Institute and Faculty of Actuaries Position Paper: Budget 2014 1. The ...

Institute and Faculty of Actuaries Position Paper: Budget 2014 1. The Budget announced the Government’s plans to increase freedom and choice by enabling people to withdraw income, or capital, from pension pots at the point of retirement, or thereafter, as they see fit. The changes to tax rules have the potential to revolutionise pensions; reducing barriers to choice and giving individuals the opportunity to consider a broad range of options, as they prepare for retirement. The IFoA prepared this position paper to outline its perspective on the key announcements. Going forward, the IFoA will look to examine the policy announcements in more detail and, where appropriate, undertake research to inform future policy development. 2. Our key messages are:  As a profession, actuaries are experts in analysing mortality experience and understanding the difficulty in predicting life expectancy. However, there is a significant difference between assessing life expectancy for relatively stable populations and determining an individual’s actual future lifetime.  The Government is seeking to ensure that individuals have access to the information they need to understand the financial consequences of under-saving for retirement. Actuaries are keen to work with the Government to help bridge the gap between the reality of longevity and individual expectations.  The cost implications of providing ‘guidance’ face-to-face could be considerable. Whilst the cost burden may initially fall on scheme providers, consumers may ultimately pay the price.  The IFoA believes it would be sensible to consider the benefits and risks of delivering guidance through other channels, as opposed to just face-to-face. Consideration could also be given to the fact that, in future, this will not be a ‘point in time’ judgement for consumers, with decisions effectively being required on an ongoing basis, once in retirement.  Although there may be a decrease in the number of people who choose to annuitise at retirement, the impact of the Budget announcements may be to delay, rather than remove, the annuity purchase and, as a result, the average age at which annuities are bought may increase.  It is difficult to predict how individual behaviour might change in response to the Budget announcements. The IFoA notes that there may be unintended consequences for those who choose to withdraw large amounts of pension savings flowing from discrepancies in the respective treatment of income and capital in local authority financial assessments for individuals with long-term care requirements. Further analysis of these implications would be welcome. Encouraging pre-retirement savings 3. The Government has stated that ‘Additional flexibility may also encourage more people to save in pensions, either through an individual pension, or through a scheme set up by their 1 employer’. The IFoA believes that too many DC scheme members are currently accruing insufficient savings to meet their expectations in retirement and recognises the Government’s

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HM Treasury (2014), Freedom and choice in pensions, p. 40

efforts to build on the anticipated change in behaviour from auto-enrolment with a more 2 flexible retirement model. We note the results of NAPF’s Spring Workplace Pensions Survey 2014; that 28 per cent of workers are more likely to save in a pension following the Budget, and we believe that further research is required to explore the extent to which the announced 3 tax changes will incentivise greater savings towards retirement by working age adults. 4. As a profession, actuaries are experts in analysing mortality experience and understanding the difficulty in predicting life expectancy. However, there is a distinct difference between assessing life expectancy for relatively stable populations and determining an individual’s actual future lifetime. 5. There is also a body of evidence to suggest that people tend to underestimate the amount they need to save to meet their income expectations in retirement. A recent industry poll suggested that people underestimate longevity by up to ten years and this exacerbates 4 under-saving. Actuaries are conscious of the gap between the reality of mortality and consumer expectations, and the inherent uncertainty around estimating future mortality experience. The Government is seeking to ensure that individuals have access to the information they need to understand the financial consequences of under-saving for retirement. Actuaries are keen to work with the Government to help bridge the gap between the reality of longevity and individual expectations. The ‘Guidance Guarantee’ 6. Details of the proposed ‘Guidance Guarantee’ have yet to be announced, but the Government has stated it expects providers to be responsible for its delivery, and that it will provide £20million to the industry to develop it. 7. We would welcome further details on the Government’s expectations around the ‘Guidance Guarantee’. In particular, clarification on the definition of ‘provider’ would be useful - it is currently unclear where responsibility for the delivery of guidance will lie within some schemes, such as Small Self Administered Schemes (SSASs). 8. We would urge the Government to clarify its definition of ‘guidance’. From ‘information’ to ‘advice’, the spectrum is broad; it will be important that both those charged with providing guidance, and those who will receive it, have clear expectations around its scope and content. The IFoA would expect the definition adopted to have significant implications, both for the model of guidance developed, and for service delivery costs. Online financial guidance products have been available for some time and the Money Advice Service offers free, impartial, guidance through a range of communication channels, as does The Pensions Advisory Service. The IFoA would welcome further information on how the new guidance offer will be distinct from the free services already available. 9. We believe a challenge will exist in ensuring that the guidance provided captures the range of options that may be appropriate for consumers – a range, which is likely to increase as the

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DWP (2012) Reinvigorating workplace pensions, November 2012, Cm 8478, p. 2 NAPF (2014) http://www.napf.co.uk/PressCentre/Press_releases/0400-28-per-cent-of-workers-more-likelyto-save-into-a-pension-following-Budget.aspx 4 http://newsroom.mgmadvantage.co.uk/long-life-not-according-to-the-wife/ MGM Advantage research among 2028 UK adults, 314 of which were aged 55-64, conducted by Research Plus Ltd, fieldwork 17-22 October 2013. Respondents were asked “Being as realistic as you can, approximately how old do you think you’ll live until?” 3

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market innovates – without overreaching into the jurisdiction of regulated financial advice. It will be important that consumers do not view the ‘Guidance Guarantee’ as a free alternative to regulated financial advice. We would welcome clarification on the role of the Financial Conduct Authority and the Pensions Regulator in ensuring that the guidance on offer is appropriate and meets its stated purpose. 10. We would welcome further details on the Government’s rationale that guidance should be delivered face-to-face. It may be that different models of delivery are appropriate for different individuals. Depending on levels of financial literacy, those who are more vulnerable may be more likely to benefit from face-to-face support, whilst others would prefer to access guidance online. 11. The cost implications of providing ‘guidance’ face-to-face will be considerable. From April 2015, the Government expects around 320,000 DC scheme members to retire annually with the option of ‘complete choice’. Whilst the cost burden may initially fall on providers and scheme sponsors, consumers may ultimately pay the price. Furthermore, the requirement for guidance is likely to extend beyond one purchasing decision, at the point of retirement. Those who choose not to buy an annuity at retirement will have a continued need to manage their pension pot, in light of changes to investment conditions, annuity rates and their personal circumstances. Unless the ‘Guidance Guarantee’ is extended beyond one decision at the point of retirement, it may increase the risk of subsequent choices leading to unsatisfactory outcomes throughout a person’s later life. Defined Benefit (DB) / Defined Contribution (DC) Transfer 12. The Government recognises in its consultation Freedom and choice in pensions that the ‘attractiveness of transferring from defined benefit to defined contribution may increase as a result of the changes to the tax framework for how defined contribution pensions savings can 5 be accessed.’ In response, the Government intends to introduce legislation that will remove the option to transfer from public service DB schemes to DC schemes, except in very limited 6 circumstances. It is also consulting on whether transfer should continue to be an option for private sector DB schemes. From a public finance perspective, if significant numbers of DB scheme members transfer, the IFoA recognises the Government’s concerns; investments in government bonds may decrease and the Government could potentially face a funding issue. We believe further research is required to explore the potential impact on the bond market more fully. 13. If the Government opts to ban Defined Benefit (DB) – Defined Contribution (DC) transfers, removing this option will not be straightforward; the definition of DC and DB should be clearly defined and a decision made on where the line will be drawn, and how this impacts hybrid schemes. 14. The IFoA also notes that there will be some DB scheme members for whom a ban on transfers could potentially leave them worse off, such as individuals who have no financial dependants and who could have converted their pension into a higher single life pension. 15. If members retain the right to transfer to DC schemes, it will take some time to understand the full implications. However, there is likely to be an increase in transfers out, particularly after the age of 55 (increasing to age 57 by 2028). It is also possible that longevity risk will

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HM Treasury (2014), Freedom and choice in pensions, Cm 8835, p.34 Ibid, p. 33

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increase in DB schemes, as those whose mortality is expected to be higher than average in retirement, may be incentivised to transfer and withdraw their pension early. Impact on the retirement income market 16. The IFoA believes that, for some retirees, annuities could remain a valuable product; there will be a continuing need for individuals to protect against the financial risk of outliving their resources. The proposed changes have the potential to encourage market innovation (both within the annuities and broader retirement income product markets), thereby increasing the range of products available. The impact on the scale of annuity sales is difficult to estimate; however, it is likely that there will be a change in the profile of the future annuitant population. On this basis, companies may need to review their longevity assumptions, as those taking out annuities in future, are more likely to be anticipating a higher than average life expectancy than the current average annuitant. 17. Companies currently offer “lifestyling” default funds for those approaching retirement. The current structure of these funds may need to be reviewed to reflect the alternatives to annuitisation. Consumer profiling may need to become more sophisticated to ensure that retirement income products are appropriately structured to attract prospective purchasers. 18. Although there may be a decrease in the number of people who choose to annuitise at retirement, the impact of the Budget announcements may be to delay, rather than remove, the annuity purchase and, as a result, the average age at which annuities are bought may increase. The announcements may increase the demand for products that offer combinations of guarantees and insurance (such as temporary annuities or variable annuities). However, the current economic realities (including low interest rates and the cost of providing capital to back such guarantees under Solvency II) may continue to make it difficult to offer these at a price consumers find attractive. 19. The IFoA notes the Government’s position that the retirement income market needs to meet growing social challenges – such as funding care in later life. Our members are exploring the options for aligning pensions and care funding through product development and we welcome the opportunity to discuss our work in more detail. It is difficult to predict how individual behaviour might change in response to the Budget announcements. The IFoA notes that there may be unintended consequences for those who choose to withdraw large amounts of pension savings and, subsequently, fail to qualify for assistance with social care costs; whilst others with the same financial circumstances, who purchase an annuity, are eligible for financial support (as a result of discrepancies in the respective treatment of income and capital in local authority financial assessments). Further analysis of these implications would be valuable to explore the consequences of these financial decisions at the point of retirement. 20. Should you wish to discuss any of the points raised further, please contact Amy Tarr, Head of Policy ([email protected]) in the first instance.

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