Transcript mick-mcateer-lcp-dc-conference-april-16

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
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Mick McAteer, 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 1st/ 2nd 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
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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?