Auto-protection: More than one way to skin a cat
This month, the UK defined contribution (DC) sector opens its doors to new freedoms. On 6 April, savers over the age of 55 will be able to access their pensions in any way they please due to the removal of compulsory annuitisation.
Compulsory annuitisation stemmed from the paternalistic idea that pension assets must be used to secure a retirement income. However, after years of poor annuity rates and arguments over competition and value for money, the Liberal Democrat and Conservative coalition made the politically popular decision of trusting savers to make their own retirement decisions.
However, while the attitude may be liberal, the build up of DC pensions is not. Auto-enrolment nudges workers into savings, pension funds adhere to strict governance, and charges in default investment funds are now capped at 75 basis points after government intervention.
This somewhat contradictory sentiment raises the question of whether a default retirement solution is required. With a raft of options expected to be available for consumers, the potential for confusion, and mis-selling, is rife. Consensus over the need for a default retirement system is growing, reinvigorated by a recent paper from the Centre for Policy Studies (CPS). This was supported by a selection of MPs who suggested an independent pensions commission should explore the idea.
The CPS paper begins with the idea of defaulting savers into annuities at age 55 and incorporates a state-led, not-for-profit annuities auction house to encourage competition in the market. However, after the industry rejected default annuities, and Liberal Democrat pensions minister Steve Webb accused CPS fellow Michael Johnson of missing the point, Johnson came back with the alternative solution of a mixture of income drawdown and a later-life annuity product.
Johnson says the default system, which would kick in if savers did not engage with providers, is a balance between paternalistic and liberal mindsets, with the pensions freedoms available for those who want it. Despite Webb’s argument that the government should not interfere with the decisions of savers as long as guidance is given, the idea of a default is gaining momentum.
Graham Vidler, director of external affairs at the National Association of Pension Funds (NAPF), said the organisation shares Johnson’s views of the need for a default system but not his original proposal for annuities, nor their becoming automatic at a certain age.
The NAPF’s view is different. Vidler says the default option should be designed or selected by the trustees of a DC scheme, or an independent governance committee in the case of insurance-based offerings. He also says trustees and governance committees should create solutions best suited to their memberships under guidance from the government.
“We do not think people should be confined to annuities,” he says. “Depending on pot sizes, and members’ age, earnings and attitude towards risk, you could envisage defaults of very simple cash-out plans, another for annuities as described by the CPS, or something combining flexibility upfront but with a pre-commitment to longevity insurance later on, in a similar vein to ATP’s deferred annuities system.”
The NAPF’s idea carries a lighter touch than the CPS’s, or even the process currently used in auto-enrolment. It should not be seen as a decision made in absence of member action but rather a solution to help a less informed member.
After May’s general election, the next government will have to make a decision on the base level in the default discussion.
The Liberal Democrat view is clear, while the Conservative one is less so, with the CPS paper being backed by one of its members in the Upper House. The Labour view remains unclear.