell their added value: Our research demonstrates the value add of financial advice – in terms of greater asset accumulation during working life and increased income in retirement. Since those who receive advice accumulate more assets and have more retirement income than those who don’t, this shows that advisers are good value for money. Post RDR, people now understand what taking advice will initially cost them, but many of those who fail to take advice are unlikely to know what the potential long term financial rewards are. It is up to the advice sector to convince them.
    5. Harnessing technology to promote advice services: The front door isn’t just the high street. Increasingly consumers are looking at internet based solutions including online non-advised routes in order to support their financial planning needs. The advice sector must explore whether these other routes are an opportunity or a threat, including whether there are possibilities for working in collaboration with these other businesses. In addition, the industry should consider ways in which “robo advice” could complement existing expert financial advice. Advisers working with robots may well be the future, but only if it adds to, rather than detracts from, the current value of advice.

2.4 How can we raise financial capability across the lifetime?

33. In 2016, in collaboration with the Money Advice Service, we undertook a review of the evidence on what types of financial capability interventions work best with regards to people aged over 50.

34. The general evidence (not just older people) on what works is largely inconclusive. This is partly because of the substantial heterogeneity in results. In other words, not all interventions work in the same way and for the same types of people, and some financial behaviours are easier to change than others. In particular, financial education interventions may be more successful in helping people manage their day-to-day expenses, rather than changing people’s behaviour in relation to retirement saving. Indeed, because many consumers may not save because of behavioural biases, such as the tendency to procrastinate or the lack of self-control, financial capability interventions based on choice architecture have been proven to yield better results (see for example the Save More Tomorrow™ programme by Richard Thaler and Shlomo Benartzi and Automatic Enrolment in the UK). Furthermore, interventions that work for young people may not work for the old, given age-specific financial needs.

35. The evidence on what financial capability interventions work for older people is even sparser than for other age groups. Most interventions reviewed in our research tended to be small-scale and were not designed within a robust impact evaluation framework, and thus not rigorously assessed[9]. Without rigorous evaluations, we cannot be sure of the actual success of interventions and therefore their cost-effectiveness.

36. The overarching theme of our review was that more evidence is needed on what works and this can only be achieved by allocating more resources for proper evaluation – something which is not often done. Currently evaluations of programmes targeting older people are few and far between, and where they exist they are relatively limited. As a result, we know less about what works regarding the older age group than amongst schoolchildren or working-age adults.

37. Nevertheless, based on our review of evidence on financial capability interventions targeting older people, and in light of the general findings highlighted by the broader literature on financial capability, we argue that interventions should adhere to the general principles listed below.

    1. Providing ‘just in time’ financial capability programmes: Programmes that are immediately applicable have a stronger impact, since the effects tend to dissipate over time
    2. Financial capability interventions should exploit peer effects: This can be achieved by encouraging participants to discuss what they learned with their colleagues, friends and relatives to maximise potential impact.
    3. Simplification does not equal education: While a simplification of language and the elimination of jargon are more than welcome, they are just one route to increase financial capability. For more the most complex financial decisions, assistance assessing options, for example from an independent financial adviser, will remain necessary.
    4. Co-ordination is key: Delivery needs to focus on involving older people and several agencies, including but not limited to charities, local authorities and product providers.
    5. Robust evaluation should be part of the design of the intervention: When piloting a financial capability intervention, providers should think about how they are going to assess it from the outset. To really know what works, providers of interventions should include a pre and post-test assessment.

 

January 2018

[1] Franklin and Hochlaf (2017), The Global Savings Gap. Report for the ILC-UK: http://www.ilcuk.org.uk/images/uploads/publication-pdfs/ILC-UK_-_The_Global_Savings_Gap.pdf

[2] Franklin and Creighton (2015) Making the system fit for purpose: How consumer appetite for secure retirement income could be supported by the pension reforms. Report for the ILC-UK: http://www.ilcuk.org.uk/images/uploads/publication-pdfs/Pensions_Reform_Report_Web_(final).pdf

[3] FCA (2017) FCA publishes interim findings of study into retirement income market: https://www.fca.org.uk/news/press-releases/fca-publishes-interim-findings-study-retirement-income-market

[4] Franklin (2014) Freedom and choice in pensions: risks and opportunities: Report for the ILC-UK http://www.ilcuk.org.uk/index.php/publications/publication_details/freedom_and_choice_in_pensions_risks_and_opportunities

[5] Gov.uk (2017) Tough new measures to protect savers from pension scams:  https://www.gov.uk/government/news/tough-new-measures-to-protect-savers-from-pension-scams

[6] Brancati and Franklin (2015) Here today, gone tomorrow. How today’s retirement choices could affect financial resilience over the long term. Report for the ILC-UK: http://www.ilcuk.org.uk/index.php/publications/publication_details/here_today_gone_tomorrow

[7] DWP (2016) Pension Wise Service Evaluation: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/560163/pension-wise-service-evaluation-wave-1-interim-findings.pdf

[8] The report used an advanced statistical technique called propensity score matching which identifies two similar groups of individuals within the data and then assesses the impact of advice on one group (the treatment group) versus the other (the control group) thereby mimicking a scientific experiment. Using this technique, our analysis explores the impact of receiving advice during the period 2001-2007 on consumer outcomes in 2012- 14. As well as exploring the overall impact of advice, our analysis also focuses on two specific consumer groups – the “Affluent” group (wealthier subset of the population) and the “Just Getting By” group (less wealthy subset). Data are from various waves of the Wealth and Assets Survey.

[9] For more details please read: Brancati and Franklin (2016) What works? A review of the evidence on financial capability interventions and older people in retirement. Report for ILC-UK and the Money Advice Service: http://www.ilcuk.org.uk/images/uploads/publication-pdfs/What_works_-_A_review_of_the_evidence_on_financial_capability_interventions_and_older_people_in_retirement.pdf