UK must offer annuity 'auto-protection' to counter DC freedoms
The UK’s Centre for Policy Studies (CPS) has called on government to create a default decumulation system for defined contribution (DC) pots to ensure savers overwhelmed by new pensions freedoms do not make poor decisions.
The traditionally right-leaning think tank said government intervention in the retirement market was a way to appease both right a left ideologies of liberalism with savings and paternalistic oversight.
The paper, written by CPS fellow Michael Johnson, was supported by both Conservative peer Lord Holmes and the Trades Union Congress, the UK union umbrella group.
Savers could opt out of the default system, which would lead towards annuities, in order to fully access the freedoms announced in last year’s Budget that come into force in April.
Johnson also said the government should fix the annuities market by creating a not-for-profit auction house to automate the process of purchasing an annuity, and ensure savers get the best deal.
In the paper, ‘Auto-protection at 55’, Johnson wrote market intervention in the annuities market should be seen as last resort.
However, he was scathing of the work done by the Association of British Insurers, the industry’s UK trade body, arguing it excelled at ”doing just enough to keep the show on the road, but not enough to address the main issues at hand”.
Johnson put forward several proposals, including the default annuity system, called ‘auto-protection’, and forcing the open annuities auctioning.
The paper said most savers approaching retirement preferred a safe income stream in retirement, but the challenge remained to determine the structure of the default system.
“Auto-protection would ensure that savers reaching the age of 55 are not left to wallow in indecision when pondering the complexities of decumulation,” Johnson wrote.
“To the extent that people went with the default of a pension, preferably deferred, the risk of running out of money before death would be reduced, as would the risks of exposure to pot conversion fraud and moral hazard.”
Johnson also said ‘auto-protection’ could be incorporated with collective DC (CDC) schemes, with legislation currently before parliament, to encourage the hedging of an individual’s exposure to longevity risk.
“Everyone would be free to opt out of auto-protection to pursue alternatives, consistent with the liberalisations announced in the 2014 Budget,” he added.
Johnson also said the UK government would have considerable interest in creating a prudent decumulation framework given the moral hazard of relying on the state after wiping out savings.
On the annuities market, Johnson wrote automation of shopping around would change both industry and consumer behaviour.
A market place for all annuity providers could see them bid daily on appropriate DC pots, which Johnson said could create pricing tension. Pots could be bundled in order to improve pricing efficiency, which would in turn pool risk.
The paper said it was in the national interest to see a properly functioning annuities market, as sub-par annuities also lead to a reliance on the state.
It suggested the Treasury could participate in annuity provision which would provide alternative funding to Gilt auctions, an approach that would not be without precedent.
Johnson said there was legitimate concerns people may fail to purchase suitable retirement products.
“People approaching retirement need to be encouraged to purchase retirement income products that limit downside risks, notably longevity, investment and inflation risks that almost all of us are incapable of managing by ourselves.
“However, there is a risk that the guidance service will disappoint,” he said.
Other proposals included increasing the age at which savers could access savings to 60, by 2024, much faster than currently planned.
The paper also called for the 25% tax-free lump sum to be delayed until 65, or scrapped entirely, but accepted political pressure would be against this.