The Financial Inclusion Centre Financial services that work

The Financial Inclusion Centre Financial services that work for society, not the few PENSION REFORM IN THE UK: ONE STEP FORWARD, TWO STEPS BACK LCP Defined Contribution Conference, April 2016 ` Mick Mc. Ateer, The Financial Inclusion Centre, www. inclusioncentre. org. uk

CONTENTS • Objectives of pensions policy • Background to recent reforms • Impact of reforms – one step forward, two steps back • Potential solutions

OBJECTIVES OF PENSION POLICY • Pensions policy should have four objectives – Maximum number of people have sufficient assets to generate decent retirement income – Retirement incomes are sustainable (ie. people don’t run out of money/ fall back into poverty) – People are not exposed to undue risks in retirement (market risks, misselling, scams) – Pensions system/ market is as efficient as possible (more it costs, more people have to save) – How well are we doing?

BACKGROUND TO REFORM • Savings ratio falling again, 1/2 households < £ 1, 500 • Savings ratios 10 yr avg -‘Anglo-Saxon’ countries: 0. 2%; Continental Social Model (CSM): 8% (Euro area-8. 8%); ‘Family-centric’: 3. 1% • Some signs of deleveraging but unsecured credit appears to be growing again – OBR forecast total debt-income ratios will return to pre-crisis peak • Record low interest rates concealing problems (may have to confront fact that much debt will not be ‘repaid’) • Worrying levels of pension underprovision in key groups eg self-employed • Labour market changes • UK private pensions coverage heavily skewed towards 1 st/ 2 nd income deciles (FSUG) • Millions of UK households long way from financially resilience and financial security • £bns spend every year on tax relief, disproportionately benefits better-off • Subsidises inefficient pensions/ investment industry

BACKGROUND TO REFORM • Sustained underperformance of UK pension schemes compared to OECD rivals (see FIC research) • Underperformance contributes to scheme deficits/ underprovision and funding costs with impact on real wages • Supply chain more complex, inefficient with intermediaries extracting value (churning, complex investment strategies, alternative investment products etc) • Concerns about conflicts of interest in institutional markets/ master trusts etc • Market inefficiencies don’t just affect pension saver, harms real economy firm through value extraction and misallocation of resources • Pensions/ investment sector one of lowest levels of consumer trust • Affects pension provision and has macro-effects – diverts resource away from productive real economy assets to property

IMPACT OF REFORMS • But instead of tackling head on problems with accumulation phase, reforms will exacerbate existing problems • New proposals on annuities represent huge risks-should have had measured reforms to target annuity market failure • Does not deal with poor value/ low annuity rate problem • 10 yr gilts 2. 7%, cash 0. 5%, to beat current annuity rates will have to expose consumers to significant market or drawdown risk • Downside risks to income: – equity risk (-36%); – bond market risk (-20%); – longevity risk (-17%) (FSUG) • Existing annuities could be adversely affected (loss of longevity cross subsidy/ risk sharing)

IMPACT OF REFORMS • Major product design, complexity, governance risks, asset management/ insurers do not have good track record in financial innovation • Major marketing and promotion risks • Additional one-off and ongoing advice and distribution costs into supply chain – extracting more value from consumers • Distributor/ adviser risks – will they understand complexity of products/ longevity risks? • ‘Guidance’ limited - the more consumers are informed about options, the more they will demand advice and recommendations • Consumers seriously underestimate life expectancy, but significant longevity risk: life expectancy at 65=19 yrs but half will live longer • ‘Lifespan is impossible to predict with any certainty for individuals’ (Institute and Faculty of Actuaries) • Majority (57%) with DC given no thought to how long might have to fund retirement (Strategic Society Centre)

IMPACT OF REFORMS • Cognitive ability declines with age, pensions are already • • considered more complex, harder to understand by consumers – this will be exacerbated Misselling, poor outcomes will deter, not encourage saving for retirement Experiences in other countries: – New Zealand: annuities ‘death spiral’ – Australia: ½ spent lump sum on property/ vehicle, lack of genuine lifetime annuity option requires 15% more assets to fund adequate retirement Increases exposure to outright scams Overall, annuities reform goes against all the lessons from AE/ NEST

IMPACT OF REFORMS • But ‘LISA’ could further exacerbate problems • Yet more complexity into the accumulation phase • More advice and guidance needed – which means more costs being extracted from savings • UK settled for AE for a reason - we weren’t saving enough, and ‘voluntarism’ just wasn’t working • At aggregate level, still aren’t saving enough but undermining savings habit doesn’t help • We do have a housing crisis in some parts of the UK, many households face overindebtedness but idea that the same pot of money could be used for several needs – pension, housing, repaying debts – doesn’t stack up • We can’t solve one crisis by creating another

SUMMARY • Reforms undermine ability/ propensity to save for retirement at both ends – decumulation and now accumulation phases • Undermine long term sustainability of retirement incomes • Exposes consumers to much greater risks – market, misselling and outright scams • Goes against the grain of behavioural analysis • Increases greater inefficiencies into pensions system/ market, make it more costly to save • The better-off/ lucky might end up with better options, but will harm lower-medium income consumers • Threatens to reverse real progress made via NEST/ AE • One step forward, two steps back

POTENTIAL SOLUTIONS • Reform pensions tax relief, make flat rate, target savings on self-employed/ lower income households • New post-retirement/decumulation default option fund to prevent misselling and market failure - either NEST style or formalise buying of added years in state pension • But other major supply side reforms needed • Focus on things we can control, advisers/ intermediaries must become obsessive about reducing costs and improving efficiency, use simple strategies, reduce unnecessary active management costs, turnover and transaction costs

POTENTIAL SOLUTIONS • Charge caps important – competition fails to deliver value • Transparency necessary not sufficient (best solution make fund manager bear all research and transaction costs with explicit % based fee charged to client) • Need new, dedicated focus on scheme governance, conflicts of interest and conduct of business (COBs) in supply chain (wholesale and institutional sectors), inc pension advisers/ consultants • Make FCA responsible for all aspects of ‘conduct’ regulation – make TPR equivalent of PRA for pensions • In years to come, we’ll have a new Pensions Commission to put it all back together again

QUESTIONS?