Are investment pathways doing any good?

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My laptop stopped connecting to local networks last week. It turned out that I had loaded so much anti-virus software that I’d confused it into blocking perfectly friendly services. Sometimes you can have too much protection.

I was reminded of my dysfunctional laptop when reading a recent article by Fiona Tait in the Actuarial Post.  Fiona clearly explains why she thinks the point at which people make choices about how they spend their retirement savings is the key trigger for taking financial advice.  Pension savers who have reached the point of retirement, are likely to have very diverse requirements with different priorities for current and future income, as well as provision for family members.  Financial advice allows clients to focus on what they most want, rather than what everyone else wants.

There is an alternative view to this, one shared by many pension professionals immersed in defined benefit plans, that the proper outcome from a workplace pension is a stream of payments paid in line with a measure of inflation, till death. For such people, the investment pathways provide too much rather than too little choice, they favour a “one size fits all” approach to pension provision.

These same drivers appear to be in play in the UK, with the Treasury issuing a number of calls to see DC pensions further invested in UK plc.

The investment pathways seem to fall foul of both camps and reports on take-up suggest that they are not yet achieving the desired impact of reducing the number of pension pots being cashed out or remaining in heavily “de-risked” strategies following “lifestyling”.

Many readers will remember the early days of modern DC choice architecture which date back to the launch of personal pensions in 1988, fully two years after the 1986 Finance Act legislated for them. In the early days, the personal pension was valued for the number of fund links it could offer. Initially these were provided by a captive fund manager but in time “open architecture” was introduced that made available a range of funds, mostly reinsured though some were offered without life wrappers. This proliferation of choice was not greeted with enthusiasm by most savers and providers moved to rationalising fund choice by shortlisting three or four “core funds”, pacifying those who called for greater guidance while allowing “self-select” from a much longer list.

Core funds never caught on. They were soon made redundant by default funds, introduced as part of the “stakeholder pension” legislation in 2001. This legislation made it a default option a feature of every stakeholder personal pension. The default option quickly became synonymous with a lifestyle strategy which provided a degree of fiduciary management of a policyholder’s pot which became popular with trustees and their institutional advisers. It was seen as a prudent decision by regulators and remains the standard way of accumulating a pension pot to this day.

The evolution of post retirement products (often referred to as “decumulators”) has so far followed a similar trajectory. Just as personal pensions emerged from the restrictive architecture of “retirement annuity plans” (the precursors of personal pensions), so the pension freedoms emerged from the restriction on most pots which required them to purchase an annuity (the reason DC pensions were known as “money purchase”).

Feast followed famine as drawdown products proliferated, each SIPP having a new variant. But just as savers had been baffled by “open architecture” in accumulation, spenders found unlimited choice baffling and the FCA’s retirement income survey shows that most pension pots that are crystallised, are being turned to cash. The investment pathways (like core funds) are a way for people looking to spend their pensions to choose between a guaranteed income, an immediate cash-out, a drawdown of the pot over time or a roll-up of the pot to provide a bequest.

While the wealth in DC accumulation bi-furcated between “self-selection” and the non-selected “default”- leaving core funds unloved, it remains to be seen if decumulation will follow the same journey.

The arrival of a default in accumulation coincided with a product that became universally accepted – “lifestyle”. But as yet, no such product has been developed beyond the current choice architecture of investment pathways.

There is considerable interest amongst those involved with pensions policy in the development of a Retirement Income Covenant in Australia. From July, Australian DC pensions (know as “Supers”) will have to provide members with a default decumulation pathway to ensure that tax-advantaged savings are put to use for a “wage in retirement”. This Government initiative is driving many Supers to develop products that have the look and feel of annuities, with enhanced returns that derive from more aggressive investment strategies and the loss of guarantees on income.

It remains to be seen whether Australians will be more comfortable swapping their pots for these non-guaranteed pensions. Their popularity (or lack of) will be as assiduously monitored by global policy-makers as auto-enrolment opt-out rates were – a decade ago.

The Australian system is primarily based on compulsion and many commentators see a hardening in the Retirement Income Covenant that will require savers to convert to an annuity like product (ensuring savings are recycled into the Australian economy and invested money becomes capital for economic investment).

These same drivers appear to be in play in the UK, with the Treasury issuing a number of calls to see DC pensions further invested in UK plc. This looks likely to lead to an easing in solvency regulations for annuities and a relaxation in permitted links regulations allowing pooled funds to provide self- more aggressively invested in retirement funds – offering self-annuitisation and non-guaranteed income streams, more attractive (but riskier) than guaranteed alternatives.

If we are to move beyond investment pathways – which appear to this author to be doing little good to the advised and non-advised saver, we should look to Australia and the development of what the Work and Pensions Committee refer to as “contract-based CDC”).

The arrival of an acceptable alternative to the non-advised investment pathways looks some way off, but simultaneous reviews by the FCA of the consumer journey and the DWP of “decumulation”, may lead to an acceleration of progress, both in the promotion of advice and of default solutions for the non-advised.

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Henry straddles the world of traditional finance and FinTech and is an active entrepreneur who helps people make good pension decisions. He founded AgeWage and the Pension PlayPen to map the pensions genome and ensure everyone gets data driven information on value for money

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